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NEWS - PLANNING
Investors wake up to promoters
6/6/2002
Wary of the Tax Office, well-informed taxpayers are steering clear of exotic tax-driven products, not investing without product rulings and seeking commercial investments endorsed by independent researchers.
Investors are also opting for tax deductions available through more traditional investments - in particular, gearing into the stockmarket - the shift fuelling an explosion in the growth of all kinds of geared equity products.
And tax advisers report a return to specific advice tailored around business structures, rather than a quick fix engineered to solve a June 30 tax problem.
"Mass-marketed tax schemes, to use the Tax Office jargon, are completely dead," says Les Szekely, a senior tax partner with Howarth Sydney.
"In terms of public products, the only things with half a chance have product rulings and, even then, the supply of investments with product rulings is well down on past years."
"The whole mood of the market has changed and what we advise people is not to get into anything that's been marketed on its tax advantages, unless it's got a product ruling."
Kris Chikarovski, a director of Remuneration Planning Corporation, says the firm, which pioneered certain employee benefit arrangements, is not looking at tax-driven structuring.
"Tax considerations are always a secondary issue for us. Previously, there was an opportunity for devising more tax effective plans, but now the pendulum has swung back the other way," he says.
The product ruling mantra is one change in the market and it appears to coincide with declining demand for tax products. The number of product rulings issued to date is well down on last year and independent research house Van Eyk has endorsed only one agricultural scheme to date.
Some financial planning groups are not putting any traditional tax-effective products on their recommended lists.
"The problem we've had in the past is the promoters make more money than the investors," says Brian Fitzpatrick of Count Wealth Accountants, which recommends one tax effective investment and is looking at adding just one more.
Fitzpatrick cautions against investing more than 5 per cent of a portfolio in tax-effective products.
Advisers are also quick to warn that a product ruling is merely the ATO saying tax deductions will be allowed, it says nothing about the investment's merit or the potential of the product.
Furthermore, the kind of tax benefit available this year has been described as "not very exciting", "whoopie-doo" and "mundane", by three different advisers, who recall the raft of highly leveraged products around in the late 90s that offered multiple tax deductions for each $1 invested.
"It's been dry time for the big deduction deals since 1999," says one promoter who was a major player in that market.
"I don't know anyone who's going around saying 'I can get you a big deduction'. I don't know what people are doing this year; paying their tax, maybe," he says.
Taxpayers are right to be wary. For thousands of investors caught in mass-marketed tax schemes, the experience has left them in no doubt exactly who is in the firing line when tax effective investments go wrong, and it's not the promoter, the big name accounting firm that gave the tax opinion or the Tax Office.
"Once this problem is solved, it's highly unlikely I'll invest in anything that involves the bush because I've been so badly stung by this," says Henry Sheil, a Freemantle engineer who owes the tax office some $150,000 after investing in eight agricultural products, including tea trees, lemon mrytle, apples and macadamias, over four years leading up to 1998.
Sheil is one of 26,000 taxpayers still to decide what to do about the ATO settlement offer, which aims to bring the long-running schemes saga to an end. The deadline was extended to June 21 late last month.
While Sheil, like many investors, directs his anger at the ATO - "if they had put out some clear public statement earlier, thousands of people would have heeded the warning" - he reserves some fury for the tax profession and in particular the accountants, lawyers and barristers who lent their brand names to tax scheme prospectuses.
"They got the fee, they gave the advice and they put their credibility on the line," Sheil says.
"My tax agent is a one-man-band and he invested in a lot of the same things I invested in. It does go right to credibility, the reason he [the promoter] got the opinion from Deloitte or whoever, was because it had credibility."
The ATO's most recent court victory in the Vincent case, as it stands, (the taxpayer is appealing against the decision) is a salutary lesson for investors.
Julie Vincent, a Perth taxpayer, claimed $37,350 in tax deductions over two years in a stud cattle-breeding project at Tamworth in northern NSW.
While Federal Court judge Robert French decided the Active Cattle Project was a tax avoidance scheme, he said Vincent entered into the project in good faith after taking advice from her accountant.
"The gaining of a tax benefit was not her principal purpose," the judge wrote. "It was her hope that the scheme would eventually yield a modest income stream for her and her family. In the end the scheme has failed, the companies involved have been placed under administration and the deductions disallowed.
"This is not a case of a wealthy or high income person deliberately seeking to avoid her taxation obligations. The conclusions which I have reached do not reflect upon her personally. However, they highlight the need for clear, reliable and independent advice for persons considering participating in mass marketed schemes which promise tax benefits," Judge French said.
His substantive findings have implications for investors in other schemes. In denying tax deductions under the general provisions, Judge French found Vincent was not carrying on a business, as she was a passive investor. All she did was sign a management agreement, she was not involved in the business and appeared to invest for the minimum period possible to obtain the tax deduction.
"That would have to be a big problem for investors in a wide range of schemes, says former deputy chief tax counsel, now Deloitte tax partner, Michael Bersten.
Most tax schemes were put together on the assumption the tax law would consider passive investors to be carrying on a business.
In another blow to investors, Judge French denied tax deductions for borrowings as, apart from an amount of $7,500 Vincent borrowed from her father, the loans advanced by the promoter were fictitious.
"Most schemes the Commissioner is interested in have some sort of round-robin so it's always an issue whether the loans stand up or not," Bersten says.
The case, he says, clearly puts to rest the argument that the Budplan tea-tree oil test case was confined to its own facts.
While investor groups have argued, since the Vincent decision, that taxpayers should not pay for the acts of scheme promoters, the ATO would no doubt argue, why should other taxpayers?
Many tax advisers not involved in the schemes debacle say the ATO settlement offer is fair. It allows deductions for cash outlaid but not loans, requiring the repayment of primary tax without penalties and interest free for two years.
"It's a no brainer", said one adviser who himself invested in a tree scheme gone wrong.
The situation investors find themselves in is no surprise, says Peter Haggstrom, a former special tax adviser to the Commonwealth Ombudsman.
"Tax is one of those areas where you have to protect yourself," he says.
Margin lenders and warrant issuers expect to write record business in June, as investors opt to claim the tax deductions available through leveraged stockmarket investments.
The total margin debt of Australian retail investors is projected to exceed $10 billion by June 30, capping a period of extraordinary growth that has seen the industry expand by 177 per cent since January 1999.
Scott Young, head of Macquarie margin lending, says the after-tax difference between protected loans and traditional margin lending was between 3 and 5 per cent.
He says the extra cost bought security for long-term investors rather than a tax deduction.
"People are prepared to pay to avoid losing sleep over shares. It's a set-and-forget product for risk-averse passive investors."
However, advisers caution buyers to look at the cost of protection. If you don't expect to cover the interest cost with dividends and capital gains you're still behind.
Late last month, the tax commissioner kicked off the traditional tax planning season with high-profile raids on Melbourne tax advisers believed to be promoting tax avoidance schemes to higher income earners.
Retirement village, theatre and film products were targeted and more raids are planned in the run down to June 30.
That's another change; the ATO's increasing use of the anti-avoidance rules in addition to the tax commissioner's wide-ranging access powers under section 264 of the tax law.
"The ATO very rarely issued section 264 access notices. It needed to be an extreme case but today they are spitting them out like confetti," says Szekely.
Finally, experts say investors still keen on investments with a tax feature must consider what they are willing to do if something goes wrong.
"First get your own advice," says Haggstrom. "A good tax opinion will look at the counter arguments. You need to take a position and be prepared to argue it right down to the Federal Court if a substantial sum is involved. If you're not prepared to do that, don't do it. Like a junkyard dog, ATO staff can smell weakness."
Reading the tax law is more of an art than a science, Haggstrom says, and the advice you get depends on who you ask.
"It's all a matter of opinion and you need to assess whether you're prepared to go down to the wire because if the tax Commissioner comes along and takes an alternative view, you have to be prepared to stump up the primary tax and penalties or fight him."
"At the end of day, it's caveat emptor [buyer beware]".
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