CHANGE IN THE FINANCIAL POSITION OF THE TAXPAYER FROM THE SCHEME: s 177D(b)(v)
105 This paragraph of s 177D requires the Court to have regard to 'any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result from the scheme'. It is clear that the applicant's financial position will no longer be effected by the Project as it went into liquidation in 2002. Therefore the Project has resulted in a failure of significant commercial return and will not result in any further return to the applicant.
106 The respondent submits that the paragraph also requires the Court to look at its application at the time the applicant entered the Project, the point being in particular to find whether the commercial benefits were certain or uncertain as against the certainty of tax benefits incorporated in the scheme.
107 The Prospectus told the applicant that he could expect in respect of a single farm a return on investment of 19.2 per cent, whether or not he took no loan or took loan repayment option 1 or 2. One farm was to consist of 10 000 trees. The Prospectus identified as marketing risk factors being the possibility of price fluctuation and oversupply. It stated that it was anticipated that selling prices for oil may be a little erratic as the impacts of increased production and developing demand are likely to move at differing rates at different times over the term of the Project. The tables on which return on investment predictions were based utlilised a selling price of $60.50 per kg escalating at an assumed inflation rate of 5 per cent per annum thereafter.
108 The applicant contends (subjectively) he reasonably expected to make a substantial profit from the Project. This did not eventuate, on his argument, due entirely to a fall in the tea-tree oil prices and despite the additional voluntary payments he made to the Trustee to carry out the 2001 harvests. Also he argues that the projected average profit of 19.2 per cent per annum is very similar to the forecasted return in Cooke's case referred to by Carr J in Sleight's case at [245].
109 The respondent starts from the position that as a result of their entry into the Project, the Calders obtained an immediate improvement in their after-tax cashflow. Their net cash inflow was to come, not from earnings from growing tea-trees for oil, but from tax savings. As explained by the Prospectus, this financial result arose because the Calder's claimed deductions (totalling $32 050) far exceeded the requirements of the Calder's personal cash for the scheme ($14 475).
110 However, the respondent asserts that beyond the net cash inflows generated by the large up-front tax deductions, the Project represented a very poor investment on any properly objective view. He contends that even accepting the assumptions made about price and yield in the Prospectus, the Project had nothing to recommend it beyond the fact that entry could be made utilising the tax savings and without further risk to the participant.
111 For these views the respondent relies upon the report annexed to the affidavit of Mr Langridge. In that report Mr Langridge stated in relation to the projected return on investment of 19.2 per cent the first two years had been ignored and when they were taken into account the average return was reduced to 15.9 per cent. Additionally he stated that the inclusion of the inflationary increases at 5 per cent per annum had the effect of increasing the average return from 9.7 per cent to 19.2 per cent. If the error in relation to the first two years was taken into account, the average return was calculated at 7.6 per cent.
112 Mr Langridge's evidence was also that, accepting the yield and price assumptions made by the Prospectus and the inflationary increases built into the projections, the best a participant in the scheme could hope for from the Project was a before tax return of 8.91 per cent (on Loan Option 2). He said the higher after tax return was the consequence of the tax effects of the participant's loan. He regarded the before tax return as wholly inadequate for the high risk nature of the investment. If the inflationary factor was excluded, he considered the projected 'return' on the Project to be negative. The applicant contends that a major flaw in the approach on this is Mr Langridge's assumption of no price increase over 15 years, the exclusion of the so-called 'inflationary factor'.
113 The respondent relies on the Langridge report in the following specific respects. First, he contends the income projections in the Prospectus were misleading. He says they excluded the participant's cash outflows of $3725 in 1994 and $10 750 in 1995 for prepaid interest, seeds, and capital repayment in respect of the Loan Options. The applicant contends that the respondent's reliance on net cash flow does not assist because the projection in the Prospectus does not purport to show net cash flow. Rather it shows a 'cash distribution' figure which he accepted as correct.
114 Second, the respondent relies on the Langridge report for the proposition that the income projections in the Prospectus purported to express a percentage return on investment without any conceptual basis. However, the applicant points to Mr Langridge's evidence as actually being to the effect that the calculation, in apparently ignoring the first two years of the 15 year period, was 'conceptually incorrect.' Further Mr Langridge had testified that 'return on investment' is widely used as a basis for considering investments. Additionally reliance is placed by the applicant on the use of that test by Carr J in Sleight at [245] and by Hill J at [111].
115 Third, the respondent contends the return referred to in the Prospectus was distorted by the inclusion of annual 5 per cent inflationary figures as was the exclusion from the calculation of negative income in the 1995 and 1996 years. The applicant argues that this statement is fundamentally flawed, being based on the unfounded conjecture that prices would not increase, either at the 5 per cent per annum forecast or at all. Mr Langridge agreed that his speculation that prices might fall was conjecture. Therefore the applicant contends this is not an assumption or conjecture which any reasonable investor reading the Prospectus would have made. Further, it is submitted that no objective assessment, based on the material in the Prospectus, could conclude (as the respondent urges) that the likely return without tax benefits was so poor that an investment in the Project must be 'tax driven', as Mr Langridge maintained.
116 The respondent accepts that Main Camp was a large, professional operator which recognised the need for marketing and was active in pursuing new markets. Hence it maintained a premium price but one which was affected by overall price falls. Nevertheless the respondent submits that it was unlikely the income projections would be met, for a number of reasons. First they assumed constant growth in both yield and price without provision for any fluctuation as might be expected in any agricultural project. Second, they were based on assumptions about yield which were at the high end of expectations when plantation farming of tea-trees was in its infancy with a vast amount unknown. Third, they were based upon assumptions about price which ignored the risk of an oversupply of tea-tree oil in the near future. Accordingly, the projected growth in prices depended upon the establishment of new markets of tea-tree oil.
117 The applicant argues that there was no assumed constant growth in yield and the projected increase in price was supported by the expert's reports, excess of demand over supply, the 10 per cent (compounding) increase over the previous six years and the generally positive outlook for markets reflected in the Prospectus. The projected price increase of 5 per cent was within the average price increase for agricultural products. Experience shows, as Mr Langridge was forced to concede during trial, that prices do generally increase. Given the information in the Prospectus, an ordinary investor, such as the applicant, would reasonably conclude 5 per cent was achievable and even conservative. Regarding the yield forecast, the applicant maintains that while their witness Mr McClymont agreed it was at the "high end of expectations" there was nothing in the Prospectus or anything known to the applicant to suggest the forecast yields could not be achieved.
118 The respondent submits that the evidence of the applicant's expert witness, Mr McClymont is at odds with the above and his support of the Prospectus projections about yield and price ought not to be accepted. Mr McClymont dismissed the risk of an oversupply of tea-tree oil affecting future prices because of marketing work being done and he indicated that the expansion of international markets was critical. The respondent contends that Mr McClymont does not understand these markets or have knowledge of their requirements and thus is not qualified to express a view about future prices for tea-tree oil. The applicant maintains that Mr McClymont, as an expert, considers that the statement in the Prospectus as to yield, prices and markets was correct and the forecasts reasonable. He contends Mr Langridge disagrees solely due to his flawed and selective analysis of the Prospectus.
119 The respondent also contends that Mr McClymont lacks the independence a Court should expect from an expert witness as he refused to entertain or accept any alternative view put to him. To support this contention, the respondent states that Mr McClymont staunchly defended views favourable to the applicant and Main Camp and had been close to Main Camp projects both throughout their life and failure. Accordingly, it is submitted that the respondent's witness, Mr Langridge, who is not involved in the tea-tree oil industry, would make an objective business appraisal of the material presented by the Prospectus and the future outlook for prices. It is Mr Langridge's opinion that there was likely to be a downward pressure on prices.
120 In his third affidavit Mr McClymont highlighted the importance of Main Camp's research and development and marketing program. In his capacity as the Queensland representative of the Australian Rural Group he advised a number of tea-tree farmers on marketing. He did so because he regarded as important the creation and security of future demand. He agreed in cross-examination that the existing markets in 1997 could not support the supply of tea-tree oil. He accepted that in 1994 an oversupply of tea-tree oil was predictable if there were no marketing to obtain new markets. However, he disagreed with the statement by Mr Langridge in his report that the export market for tea-tree oil was unknown and poorly developed as at April 1994. In his opinion, the major export market for such oil was the United States, although he did not have knowledge of the approval processes there or the time taken by them. He agreed that these factors and the launch of new tea-tree oil products meant that there were a lot of things that needed to come together if the price was going to be kept up. Because of his view that marketing was being planned, he did not accept that projections made in 1994 took no account of oversupply or the challenges involved in obtaining new markets on which the maintenance of price was dependent.
121 In re-examination Mr Clymont said he was aware that as at April 1994 tea-tree oil was being marketed into the United States and it was that on which he based his belief there was the potential to keep that going and to increase the sales. He testified to the sales of oil to 30 June 1994 being at $65 a kilo, in excess of the farm gate price of $56. An Agtrans report addressing new uses for tea-tree oil was referred to him and he agreed that Main Camp captured additional margins from selling primarily directly to manufacturers. He considered the statement by the Agricultural Consultant Mr Argent that Main Camp was able to maintain price levels up to 40 per cent above the ruling farmgate prices to be correct. Other Agtrans reports were put to him which evidenced a foundation for his views on marketing in the United States.
122 The contentions and evidence on these issues are said to be relevant to that portion of s 177D(b)(v) which requires attention to the financial position of the taxpayer that may reasonably be expected to result from the scheme. It is apparent that the applicant was subjectively influenced by the forecasts of return on investment in the Prospectus. The respondent contends he should have seen the lack of commerciality in the investment through analysis of the scheme. In particular it is said against the applicant that he should have seen the commercial opportunities of the scheme did not exist or were vastly overstated because of (1) errors in calculation, (2) the role of tax savings in the projections and (3) wrong assumptions concerning future price and inflation. Even if the applicant had appreciated factor (1), that does not have the outcome that it could be said the applicant could only have reasonably expected tax benefits from the scheme. This is because Mr Langridge's evidence supports the view that there would still have been a return of between 7.6 per cent to 8.91 per cent. As to factor (3), I agree with the submission by the applicant that at the time the applicant made his investment it could not reasonably have been expected that he would have discounted entirely the possibility of any price increase and that the rate of 5 per cent was a reasonable expectation in the circumstances. Were it relevant, these factors would support a finding that the subjective purpose of the applicant lay in the pursuit of commercial gain in the course of carrying on a business.
123 However, as to factor (2) Mr Langridge's evidence was that the Project relied upon the tax deductibility and effect of the initial payments and the gearing up provided by the loan to show any rate of return. In those circumstances it cannot be objectively found that the dominant purpose of the applicant's entry into the scheme was to enable the applicant to make a commercial investment: the tax benefit was the key to the commerciality of the investment.
124 Accordingly I consider that at the time of the applicant's entry into the scheme the objective fact was that the dominant purpose of such entry was to obtain the tax benefit. Without that benefit, the commerciality would have been very substantially endangered. In Cooke the projected returns were in excess of 20 per cent per annum from the first year. That is not the case here when the projected returns are considered in the light of the expert evidence.