The Gazette 1988

GAZETTE

SEPTEMBER 1988

wh i ch is Collins -v- FrazerJ The facts of the case were that the t a x p a y e r c a r r i ed o ut s e v en separate processes which were the felling of trees, t r immi ng off of branches, reducing the trees to lengths varying f r om 5 to 30 feet, further reducing to 5 f t. lengths, reducing these lengths into planks, converting the planks into thin boards and then, finally, making up t h e t h i n b o a r ds i n t o b o x e s. McGarry J. held that profits f r om t he first f i ve processes we re t a x a b le as d e r i v ed f r om t he o c c u p a t i on of w o o d l a n d s. Conversely, such profits wou ld be exempt f r om taxation in Ireland. If there is a lesson to be d r awn f r om the case, it is probably that the occupier of wood l ands should do as mu ch as possible at the p r o c e s s i ng s t age in order to maximise the tax exemption. It may even be wo r t hwh i le to enter into a joint venture arrangement w i t h a saw-miller or other timber processer in order to ensure that the ma x i mum benefit is gained f r om the tax exemption. Forestry as a Trade The preceding paragraphs looked at the i ncome tax e x emp t i on provided by the Finance Act 1969. In 1979, relief for losses incurred " i n the occupation of wo o d l a n d s" was abolished. 4 There are reasons for thinking that the assumptions unde r l y i ng t h is legislation are fundamentally w r ong and t ha t, in f ac t, forestry should be treated as a normal business, the expenses of wh i ch are allowable in the normal wa y . In other wo r ds, if forestry is a " t r a d e " , then forestry losses are normal trading losses wh i ch are allowable in the normal wa y. Historically, occupation of land was not taxed as a normal business activity. Schedules A and B of the I ncome Tax Code p r ov i ded a f r amewo rk for raising t ax on national profits. This was perfectly understandable in the con t ext of the structure of land owne r sh ip in the U.K., consisting as it did of vast tenanted estates. In the modern context of owne r - occupa t i on and scientific farming methods, wh i ch have been applied w i t h particular success to the p r oduc t i on of t i mb e r, t he na t i onal basis is d i s t i nc t ly unreal. And, indeed, Schedules A and B we re abolished in Ireland by the Finance Act 1969. 5

The idea still persists, however, t hat forestry activities do not constitute a trade. The proponents of that argument point to a U.K. case, Coates -v-. Hotker Estates Co., 6 in wh i ch it was held that an e l ec t i on t o be t a x ab le under Schedule D rather than Schedule B did not mean that the activity b e c ame a t r ade. The au t hor suggests that this case can be distinguished under Irish law, on a number of counts, but principally on the grounds that Schedule B does not exist in Ireland and alternative bases of assessment do not exist here as they do in the U.K. Tax Code. Nowhe re does the Irish legislation say that commercial forestry activities are not a trade in the technical sense; it is simply assumed that they are not because t hey were not in the past. If this argument is correct, and commercial forestry activities are indeed a trade in the normal sense, the position then is that losses can be o f f set against other income. There wo u ld be other conse- quences for companies, such as availability of group relief and c o n s o r t i um relief. 7 A l s o, re- tirement relief for capital gains tax could be claimed if the forestry activity were a trade. 8 A test case is called for. Creating a Trade If one concedes, for the sake of a r g ume n t, t h a t c omme r c i al forestry activities are not a trade, one should then consider whe t her a f o r e s t ry a c t i v i ty can be structured so as to bring it in some wa y w i t h in the Case 1 assesment rules, t he r eby ma k i ng " l o s s " ( d e v e l o pme nt c o s t s) relief available. One possibility might be for the l andowner to f o rm a management c ompany and to a r r ange f or t he ma n a g eme nt company to be remunerated by reference to ultimate profits (while being obliged to bear all of the development costs at the outset). If p r o p e r ly s t r u c t u r e d, an arrangement of this nature should ensure that the company is taxable under Case 1 of Schedule D (in wh i ch case losses could be o f f set aga i n st o t h er i n c ome of t he company or surrendered by way of group relief). Such a company wo u l d not be en t i t l ed t o t he u l t i ma te e x emp t i on f r om t a x, howeve r, unless the structure had

been altered in the meantime so that the profits, wh en they arise, arise to the " o c c u p i e r" of the land. Pension Fund Linked Investment A more interesting, and more practical, arrangement for private individual investors is a Pension Fund Linked Investment. This is a new concept developed by one of the new generation of forestry management companies, wh i ch has been d e v i s ed w i t h t he objective of linking the inherent tax efficiency of pension funding w i t h the tax advantages of forestry. The a r r a n g eme nt c o u ld be described as a Pension Mortgage. On t he a s s ump t i on t h a t t he investor does not already have pens i on a r r a n g eme n t s, or his e x i s t i ng a r r a n g eme n ts are inadequate, he wou ld enter into a contract for a Retirement Annu i ty Scheme. These pension plans permit 2 5% of the value of the fund to be taken as a tax-free lump sum on retirement. 9 The investor wou ld then obtain a long-term loan wh i ch wou ld provide for a single repayment, funded by the tax-free lump sum received on maturity of the pension. The proceeds of the loan wou ld be invested in forestry through a who l ly own ed private company. The company wou ld lease the property to a forestry management company or, indeed, to another c o m p a n y c o n t r o l l ed by t he investor. The purpose of the lease is to ensure that the company 's income is rental income, liable to tax under Case V of Schedule D. This being the case, income tax relief at full marginal rates will be available to the borrower on all interest payments. The tax analysis of the t r ansac t i on is t hen as f o l l ows: (i) The i n v e s t or o b t a i ns a deduction for interest paid during the t e rm of the loan, on t he bas is t h a t t he company is one of wh i ch he is a director and the income of wh i ch is chargeable to tax under Case V of Schedule D ; i o (ii) The investor will receive tax

relief f or t he r e t i r eme nt a n n u i ty p r em i ums at his marginal income tax rate, up to 1 5% of his net relevant earnings. 11

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