Tea-tree Oil Ruling: Investors In Scheme Face Higher Tax Bills

Sydney Morning Herald

Tuesday May 30, 2000

By ANNE LAMPE

Thousands of investors in the Budplan tea-tree oil research investment schemes are expected to be hit by amended tax assessments and possible penalties following a further ruling that the schemes should not have received special tax treatment.

The Budplan tea-tree oil research investment schemes were marketed from 1995 by Mainstar One and about 12,000 investors invested an average of $50,000, or $600 million in total, into a range of Budplan investments between 1995 and 1997.

Also, the Administrative Appeals Tribunal has upheld an earlier decision by the Industry Research and Development Board that the Australian Tea Tree Oil Research Institute, based in Ballina, should not receive special tax treatment.

The board had decided earlier that the institute did not qualify for tax deductions as a research institute because too little of the funds invested actually went to researching tea-tree oil applications.

The AAT has now confirmed that that decision was correct.

Investors in the scheme borrowed heavily from an associate of the management company to finance their entry into the scheme, and face Tax Office action denying them their deductions for large upfront management fees and interest charges.

They may also face penalties and interest on the tax forgone.

The Tax Office is sending out amended assessments on the schemes to investors and a test case on the amended assessments is foreshadowed. How the test case will be funded remains unclear. Investors were approached recently to contribute $100 each to fund the case.

Investors were told that the institute's function was to research tea-tree oil-based products for use as an acne treatment, as hospital and antiseptic products and as a range of personal care products.

To qualify as a bona fide research organisation, the institute had to satisfy several conditions. It satisfied two relating to staffing and equipment but failed several other critical tests.

The AAT's deputy president, Mr Brian McMahon, noted that the institute and the investment management company had five common directors and three of the directors of those companies were also directors of the loan company.

Critically, the institute undertook research only referred to it by the management company, the sole party entitled to benefits of any research.

``As there was only one virtual client of the applicant, the financial relationship between them determined the fee and charges structure of the applicant," Mr McMahon found.

Loan agreements were available to all participants. A typical loan was $50,000, of which $12,500 was to be repaid in 12 instalments, plus a first-year interest bill of $7,500.

These were the only cash requirements which a participant was required to meet. No further repayments were required of the principal or interest other than from profits resulting from the exploitation of the research and development.

Of the $50,000 paid by the loan company to the manager at the direction of the participant, $5,000 was to go to the manager as a management fee and the rest was pre-payment for the research and development work.

What weighed most heavily against the institute in the AAT's eyes was that it had to deposit the money back with the loan company on a non-recourse basis. So in 1995-96 the institute received $76,335,784 in prepaid research fees for work done for the schemes, but the vast bulk of this $70,894,752 was placed back on deposit with the lending company.

The AAT concluded that these loan arrangements were contrary to normal commercial terms and the fees and charges structure referred to in the pricing structure did not refer to fees and charges which the institute might invoice to third parties.

``The structure was certainly not on normal commercial terms."

The AAT pointed out that the peculiar funding arrangement between the institute and the management company was not disclosed in the prospectuses; nor was the fact that the funds were placed on deposit at a low rate of interest and ``in circumstances that made it highly questionable whether the deposits would ever be recovered because of the performance of the business".

Actual spending on research in the period to June 30, 1996, was less than 0.1 per cent of fees charged to the participants, the AAT found.