Clear Thinking Needed on WET Rebate for Blends

In recent months, wine industry stakeholders have repeatedly sought our views at Fox Tucker on various issues concerning Wine Equalisation Tax (WET) rebate claims for blended, or further manufactured, wine that has been made using wine acquired from an earlier producer.

The questions have arisen due to uncertainty surrounding the practical application of the new “earlier producer rebate” provision^[1], and recent increased ATO scrutiny regarding pre-December 2012 blending arrangements.

In this Tax Take we’ll provide our summary view in relation to two of the most commonly asked of these questions, along with a couple of other related matters.

Please note, however, that these are just our opinions and should not be construed as advice. The Commissioner of Taxation (Commissioner) may have a different view. As always, if you have any specific questions in relation to the application of these issues to your own circumstances, you should contact us directly.

Question 1

“Does ‘Producer A’ need to have exhausted its own entitlement to the WET rebate before giving notice to ‘Producer B’, which is acquiring wine from ‘A’, that ‘A’ is not claiming the rebate with respect to its sale of wine to ‘B’?

Unfortunately, we seem stuck with the literal wording of the section here, which requires a simple answer of “yes”.

However, we would advocate a more purposive interpretation of the provisions by the Commissioner which allows the rebate in these circumstances, given this would better meet the purpose of the rebate, and the literal interpretation appears to us to result in unintended consequences.

If an earlier wine producer is, on the facts, “entitled to a producer rebate of a specified amount” for the “other wine”, then this notice to the purchasing producer must be in relation to the amount to which they are entitled.^[2]

Therefore, as “entitlement” and the “amount of entitlement” are determined under ss 19-5 and 19-15 respectively, unless a wine producer, or group of associated producers, has exhausted its maximum $500,000 entitlement, or there is some other reason for the dealing to be denied the full producer rebate, the default entitlement on all rebatable transactions must always be the standard 29% of the price for which the wine is sold.

Hence, the “specified amount” must, always, for the purposes of the “earlier producer rebate” provision (s 19-17), be that 29% calculated amount. In short, notification is in relation to entitlement, not amount claimed.

The provisions do not contemplate circumstances when a producer might choose not to claim the rebate. In effect they assume a wine producer will always want to claim the WET rebate on each and every rebatable dealing it has until its entitlement is exhausted.

This may ordinarily be true, particularly for wine producers who do not anticipate exhausting their maximum WET rebate entitlement in a particular year. However, there are in practice circumstances when a wine producer might prefer not, and choose not, to claim the rebate amount to which it’s entitled. For example:

• A wine producer that has historically exhausted its maximum rebate entitlement, and anticipates doing so in the current financial year, may wish to defer claiming the rebate on particular earlier rebatable dealings in the financial year and instead claim the rebate on later rebatable dealings.
• A wine producer that is a member of a group of associated producers (which as a group is only entitled to a maximum rebate of $500,000), may, despite being entitled to claim the rebate on a particular dealing at the time of the dealing, choose not to claim the rebate on that dealing by reason of another member, or members, within the group historically claiming the maximum entitled rebate.

A practical application of the literal interpretation of s 19-17 in the above two examples means, among other things, that (addressed respectively):

• Until such time as a vendor wine producer has exhausted its own maximum rebate entitlement, it is being prejudiced against by purchasers who will choose to either defer their purchase of the wine from that vendor producer, or not buy the wine at all, choosing instead to purchase from another wine producer whose “WET is already full”. Further, bona fide purchasing wine producers who, by necessity, budget for the (partial or full) receipt of the WET rebate on the sale of their own blended (or further manufactured) product, risk being denied their own rebate on their blended product on grounds that, in preferring to purchase from an earlier producer who has exhausted their own rebate entitlement, their purchase might be considered uncommercial or collusive.
• Each member entity of a group of associated producers will need to monitor, on a real-time basis, each other member’s entitlement. This will, in effect, cause each member to claim its share of the rebate amount. This brings significant practical compliance difficulties and is a change in the historically accepted position (legislatively and in terms of ATO administration) of allowing a specific member entity, or entities, within the group to, between them, exhaust the maximum rebate amount.

The underlying policy of introducing the “earlier producer rebate” provision was “to ensure that wine producers will not be able to claim multiple rebates for the same quantity of wine”. Yet, the provision as enacted does more than this.

The economic inefficiencies and consequent uncertainty created within the industry are, in our opinion, unintended consequences of the new provision. So we would advocate to the Commissioner that a purposive interpretation of the provisions be applied to allow a wine producer to give notice, if it so chooses, as to the rebate claimed, or that would be claimed, by that producer with respect to particular wine (which may be a lesser amount than that which it’s “entitled” to claim).

Such an interpretation would not detract from the underlying policy of the amended legislation.

We understand that a draft addendum to the Commissioner’s primary Wine Equalisation Tax Ruling, WETR 2006/1, is to be published in the very near future. We have not had an opportunity to review this and do not exactly know the Commissioner’s view to be advised by it, nor the flexibility with which his view will be applied. However, we have in advance of this Ruling provided our views to a number of the Commissioner’s senior officers and are hopeful these may have been of some influence.

Without speaking for the Commissioner, and without awaiting his published view, we believe the Commissioner is likely to adopt the literal interpretation of s 19-17. However, with the ATO’s primary focus being to apply the provisions in such manner as to mitigate the historical mischief that existed under the prior regime (and curb any future mischief that the new provisions might generate), we can only hope that a pragmatic, flexible application will apply in circumstances where the bona fides of a producer are genuine.

We will update on the significant contents of the addendum in due course.

Question 2

“Ignoring the ‘earlier produce rebate’ provision for pre-10 December 2012 assessable dealings, or assuming that that provision is met for post-10 December 2012 assessable dealings, is ‘Producer A’ entitled to the WET rebate on blended wine sold by it where the blended wine is of the same variety?”

This question was touched on in a paper presented by the author earlier this year at the Tax Institute’s South Australian Agribusiness Forum^[3], the content of which we’ll revise and expand on here to account for more recent developments.

There is no prohibition on producers blending or further manufacturing wine of the same variety, provided an argument can be sustained that the blending or further manufacture was sufficient to produce a product that is commercially distinct.

The Commissioner’s audit/review focus in relation to WET rebate claims on blended transactions, we understand, is focused in two primary issues, namely:

1. Whether the producer is in fact entitled within the scope of the legislative provisions to claim the rebate on the blending and subsequent sale of the blended wine; and
2. If so entitled, whether that rebate ought effectively to be subsequently denied by an application of Div 165, on the basis that parties have engaged in an uncommercial and collusive arrangement to obtain the benefit of the rebate.

Historically, the Commissioner’s audit activity appears focused on a producer’s bona fides but, more recently, the Commissioner has sought to examine a producer’s actual entitlement to the rebate at first instance on its “blended” wine.

If there is no entitlement to the rebate on the basis that there is no manufacture of wine, then it’s unnecessary for the Commissioner to seek to deny the rebate on the basis of any “associated producer” relationship, or there being any uncommercial or collusive arrangement to which Div 165 might apply.

Ignoring issue “b” therefore, and focusing on issue “a”, it is noted that entitlement to the rebate requires, among other things, the blending of wine to meet the expanded legislative definition of “manufacture” in s 33-1. That is, in general terms, the blending of two or more wines will fall within the definition of manufacture if the blended wine is “commercially distinct from the parts or ingredients”.

There is no legislative definition of the expression “commercially distinct”, but it’s the Commissioner’s view that each individual blended wine will need to have characteristics that, when combined with the characteristics of the other blended wine, results in wine having its own commercially distinct characteristics.

This could include, for example, colour, shape, aroma, chemical composition or utility. The grape wine that is formed from these processes is to be marketed to the consumer as a different wine to each of the grape wines used in the blend.

In circumstances where different varieties of wine are blended, this is easier to establish. However, blending the same variety of wine can still qualify as the manufacture of new wine.

Is simply improving the wine enough?

The above summary still begs this question: is improving the quality of purchased wine sufficient for the resultant blend to be considered commercially distinct. And if so, to what extent, or by what degree, does the quality need to be improved?

On our review of the Commissioner’s publicly available information, it appears that the Commissioner has historically accepted that improving the quality of a wine by blending it with a higher quality wine can cause the resultant blend to be commercially distinct from its constituent parts. As noted in the Edited version of Private Ruling Authorisation Number 1012316394679:

“At issue, is whether a blend of more than 50% of Vintage A and less than 50% of Vintage B will result in a final product that is commercially distinct, such as have a distinctive character, from the Vintage A and the Vintage B, or whether the blend will merely be akin to the Winery’s product badged under your label.

You submit the blend will achieve a characteristic that is unique with the addition of Vintage B enhancing the flavor profile of the final product. This will result in a quality consistent with the other Shiraz vintages that you have produced in the past.

We acknowledge with the addition of Vintage B it is likely that the flavour profile of Vintage A will be enhanced. This is because of the exceptional quality of Vintage B. It may be said what you will ultimately end up with will be distinct from what you started with. The final product will be neither Vintage A nor Vintage B. It will not be the ‘former’ as it will have a better flavour and more appealing qualities; it will not be the ‘latter’ as it will not have the exceptional quality that wine possesses because of the extraordinarily good growing season for grapes in that year.

Accordingly, it is likely the final product will be commercially distinct from its inputs. You will satisfy the second limb of the extended meaning of manufacture and be a producer of rebatable wine pursuant to subsection 19-5(1) of the WET Act. You will therefore be entitled to a WET producer rebate for the blend in accordance with Division 19 of the WET Act.”

Despite the above-stated position, there is danger in relying on this view. Private Rulings are not legally binding and are not of general application to all taxpayers.

They’re also specific to the factual circumstances and arrangements put to the Commissioner by the person applying for the Ruling. In particular, the edited version of the Private Ruling referred to above fails to disclose the percentage mix of the two different vintages, and is for a producer winery blending to sell under its own label, as opposed to a producer selling bulk wine that may or may not be further blended.

That said, if on the facts an argument can be sustained by a producer that the degree of change in the blended or further manufactured product is such that it’s commercially distinct from its parts, then the blended product ought to be rebatable (subject to other rebate limitations).

Finally, we remind taxpayers that if the Commissioner asserts that the blended wine is not commercially distinct, the burden of proof will be on the producer to show that it is.

Private Binding Rulings

Our opinion has also been sought recently on the merits and procedure for obtaining an advance “Private Binding Ruling” from the Commissioner on certain wine structures and arrangements.

While in other contexts, such an application might be perceived as bringing unnecessary attention to a taxpayer’s affairs and activities, given the current ATO audit environment and uncertainty in relation to the WET rebate, such applications might be warranted (indeed advisable) in some circumstances.

We’ll discuss the pros and cons of Ruling Applications further in our next Tax Take.

WGGA feedback on WFA-suggested reforms

As a post script to our October Tax Take, in which we discussed the Winemakers’ Federation of Australia’s (WFA) proposed “Action Points”, including suggested reforms to the WET rebate, we note publication of the Wine Grape Growers Association (WGGA) summary feedback report on the WFA’s review, which you can download here.

Although the WGGA report lacks the detail of the WFA publication, we support the WGGA’s implicit preferred approach of seeking a more considered review of the WET rebate provisions prior to any reform, and that any change should, in effect, reflect the concerns of grape growers just as much as those of processors and large wine enterprises.