Edited version of private ruling

Authorisation Number: 1011634093438

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Ruling

Subject: Land leased for forestry and future forestry operations

1. In relation to your Forest Property Agreement (FPA), were you carrying on a business?

No.

2. Is your FPA to be treated as an ordinary commercial lease?

Yes.

3. If you were not carrying on a business, that is, merely passive investors, will you be able to deduct a negative gearing loss?

Yes.

4. Is the FPA termination payment you received a capital gain rather than ordinary income?

Yes.

5. Will your FPA termination payment be eligible for a capital gains tax (CGT) discount?

Yes.

6. Can your holding costs (such as interest) be applied to reduce your capital gain?

No.

7. If you maintain the trees until they are mature enough to fell, and you sell to a contractor, who pays you a royalty (on a per tree or on a percentage of income basis), will your receipt be a revenue receipt rather than a capital receipt?

Yes.

8. If you fell the trees and sell the timber yourselves, will the proceeds be treated as ordinary income?

Yes.

9. If you tend the trees until they are mature enough to fell, and you sell to a contractor, who pays a lump sum giving them the right to fell the trees, regardless of the amount of trees they fell, will your receipt be a capital receipt rather than a revenue receipt?

Yes.

10. May discounting be applied to such a capital receipt?

No.

This ruling applies for the following periods:

Year ending 30 June 2004

Year ending 30 June 2005

Year ending 30 June 2006

Year ending 30 June 2007

Year ending 30 June 2008

Year ending 30 June 2009

Year ending 30 June 2010

The scheme commenced on:

1 June 2004

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You entered into a Forest Property Agreement (FPA) with ABC Pty Ltd (ABC) to rent your land for the purpose of growing trees. The term of the arrangement was 20 years with annual rent.

You had not active involvement in the tree growing operation. The only costs you incurred were for interest paid on loans to acquire your land and for membership of Australian Forestry Growers so you could be kept informed about developments in the forestry industry so far as FPAs were concerned.

The FPA was terminated. Upon termination, you were paid a lump sum payment in consideration of the early termination.

The trees planted by ABC remain on your land. It is your choice as to how to deal with the trees. You can allow the land to revert to forest or you can incur maintenance costs until the trees are mature enough for felling. At that time, you may sell the trees to a contractor as they stand or you may engage a contractor to fell them and then take them to market themselves.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 104-35

Income Tax Assessment Act 1997 Section 115-25

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Were you carrying on a business?

Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) includes forest operations in the definition of the term 'primary production business'. Section 995-1 of the ITAA 1997 provides you carry on a primary production business of forest operations if you carry on a business of:

· planting or tending trees in a plantation or forest that are intended to be felled, or

· felling trees in a plantation or forest, or

· transporting trees, or parts of trees, that you felled in a plantation or forest to the place:

o where they are first to be milled or processed, or

o from which they are to be transported to the place where they are first to be milled or processed.

Taxation Ruling IT 360 is about afforestation schemes and states where a person acquires an interest in an identifiable area of land and enters into an agreement to have that land developed, planted and maintained by a management company for the purpose of growing forest trees then it is accepted that the person may be carrying on a business of afforestation.

In your case, you were not conducting any of the activities listed in section 995-1 of the ITAA 1997. These activities were conducted on your land by the lessee of your land, namely, ABC. Further, you did not enter into an agreement to have your land developed, planted and maintained by a management company from which you would earn assessable income. The FBA refers to you as the land owner and refer to ABC as the forestry company that wishes to use the subject area to carry on a long-term commercial forestry business. You simply rented your land to ABC, who developed, planted and maintained your land exclusively for their earning of business income. It follows you were not carrying on a business is respect to your FBA.

Forest Property Agreement

The Macquarie Dictionary, 1997, 3rd edn, The Macquarie Library Pty Ltd, New South Wales defines a 'lease' as follows:

lease 1. an instrument conveying property to another for a definite period, or at will, usually in consideration of rent or other periodical compensation.

Your FBA states you, the land owner, granted ABC the right to occupy your land for a term and to use it as they required. It stated you, the land owner, had no rights or interests in your land, other than the encumbrances and the right to grant the aforementioned rights to ABC. Your FBA describes payments made to you as rent and describes the increases to your rent based on the CPI. .

Taxation Ruling TR 95/6 is about primary production and forestry and applies to persons engaged in forest operations and persons not engaged in forest operations who dispose of timber. It describes various tax treatments applicable to various ways to dispose of trees owned by a land owner.

In your case, before you entered into the FBA, there were no trees on your land that could form the basis of forest operations. Further, as previously stated, you did not enter into an agreement to have your land developed, planted and maintained by a management company from which you would earn assessable income. It follows your FBA was an ordinary commercial lease, as described in the FBA. As you did not own any trees, none of the principles in TR 95/6 apply to your situation under the FBA.

Negative gearing

Taxation Ruling TR 95/33 is about the relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings. It states the Tax Office will continue to accept deductions for interest incurred on money borrowed to acquire negatively geared assets when the expenses incurred are in relation to bona fide investments, that is, investments that are expected to earn an overall profit, gain or cash flow in the longer term.

In your case, you purchased and rented your land in a genuine (not colourable) manner for the purpose of gaining or producing assessable income. It follows for the period you rented your land, you may claim relevant deductions, even to the extent where negative gearing occurs.

FPA termination payment and CGT discount

Taxation Ruling TR 2005/6 is about lease surrender receipts and payments.

It states a lease surrender receipt of a lessor will constitute assessable income under section 6-5 of the ITAA 1997 if received:

(a) in the ordinary course of carrying on a business of granting and surrendering leases

(b) as an ordinary incident of business activity, or

(c) as a profit or gain from an isolated business operation or commercial transaction entered into by the lessor. Otherwise the lease surrender receipt is of a capital nature.

Where the lease surrender receipt is of a capital nature, the lease comprises of the contractual rights vested in the lessor under the lease agreement, including the right to receive the nominated rent, but subject to the provision of possession. Upon the surrender of the lease by the lessee, CGT event C2 under section 104-25 of the ITAA 1997 happens to the lessor in relation to the discharge of its rights (as a single asset) under the lease agreement. Section 104-25 of the ITAA 1997 states the time of the event is when you enter into the contract that results in the asset ending.

A lessor makes a capital gain if the capital proceeds from the surrender of its rights are more than the asset's cost base (including, for example, any non-deductible lease incentive paid to the lessee on the grant of the lease). The lessor makes a capital loss if those capital proceeds are less than the asset's reduced cost base.

Section 115-25 of the ITAA 1997 is about discount capital gains. It states to be a discount capital gain, the capital gain must result from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event. It also states a capital gain is not a discount capital gain from CGT events D1, D2, D3, E9, F1, F2, F5, H2, J2, J5, J6 and K10.

In your case, your FPA termination was CGT event C2 under section 104-25 of the ITAA 1997 and the FPA termination payment you received was capital proceeds. If you have made a capital gain from the event, section 115-25 of the ITAA 1997 allows you to discount your capital gains.

Holding costs

Subsection 110-45(1B) of the ITAA 1997 provides expenditure does not form part of the second or third element of the cost base of a CGT asset to the extent you have deducted or can deduct it.

In your case, your interest expenses and other holding costs that relate to the income earned from your FBA, which form your negative gearing, are deductible under section 8-1 of the ITAA 1997. It follows they cannot be used to reduce your capital gain.

Tax treatment of forestry income

Taxation Ruling TR 95/6 is about primary production and forestry and applies to persons engaged in forest operations and persons not engaged in forest operations who dispose of timber. It describes various tax treatments applicable to various ways to dispose of trees owned by a land owner.

In TR 95/6, the term 'forest operations' refers to the planting, tending or felling if those operations amount to the carrying on of a business.

In determining whether particular activities constitute the carrying on of a business, courts and tribunals have considered the following elements to be relevant:

· whether the activities have a significant commercial purpose

· the scale of the activities (a person may carry on a business even though they do so in a small way)

· the nature of the activities, particularly whether they have the purpose of profit making (however, profit making in a particular year is not essential)

· repetition and regularity of the activities

· whether the activities are organised in a business-like manner

· volume of the operations and the amount of the capital employed

· whether the activities may properly be described as the pursuit of a hobby or recreation

· the degree of control held by the person over the development and maintenance of the land.

Where a taxpayer carrying on forest operations fells timber, paragraph 21 of TR 95/6 provides the total receipts derived from the sale of felled timber will generally constitute assessable income of the taxpayer (under section 6-5 of the ITAA 1997).

Where a taxpayer carrying on forest operations sells standing timber by granting a right to someone to cut and remove the timber (whether or not the right to remove the timber is exercised) paragraph 25 of TR 95/6 provides the proceeds from sale are assessable income.

Where a taxpayer receives royalties received from the grant of a right to fell timber on land owned by the taxpayer, paragraph 26 of TR 95/6 provides the royalty income is assessable income, even if the taxpayer granting the right is not carrying on a business of forest operations.

Where a taxpayer carries on another primary production business (such as cattle grazing), trees on the land constitute part of the assets of that business (under section 70-85 of the ITAA 1997). Paragraph 22 of TR 95/6 states a disposal of trees owned by such a taxpayer may result in the value of those trees being included in the taxpayer's assessable income (under section 70-90 of the ITAA 1997).

In general, were a taxpayer does not carry out forest operations, paragraph 54 of TR 95/6 states the disposal of the trees may still give rise to assessable income. Assessable income may include:

· proceeds from the sale of standing timber

· royalties received from granting rights to other persons to fell and remove timber

· profits from isolated transactions.

To conclude, whether or not a taxpayer is carrying on a business of forest operations, the proceeds from the sale of timber from their land will generally constitute assessable (ordinary) income.

Lump sum payment for right to fell timber

Paragraph 57 of TR 95/6 refers to the High Court of Australia case of Stanton v. Federal Commissioner of Taxation (1955) 92 CLR 630; (1955) 11 ATD 1. Here, the taxpayer, who was not carrying on a business of forest operations, received a lump sum, payable in instalments, for agreeing to sell standing timber. The instalments were due for payment, independent of the amount of the timber removed. The High Court determined the instalment payments were not royalties or assessable income.

Currently, such payment would fall under section 104-35 of the ITAA 1997, CGT event D1. The time of the event is when the right is created. A capital gain is made if the capital proceeds from creating the right are more than the incidental costs incurred that related to the event. Section 115-25 of the ITAA 1997 states a capital gain from CGT event D1 is not a discount capital gain.

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