Edited version of your written advice

Authorisation Number: 1051237204348

Date of advice: 23 June 2017

Ruling

Subject: Australian Carbon Credit Units Income - classified as primary production income or not

Question

Is the income from the sale of the Australian Carbon Credit Units (ACCUs) considered to be assessable primary production income of the business you conduct?

Answer

No

Relevant facts

You have owned and operated the property for over 20 years. Approximately 35% of the property’s area is used for Carbon Farming. The Project is a Native Forest Protection Project.

Native forest protection projects involve the sustainable management of forestry and agricultural projects for the purpose of generating carbon credits under the Carbon Farming Initiative. Farmers are able to continue their normal functions, but receive additional income by managing the farm in such a way as to also protect and optimise carbon stocks in native forests. The methodology involves the protection of native forests through the prevention of clearing and clear felling harvesting activities.

You entered into a contract with an agent, called the Property Development and Agency Agreement (PDA), where the agent would act as Agent for negotiating the sale of Carbon Units and providing advice.

The project is listed on the www.cleanenergyregulator.gov.au website.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 420

Income Tax Assessment Act 1997 Subdivision 420-E

Income Tax Assessment Act 1997 section 420-10

Income Tax Assessment Act 1997 section 420-12

Income Tax Assessment Act 1997 subsection 420-15(4)

Income Tax Assessment Act 1997 section 420-25

Income Tax Assessment Act 1997 section 420-42

Income Tax Assessment Act 1997 subsection 420-60(3)

Income Tax Assessment Act 1997 section 420-70

Income Tax Assessment Act 1997 subsection 420-70(4)

Income Tax Assessment Act 1997 subsection 118-15(1)

Income Tax Assessment Act 1997 subsection 118-15(3)

Income Tax Assessment Act 1997 Division 392

Income Tax Assessment Act 1997 subsection 392-80(2)

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1997 subsection 40-535(1)

Reasons for decision

Summary

The income from the sale of the ACCUs is specifically included in your assessable income under section 420-25 of the ITAA 1997.

The income from the sale of the ACCUs is not assessable primary production income from a primary production business.

You are entitled to deduct expenses incurred in preparing or lodging an application for a certificate of entitlement or an offsets report as part of the process of becoming the holder of ACCUs.

The deductions you incur in undertaking the actual eligible offsets project are generally determined under the normal income tax provisions.

The income from the sale of the ACCUs is not subject to any capital gain.

Detailed reasoning

Assessability of payments from the sale of ACCUs

You have derived income from the sale of ACCUs.

You have not sold the Carbon Sequestration Rights which are attached to the property. You have undertaken an “eligible offsets project” (Avoided Deforestation Project) under the Carbon Farming Initiative Act, with a company acting as your agent.

To be able to enter into such a project you have to have:

(a) the legal right to carry out the project on the land; and

(b) you have to hold the applicable carbon sequestration right (present and future benefit) under section 43 of the Carbon Credits (CFI) Act 2011.

At the end of each reporting period for the project you can apply to the government Regulator for the issue of certificates of entitlement to ACCUs in respect of the project. These ACCU’s are issued to you at no further cost because you have undertaken the eligible project. It is these ACCUs that have been sold, you still hold the carbon sequestration rights attaching to the property. This allows you to continue undertaking the eligible offsets project. It is important to note that the carbon sequestration rights attach to the land, not to any business that is being carried on, on the land.

The income from the sale of the ACCUs is specifically included in your assessable income under section 420-25 of the ITAA 1997. This section is within a special Division that was enacted to prevent complexities and uncertainties that would result from applying the existing income tax law to emission units. The discrete income tax provisions specify the income tax treatment of units registered on the Australian National Registry of Emission Units. The ACCUs are such emission units (section 420-10 of ITAA 1997).

The Carbon Farming Initiative (CFI) is a carbon offset scheme that will allow project managers that are recognised offset entities to generate ACCUs through the abatement of greenhouse gases.

ACCUs represent abatement of greenhouse gases achieved as a result of offsets projects that remove carbon from the atmosphere and store it in soils or trees. You have undertaken an Avoided Deforestation Project. Under this project the established native forest must not be cleared and it is managed in order to achieve a mix of native trees, shrubs and understory species.

There are special rules in Division 420 of the ITAA 1997 that apply to your dealings in ACCUs that are registered on the Australian National Registry of Emissions Units.

You must include as assessable income the amounts you are entitled to receive when you sell or otherwise dispose of an ACCU arising from your eligible offsets project. You are entitled to deduct expenses incurred in preparing or lodging an application for a certificate of entitlement or an offsets report as part of the process of becoming the holder of ACCUs (subsection 420-15(4)).

If the value of the ACCUs you hold at the end of an income year has changed from the value of the ACCUs you held at the beginning of the income year, you will either include an amount in your assessable income or be entitled to a deduction under section 420-45 of the ITAA 1997. The cost of ACCUs issued to you by the clean Energy Regulator for the purpose of determining your closing value at the end of an income tax year is the market value just after they were issued to you (subsection 420-60(3)).

Section 420-10 includes in the meaning of registered emission units an Australian carbon credit unit (ACCU). The meaning of holding a registered emissions unit is provided in section 420-12 as: if you are the entity in whose Registry account (within the meaning of the Australian National Registry of Emissions Units Act 2011) there is an entry for the unit. The copy of the agreement between yourself and Terra Carbon Pty Ltd and the information on the Regulators website indicate that you are the holder of ACCUs on this registry.

You have disposed of a number of these units, therefore section 420-25 will apply to include these amounts in your assessable income in the year of disposal. Deductions for expenses incurred in ceasing to hold a registered emissions unit are allowed under section 420-42.

Subdivision 420-E sets out the law relating to the exclusivity of this Division in relation to deductions and income. The income from the disposal of ACCUs is dealt with specifically in subsection 420-70(4). This states that: An amount is not to be included in your assessable income under any provision of this Act outside this Division because an Australian carbon credit unit was issued to you in accordance with the Carbon Credits (Carbon Farming Initiative) Act 2011.

Note 1: A capital gain or capital loss you make from a registered emissions unit is disregarded (subsection 118-15(1)).

Note 2: A capital gain or capital loss you make from a right to receive an Australian carbon credit unit is disregarded (subsection 118-15(3)).

This clearly shows that the income from the sale of ACCUs will not give rise to any capital gain and therefore there will be no application of the small business concessions for capital gains tax.

Assessable Primary Production Income

For income to be subject to the primary production averaging provisions in Division 392 of the ITAA 1997, it must be considered 'assessable primary production income’ as defined in subsection 392-80(2) of the ITAA 1997. Regard has to be given to assessable income that was derived 'from’, or resulted 'from’ carrying on a primary production business.

Definition of primary production business

'Primary production business’ is defined in section 995-1 of the ITAA 1997:

primary production business : you carry on a primary production business if you carry on a ^*business of:

(a) cultivating or propagating plants, fungi or their products or parts (including seeds, spores, bulbs and similar things), in any physical environment; or

(b) maintaining animals for the purpose of selling them or their bodily produce (including natural increase); or

(c) manufacturing dairy produce from raw material that you produced; or

(d) conducting operations relating directly to taking or catching fish, turtles, dugong, bêche-de-mer, crustaceans or aquatic molluscs; or

(e) conducting operations relating directly to taking or culturing pearls or pearl shell; or

(f) planting or tending trees in a plantation or forest that are intended to be felled; or

(g) felling trees in a plantation or forest; or

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

(i) where they are first to be milled or processed; or

(ii) from which they are to be transported to the place where they are first to be milled or processed.

The eligible project activity that you are involved in, that gives rise to the ACCUs, is the 'avoided deforestation project’. This involves not clearing the project native forest (which you had the right to clear) and maintaining and managing it so that it can store carbon. This is a separate activity from your ongoing primary production business. The project does not fall within the definition above.

It can be seen that there needed to be a separate clause to cover forestry operations as they are not considered to be included in cultivating and propagating plants. Because the definition relates to a 'business’, it would ordinarily be inferred that item (a) applies to plants etc. that give rise to physical produce that is sold for a profit. However, if item (a) were to extend to non-physical products (ACCU’s), the activity would still need to involve 'cultivating or propagating’ the native flora. The project does not fall within the natural meaning of this expression. In your case you are maintaining a native forest. To fall within the definition of forestry operations included in a primary production business the trees you are tending would have to be for the purpose of felling. In your eligible project you are not allowed to clear the trees. The eligible offsets project does not meet the requirements of any of the clauses in the definition.

This argument is further supported by the information discussed on the issue of whether Mallee trees – grown and maintained for carbon credits were considered horticultural plants in ATO ID 2004/634. The term 'horticulture’ is defined in subsection 40-535(1) of the ITAA 1997 and includes a list of items which is not an exhaustive list, but there are certain features common to them. In particular, all of the products or parts listed are severable from the plant, extracted from the plant in some way or result in the partial or total displacement of the plant.

An element of the carbon sequestration regime is that the trees must be maintained and not harvested, or have any part of them severed or extracted. The carbon is stored in these plants.

Assessable income 'from’ a primary production business

The assessable income derived from the sale of the ACCUs is not income 'from’ your activity. A good explanation of assessable income 'from’ a business activity is provided in TD 2013/2 Income tax: does ordinary income derived by an individual from allowing wind farming infrastructure to be constructed, operated and accessed on freehold land that they own and use in carrying on a primary production business constitute 'assessable primary production income’ of that individual for the purposes of Division 392 of the Income Tax Assessment Act 1997?:

10. In Watson v. Deputy Commissioner of Taxation (2010) 182 FCR 104; [2010] FCAFC 17; 2010 ATC 20-167; (2010) 75 ATR 224 ( Watson ), the Full Federal Court considered the phrase 'assessable income from the business activity' for the purposes of subsection 35-10(2) of the ITAA 1997. The court noted that the primary question was the meaning of the word 'from' in the expression.¹ In that regard, the court referred to Beaumont J in BHP Petroleum (Timor Sea) Pty Ltd v. Minister for Resources (1994) 49 FCR 155 at 170-171 who stated:

In my opinion, ... 'from' is intended to have its dictionary meaning, that is to say, to indicate the starting point, source or origin ...

and held that a similar meaning should be given to the word 'from' for the purposes of subsection 35-10(2).²

11. In considering the words before them, Dowsett, Stone and Bennett JJ noted in Watson that the taxpayer's 'income will be from his business activity... if it can be related in some way to the business which he has conducted ...'.³

12. The court also noted:

If the starting point or source of the assessable income must be the business activity carried on in that year, the extent and nature of that business activity must be identified before one can determine whether or not particular income is 'from' it... that such activity was the origin of that income.⁴

13. On this basis, it is only ordinary income derived from or resulting from the particular primary production business being carried on that can constitute 'assessable primary production income' for the purposes of subsection 392-80(2) of the ITAA 1997.

The assessable income we are considering is from the sale of the ACCU’s that were issued on the basis of the eligible project undertaken in conjunction with the company as your agent, on the property. It is the fact that you have the legal right to carry out the project and you hold the applicable carbon sequestration right for this property, that allows you to conduct the activity on the property and derive the income. It would be possible for taxpayers to do this even if they did not carry on a business (or any kind of business) on the property. This project does not fit within the definition of 'primary production business’ and it is not part of your current primary production business. Support for this is found in Taxation Ruling TR 95/6 at paragraph 14:

14. The planting, tending or felling of trees will only be forest operations if those operations amount to the carrying on a business. A person who plants, tends or fells trees but is not carrying on a business is not conducting forest operations. This is so even though the person may be conducting another form of primary production business. Similarly, a person who merely sells standing timber without tending or felling those trees is not conducting forest operations. [emphasis added]

Your eligible offsets project is not considered a forestry operation in terms of this ruling. You are running a primary production business activity and income would be derived from the sale of these animals or their bodily produce. This is clearly primary production income within the definition above. This activity is carried on, on this property, but it does not mean that because the project is also carried on at the property that it is all the same business. Two separate activities can be carried on at the property. There is no causative connection between the income derived from the sale of the ACCUs and the primary production business being carried on.

The ultimate income from the eligible offsets project and not clearing trees is from the sale of the ACCUs. This income is assessable under Division 420 of the ITAA.

The income from the sale of the ACCUs is not 'assessable primary production income’ under subsection 392-80(2) of the ITAA 1997.

Other considerations

Taxation Rulings IT 210 and IT 225 contemplate that the short term hiring of plant from one primary producer to another would be a recognised incident of carrying on a business of primary production and thus income from the occasional short term hire to other primary producers would be income from carrying on a primary production business. However, where a separate hiring business is being operated by a primary producer or where hiring is done on a regular basis, the income from the hire of plant would not be income from carrying on a primary production business.

The eligible offsets project and the eventual sale of the ACCUs can be distinguished from these types of activities. The eligible offsets project description is: The protection of native forests through the prevention of clearing and clear felling harvesting activities. It does not fall within the definition of a primary production as there is no intention to harvest the trees or part of the trees. In fact it is the opposite, as the trees are to be preserved. The Emissions Reduction Fund requires sequestration projects to choose a permanence period of either 25 or 100 years. Once you have nominated a permanence period you will not be able to vary that period. In your case you have nominated a period of 100 years. The eligible offsets project is not something happening on an occasional basis in association with the primary production business that is carried on. It is a separate activity of substantial scale in terms of the amount of income derived from the sale of ACCUs, it cannot be considered a primary production business and the income derived from the sale of ACCUs is not primary production income.

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