| Disclaimer This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law. You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4. |
Edited version of your written advice
Authorisation Number: 1051262401568
Date of advice: 1 August 2017
Ruling
Subject: Income Tax- Capital Gains Tax – Water Rights
Question 1:
Is an interest in a water license a capital gains tax (CGT) asset as defined under section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Answer:
Yes.
Question 2:
Does the Commissioner accept as reasonable the company’s method of apportionment of the cost base of the water licenses?
Answer:
Yes.
This ruling applies for the following periods:
Year ended 30 June 2017
The scheme commences on:
1 July 2016
Relevant facts and circumstances
The company was incorporated at a point in time.
The company issued two fully paid ordinary shares to the following shareholders:
● Shareholder A
● Shareholder B
The company acquired two water licences (the licences).
The licences were transferred to the company from another entity owned by the shareholders of the company.
The value of the water licences at the time of the transfers was nil as a market did not exist in relation to the trading of water rights.
In the 20XX-XX income year the company, Shareholder A and Shareholder B agreed to sell 50% of the licences to a third party.
The company made a gain of the sale of the water rights.
The company is not carrying on a business of buying and selling water rights.
In 2009, amendments were made to the Natural Resources Management Act 2004 to meet requirements of the National Water Initiative to separate or 'unbundle’ water rights and make the transfer of water rights easier.
Relevant legislative provisions
Income Tax Assessment Act 1997 Part 3-1
Income Tax Assessment Act 1997 Section 104-5
Income Tax Assessment Act 1997 Section 104-10
Income Tax Assessment Act 1997 Section 112-25
Income Tax Assessment Act 1997 Subsection 112-25(3)
Reasons for decision
The CGT provisions in Parts 3-1 and 3-3 of the ITAA 1997 apply to CGT assets. A CGT asset is defined broadly as any kind of property, or a legal or equitable right that is not property.
Water Rights
Water rights, such as licences and water allocations are CGT assets as defined in section 108-5 of the ITAA 1997. They are legal rights existing by the terms of the prevailing State legislation and therefore satisfy the definition.
Where a water right has been acquired after 19 September 1985 any disposal of that right will have CGT consequences. The capital gain on each disposal will equal the excess of the consideration over the cost base.
In this case, the company has acquired two water licences. Therefore, the company has CGT assets to which a CGT event may happen.
CGT event
A capital gain or capital loss will occur when a CGT event happens to a CGT asset. The most common CGT event occurs when a CGT asset is disposed of, CGT event A1.
Where an owner permanently disposes of their water entitlement, for example by sale or assignment, CGT event A1 happens. This event happens when the owner enters into the contract. If there is no contract, the event happens when the change of ownership occurs.
You make a capital gain to the extent that the capital proceeds from the disposal exceed the cost base of the water entitlement. A capital loss is made to the extent that the reduced cost base of the water entitlement exceeds the capital proceeds. Split or changed assets When an asset is split into two or more assets subsection 112-25(1) of the ITAA 1997 set out what happens: |
(a) a CGT asset (the original asset) is split into 2 or more assets (the new assets); or
(b) a CGT asset (also the original asset) changes in whole or in part into an asset (also the new asset) of a different nature;
and you are the beneficial owner of the original asset and each new asset.
Taxation Determination TD 97/3 (TD 97/3) provides guidance on the application of sections 112-25 and 112-30 of the ITAA 1997. Paragraphs 4 and 5 of TD 97/3 states the following:
4. If an original land parcel is split into two or more blocks, and you are the beneficial owner of the original land parcel and each of the new blocks, section 112-25 provides that each element of the cost base and reduced cost base of the original asset (worked out at the time of the split) is apportioned in a reasonable way and included in the corresponding element of the cost base and reduced cost base of each new asset.
5. The consequences above should be contrasted with a situation where a person disposes of an interest in land. For example, a person may dispose of a 50% interest in land the person owns. The disposal of the 50% interest in the land constitutes a disposal of part of the land to which section 112-30 applies.
In this case, the company acquired two water licences and is selling 50% interest in the water licence allocation to a third party. Accordingly subsection 112-25(1) of the ITAA 1997 has no application in this case as the company is not splitting the assets but selling it water licence allocations giving rise to a CGT event A1.
Cost base
The cost base of a capital gains tax (CGT) asset is generally the cost of the asset when you bought it, plus certain other costs associated with acquiring, holding and disposing of the asset.
The 5 elements of the cost base are:
● Element 1 (subsection 112-25(2) of the ITAA 1997): The money paid to acquire a CGT asset; and the market value of any property you gave to acquire the asset.
● Element 2 (subsection 112-25(3) of the ITAA 1997): Incidental costs.
● Element 3 (subsection 112-25(4) of the ITAA 1997): Non-capital costs of owning a CGT asset (but only acquired after 20 August 1991).
● Element 4 (subsection 112-25(5) of the ITAA 1997): Capital expenditure incurred to increase or preserve the asset value or that relates to installing or moving the asset.
● Element 5 subsection 112-25(6) of the ITAA 1997: Expenditure incurred to establish, preserve or defend the title to a CGT asset.
Application to the company’s circumstances
A review of the information you have provided indicates that at the time acquiring the water licences the value of the licences were nil. As the company did not transfer all of its water licence allocations, but retained 50% of the allocation, the cost base needs to be apportioned.
The cost base apportionment rules are contained in section 112-30 of the ITAA 1997.
In this case as the value of the licences was nil, the cost base for each water licence is also nil.
Copyright notice
© Australian Taxation Office for the Commonwealth of Australia
You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).
