Edited version of private advice

Authorisation Number: 1051821375616

Date of advice: 24 May 2021

Ruling

Subject: CGT - cost base - water entitlement

Question

Can you include the licence and allocation fees required to hold the water rights in the cost base of the water rights?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You purchased XXX hectares of agricultural land with a dwelling after 20 August 19XX.

At that time the water rights were attached to the land.

The State of XXX later introduced a statutory water allocation scheme.

In 20XX your water rights were unbundled from the land under the scheme.

The rights consist of a water licence and a water allocation entitlement.

You paid fixed charges for the maintenance of channels and infrastructure, and water allocation charges for the quantity of water you can take.

You never used the property or water rights to earn income so never claimed a tax deduction for those periodic water rights charges.

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 108-5

Income Tax Assessment Act 1997 subsection 110-25(4)

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 Income Tax Assessment Act 1997 (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 on or after 20 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.

A water entitlement is separate from the land

If the separation of a water entitlement from the land is a result of a change in the relevant State legislation, the owner of the land will have two or more CGT assets: the land and any water entitlements. More than one water entitlement can be separated from the land, for example a water licence and a water allocation. Subsection 112-25(2) of the ITAA 1997 makes it clear that a CGT event does not happen at the time the CGT asset is split into two or more assets.

CGT event

CGT event A1 happens at the time an owner permanently disposes of a water entitlement (section 104-10 of the ITAA 1997). This event happens when the owner enters into a contract or, if there is no contract, when the change of ownership occurs. The owner makes 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 if the reduced cost base of the water entitlement exceeds the capital proceeds.

Cost base of split assets: 'reasonable apportionment'

Where the original asset is split into two or more assets, the method statement in subsection 112-25(3) of the ITAA 1997 is used to work out each of the new asset's cost base. In your case, the land and the water rights are the new assets. Firstly, you need to work out the cost base of the original asset - the land - at the time it was split or changed. Secondly, you need to apportion in a reasonable way each element of the cost base to the new asset.

Taxation Determination TD 97/3 provides guidance on what the ATO considers to be reasonable. In determining, for the purposes of section 112-25 of the ITAA 1997, the extent to which it is reasonable to attribute each element of the cost base and reduced cost base of the original land to the corresponding element of the cost base and reduced cost base of each new asset, we would accept any approach that is appropriate in the circumstances of the particular case, for example, on a relative market value basis.

Application to your circumstances

You asked whether the fees to hold the water rights can be included in the third element of its cost base. These include fixed charges and water allocation charges. You incurred the charges to maintain the water rights which were acquired after 20 August 1991 and these charges were not deductible. Based on these facts, the expenses can be included in the third element of the cost base (subsection 110-25(4) of the ITAA 1997).

To determine the capital gain, you also need to calculate the first element of the cost base for the water entitlement. This calculation will involve a reasonable apportionment of the cost base of the of the property when you originally purchased it. The first element of the cost base of the water entitlement could not exceed the original cost base of the property. It would have to be some value less than this as the land would have to have some value.

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