Edited version of private advice

Authorisation Number: 1052169793122

Date of advice: 21 September 2023

Ruling

Subject: CGT - biodiversity credits

Question 1

Are biodiversity credits issued to you a CGT asset?

Answer

Yes.

Question 2

Can the Total Fund Deposit (TFD) form part of the cost base of the Biodiversity Credits?

Answer

Yes.

Question 3

Are biodiversity credits that are held on capital account active assets for CGT purposes?

Answer

Yes.

This ruling applies for the following period:

30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The partnership operates a primary production business on land which they have owned for almost XX years.

The land is held on capital account.

The partners entered into a Biodiversity Stewardship Agreement (BSA) under the Biodiversity Conservation Act 2016 (NSW).

The biodiversity stewardship site designated under the agreement related to numerous lots.

Under the BSA, the partners have agreed to carry out management actions (which includes refraining from carrying out certain activities) and meet certain reporting obligations.

In relation to the biodiversity stewardship site, biodiversity credits are determined in accordance with the biodiversity assessment method. The credits are created in respect of management actions to be carried out under the BSA and has a fund attributable to it.

A central component of the agreement requires that the TFD must be paid into the Biodiversity Stewardship Payments Fund, managed by the Biodiversity Conservation Trust (BCT), before the first transfer of each biodiversity credit can be registered. The TFD is the amount representing the present value of the total of all scheduled management payments in respect of the site.

The TFD in the biodiversity conservation trust was over $1 million.

The partners sold all of the biodiversity credits for over $1 million.

All biodiversity credits were sold in this agreement.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 31-5 (5)

Income Tax Assessment Act 1997 subsection 104-47 (1)

Income Tax Assessment Act 1997 subsection 104-47 (4)

Income Tax Assessment Act 1997 subsection 108-5

Income Tax Assessment Act 1997 section 110-25 (3)

Income Tax Assessment Act 1997 section 110-35

Income Tax Assessment Act 1997 subsection 116-20 (1)

Income Tax Assessment Act 1997 subsection 152-40 (1)

Income Tax Assessment Act 1997 subsection 152-40 (4)

Reasons for decision

Question 1

Subsection 108-5(1) defines a CGT asset as:

a)    any kind of property; or

b)    a legal or equitable right that is not property.

Biodiversity credits fall within the definition of a CGT asset under paragraph 108-5(1)(a) of the ITAA 1997 as it is a form of intangible property.

Question 2

As the biodiversity credits are a CGT asset, the sale of the credits by the partners constitutes CGT event A1.

Subdivision 110-A of the ITAA 1997 contains rules for calculating the cost base of a CGT asset on the happening of most CGT events. The cost base is necessary in working out whether the taxpayer made a capital gain and the amount of the gain

The second element of the cost base of a CGT asset is the incidental costs (subsection 110-25(3) of the ITAA 1997).

Certain costs incurred are included as incidental costs to acquire a CGT asset or that relate to a CGT event (subsection 110-35(1) of the ITAA 1997).

Relevantly, of the incidental costs listed in section 110-35 of the ITAA 1997:

-        subsection 110-35(3) includes 'costs of transfer'; and

-        subsection 110-35(11) includes 'termination or other similar fees incurred as a direct result of your ownership of a CGT asset ending'.

Regarding subsection 110-35(11) of the ITAA 1997, it is noted that this subsection was added in 2010 with paragraph 2.84 of the Explanatory Memorandum (EM) to the Tax Laws Amendment (2010 Measures No. 4) Bill 2010 explaining that: 'Typically, termination fees (and exit fees) are contractual fees imposed by one party on the other as a result of the second party breaking the contract.'

The payment of the TFD (either in full or in part, depending on the circumstances) to the Biodiversity Stewardship Fund is a necessary prerequisite to registration of the first transfer or retirement of the relevant biodiversity credits. This feature is highlighted in a note in the Payment schedule of the BSA which states: 'Section 6.21 of the Biodiversity Conservation Act 2016 (NSW) requires that the Total Fund Deposit (or a portion thereof if not all credits generated in connection with the Biodiversity Stewardship Site are being transferred) must be paid into the Biodiversity Stewardship Payments Fund before the first transfer (or retirement without transfer) of each Biodiversity Credit can be registered.'

Accordingly, given that the payment of the TFD is required to affect the record of transfer/change of ownership of the assets from the sale or retirement of the biodiversity credits, it is accepted that the TFD is:

a)    a 'cost of transfer' where a biodiversity credit is transferred or sold and CGT event A1 happens (subsection 110-35(3)); and

b)    'a termination or other similar fees incurred as a direct result of your ownership of a CGT asset ending', where a biodiversity credit is retired and CGT event C2 happens (subsection 110-35(11)).

Consequently, the TFD paid is an 'incidental cost', as described in section 110-35 of the ITAA 1997, incurred by the partners that can be included in the cost base of each biodiversity credit generated from entering into the BSA.

The TFD should be reasonably apportioned across the biodiversity credits generated from entering into the BSA pursuant to subsection 112-30(1A) of the ITAA 1997.

Question 3

CGT event A1 happens on the disposal of a CGT asset. A CGT asset is disposed of when there is a change of ownership, whether because of some act or event or by operation of law (section 104-10 of the ITAA 1997).

In this case CGT event A1 will occur if you enter contracts with a purchaser for the sale of biodiversity credits.

Section 152-40 of the ITAA 1997 states:

A CGT asset is an active asset at a time if, at that time:

c)    you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a * business that is carried on (whether alone or in partnership) by:

                    i.    you; or

                   ii.   your affiliate; or

                  iii.    another entity that is connected with you; or

d)    if the asset is an intangible asset-you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

It must be demonstrated that, under paragraph 152-40(1)(b) of the ITAA 1997, the biodiversity credits, as an intangible asset, are inherently connected with the farming business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

The biodiversity credits arise in satisfaction of the amount the landowner is entitled to receive on signing the BSA that creates a conservation covenant over their land. The conservation covenant is a permanent burden on the land, that would also burden the purchaser should the land be sold at a future point in time.

The credits would not be received but for the conservation covenant on the land, which is used in the farming business. The credits are therefore inherently connected with that business and the land it uses to undertake that business. As the land is used in the farming, it is an active asset for the purposes of Section 152-40 of the ITAA 1997.

As a result, the biodiversity credits will be active assets under paragraph 152-40(1)(b) of the ITAA 1997 for the purpose of the small business CGT concessions.

The remaining relevant requirements in Division 152 of the ITAA 1997 must be met to qualify for the small business CGT concessions.

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