Edited version of private ruling

Authorisation Number: 1011911107368

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Subject : Capital Gains Tax - Water entitlement

Question

Is the sale of a water entitlement a CGT event for the purposes of section 104-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period

1 July 2009 to 30 June 2010

The scheme commenced on

1 July 2010

Relevant facts

Person XX inherited the farming property on which you both reside post September 19XX. Included as part of the property was a water entitlement. There was no specific or separate value placed on the entitlement at this time.

You later you jointly purchased an adjoining farming property which included another water entitlement.

The properties have both been used in your farming business continuously from the date of acquisition.

Later, the water was 'unbundled' from the land under the relevant legislation and became a separate asset to the land.

By reference to the relevant government register you have determined the water value at the time of unbundling to be $X per mega litre.

In 20XX you sold both water entitlements to the government as part of a buyback scheme for an amount exceeding $X.

You wish to know the CGT implications of this sale.

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 section 112-25(3)
Income Tax Assessment Act 1997 Part 3-3
Income Tax Assessment Act 1997 Division 128
Income Tax Assessment Act 1997 Division 152

Reasons for decision

Summary

The sale of the water will result in a capital gains event. The gain will be your respective share of the capital proceeds from the disposal less the cost base.

Detailed reasoning

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 entitlements, including access licences, water allocations, extraction components, and supplementary licences, are CGT assets.

A capital gain or a capital loss is made when a CGT event happens to an asset. A CGT event may also happen when a right is created over and asset.

A person who acquires a water entitlement as a beneficiary of a deceased estate

When a person dies there is a change of ownership of the deceased's CGT assets. If a person acquires a water entitlement as a beneficiary, the cost base of the asset is either:

if the water entitlement was acquired by the deceased pre-CGT, the market value of the entitlement on the day the person died, or

if the water entitlement was acquired by the deceased post-CGT, the cost base of the asset on the day the person died.

A water entitlement is separated from the land

If the separation of a water entitlement is a result of a change in the relevant State legislation, the owner of the land will have two CGT assets, being the land and the water entitlement. More than one water entitlement could be separated from the land. No CGT event happens on this splitting of a CGT asset into two or more assets.

Cost bases of relevant split assets: "reasonable apportionment"

The cost base of the relevant asset that emerges after the change in the form of the original asset is determined by section 112-25(3) of the ITAA 1997. Each element of the cost base or reduced cost base of the relevant asset must be determined. Then these elements must be apportioned "in a reasonable way" between the assets that result from the split or change. "Reasonable" can have a number of meanings.

Taxation Determination TD 97/3 provides guidance on what the Tax Office 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, e.g. on an area basis or relative market value basis.

Permanent trade

Where an owner permanently disposes of a water entitlement, CGT event A1 happens (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.

Calculation of capital gain

CGT Event A1

The general rule for working out a capital gain is as follows:

Please refer to the Guide to Capital Cains Tax for further information regarding capital gains tax.

In order to work out the net capital gain for the income year, you must:

· reduce the capital gains made from CGT events in the year by any capital losses from other CGT events that took place in the year; then

· apply any unused capital losses from previous years against any remaining capital gains; then

· reduce any capital gains that remain by the discount percentage (if the CGT general discount is applicable to that capital gain); then

· apply any of the small business concessions of Division 152 of the ITAA 1997 that are applicable; and finally

· add up the remaining capital gains, which are termed the net capital gains.

Application to your circumstances

When the properties were acquired, there was no separate value affixed to the water rights.

The water was 'unbundled' from the land under the relevant legislation and became a separate asset to the land. You have determined the water value at the time of unbundling to be $X per mega litre.

As there was no value affixed to the asset prior to the unbundling, it would be reasonable in the circumstances to treat this as the cost base of the asset.

The capital gain will be the amount of sale less the cost base determined above.

Calculations of the net capital gain and eligibility to apply the various concessions available under Division 152 of the ITAA 1997 have not been considered in this ruling.