Edited version of your written advice

Authorisation Number: 1013032138063

Date of advice: 9 June 2016

Ruling

Subject: Whether assessable primary production income

Question

Is the income from the sale of the Australian Carbon Credit Units (ACCUs) considered to be assessable primary production income under subsection 392-80(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period(s)

Year ending 30 June 3016

The scheme commences on

1 July 2015

Relevant facts and circumstances

You operate a farm/primary production business in partnership.

All the partners have been farming all of their lives.

You have recently sold ACCUs.

Under the carbon credit contract, you have to maintain firebreaks, fencing and monitor wild animals. Primary production assets are used to carry out these duties.

The plants are on hand and are preserved to be able to generate the carbon which is a product of the plants.

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.

Detailed reasoning

Australian Carbon Credit Units

The income being considered is from the sale of ACCUs.

The Carbon Farming Initiative (CFI) allows farmers and land managers to earn carbon credits by storing carbon or reducing greenhouse gas emissions on the land. These credits can then be sold to people and businesses wishing to offset their emissions.

Carbon credits cannot be issued for business-as-usual activities. To be eligible, projects must deliver extra reductions in greenhouse gas emissions. This is known as "additionality" and is a requirement of all offset schemes. The CFI includes a list of eligible activities - called the "positive list"- that are not common practice and deliver additional abatement.

What is an ACCU?

An ACCU is a unit issued to a person by the Clean Energy Regulator (Regulator) by making an entry for the unit in an account kept by the person in the electronic Australian National Registry of Emissions Units (Registry). Each ACCU issued represents one tonne of carbon dioxide equivalent (tCO₂-e) stored or avoided by a project. An ACCU can only be issued to a person if the person has a Registry account and a Registry account can only be opened by a person after the Regulator has considered whether they are a 'fit and proper person'.

Issue of ACCUs

The Regulator issues ACCUs for greenhouse gas abatement activities undertaken as part of the Australian Government's Emissions Reduction Fund. The issuance of ACCUs is governed by the CFI Act 2011, the Carbon Credits (Carbon Farming Initiative) Regulations 2011(CFI Regulations 2011) and the Carbon Credits (Carbon Farming Initiative) Rule 2015 (CFI Rule 2015).

Eligible activities are undertaken as 'eligible offsets projects'. There are a number of requirements that must be satisfied before a project can be declared an 'eligible offsets project', and there are ongoing requirements in undertaking an eligible offsets project. The requirements include:

• The project proponent must pass a 'fit and proper person test'.

• There must be an approved methodology for the type of project.

• The project must deliver abatement that is additional to what would occur in the absence of the project.

• The project must meet the applicable 'additionality' requirements.

• The project must be undertaken in accordance with the methodology and comply with other scheme eligibility requirements.

• The project proponent must report to the Regulator about the conduct of the project and the abatement achieved. Certain reports must be accompanied by a report prepared by a registered greenhouse and energy auditor.

Property rights in ACCUs

An ACCU is personal property. The registered holder of an ACCU - the person in whose Registry account there is an entry for the ACCU - is its legal owner and may, subject to the CFI Act 2011 and the Australian National Registry of Emissions Units Act 2011 (ANREU Act 2011), pass good title to the ACCU to another person.

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 Emission Units.

Assessability of payments from the sale of ACCU's

You have derived income from the sale of Australian Carbon Credit Units (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 an 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).

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 nil 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).

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. 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.

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 grazing/farming primary production business. The eligible 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. 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 of a primary production business.

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.

The key 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 and ACCUs, are issued on the basis of the carbon stored.

Assessable income 'from' a primary production business

The assessable income derived from the sale of the ACCUs is not income 'from' your grazing activity. A good explanation of assessable income 'from' a business activity is provided in TD 2013/2:

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 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. 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, but similarly it is not part of your grazing/farming business.

Your primary production business activity is one of livestock grazing/farming and income would be derived from the sale of produce/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 eligible 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 grazing/farming 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 and not assessable under any other section of the ITAA 1997, under the exclusivity provisions of Sub-division 420-E.

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 contemplates 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 is ongoing as further ACCUs can be obtained in later years if reports show an increased storage of carbon. It cannot be considered a primary production business and the income derived from the sale of ACCUs is not primary production income.