Edited version of your written advice

Authorisation Number: 1051180836934

Date of advice: 13 January 2017

Ruling

Subject: Capital gains tax - cost base - water entitlement

Question

Whether you can apply a weighted average price for Permanent Water at time of unbundling as the cost base with regard to capital gains tax calculations?

Answer

No

This ruling applies for the following period(s)

Year ended 30 June 2016

Relevant facts and circumstances

You are the trustee of the deceased's estate.

Post 20 September 1985, the deceased acquired farm land property including permanent water holding from the estate of their parent. The total market value at their date of death was established. The parent acquired the property prior to 20 September 1985.

In 20XX under the state Water Act, water was unbundled from the land and became a separate asset to the land.

You have provided a copy of advice from a water valuing firm showing what the weighted average price for the water entitlement would have been per megalitre at the time of unbundling.

You have sold the water entitlement.

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.

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.

A person who acquires assets 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 an asset as a beneficiary, the cost base of the asset is either:

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

● if the asset was acquired by the deceased post-CGT, the deceased's cost base of the asset on the day they died.

Where land was acquired after 20 September 1985 but before a water entitlement was separated from the land

You have stated that when the property was inherited the total market value was established. This market value would be your cost base as the deceased's parent had purchased the property prior to 20 September 1985.

Under the government initiative, water rights were separated from the land in 20XX. When this happened the deceased acquired separate water licences for the property.

When an original asset is divided into two assets without any change in beneficial ownership, subsection 112-25(2) of the ITAA 1997 provides that the splitting is not a CGT event. Thus the water licence is taken to have been acquired when the land was acquired.

When an asset is split into two or more assets, the cost base and reduced cost base of each new asset is worked out under the method statement in subsection 112-25(3) of the ITAA 1997. Under the method statement, each element of the original assets cost base or reduced cost base is apportioned in a reasonable way to each new asset.

The market value of the property when the deceased acquired it will be your total cost base for the original asset of land and water rights combined. This amount has to be apportioned between the two assets that have been created with the splitting of the original asset in 20XX.

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 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 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.

Application to your circumstances

You have disposed of the water entitlement. To determine the capital gain you have to calculate the cost base for the water entitlement. This calculation will involve a reasonable apportionment of the total cost base which is your cost base for the property and water entitlement before unbundling of the water entitlement in 20XX.

The cost base of the water entitlement could not exceed this total market value. It would have to be some value less than this as the land would have to have some value.

You cannot use the weighted average price per megalitre which was estimated as the value at the time of unbundling.