Edited version of private advice

Authorisation Number: 1051605267548

Date of advice: 8 November 2019

Ruling

Subject: Conservation covenant

Question 1

Is the capital gain or loss that you incurred when the option was granted disregarded when the option was exercised?

Answer

Yes.

Question 2

Does CGT event D4 apply to the portion of the Offset Area Fee that relates to the conservation covenant?

Answer

Yes.

Question 3

Is the portion of the Offset Area Fee that relates to the provision of services under the management plan assessable income?

Answer

Yes.

Question 4

Is the portion of the Works Amount that relates to the additional land included in the Offset Area classified as additional capital proceeds for CGT event D4 happening and for the provision of services under the management plan?

Answer

Yes.

Question 5

Is the portion of the Works Amount that relates to enclosing the offset area an assessable recoupment?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX to year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You and a Company have entered into a call option for offset agreement and a related Offset Deed.

The company is required to offset certain environmental impacts and in this respect it wishes to locate an offset area on the land owned by you.

The fundamental outcome of entering into the offset deed is that your rights in relation to the land will be permanently changed and you will undertake management activities associated with the management of the offset area.

The permanent change to the status of the land effectively means that you cannot undertake the clearing of any land subject to the offset while grazing of the land by livestock will only be permitted in the short term for brief periods for the purpose of fuel reduction to prevent fires. In the long term the increase in leaf canopy cover will result in little, if any, grass growth. Accordingly, the effect of the legally binding arrangement is that the value of the area of land subject to the offset deed, for agricultural purposes will be reduced to nil.

The legally binding arrangement will be recorded on the title of the property and will be binding not only on the current owner of the land but also on future owners of the land.

You entered into a call option for the offset agreement and received a call option fee.

The option was exercised and an offset deed was signed.

You will receive an Offset Area Fee which is calculated based on the size of the land included in the offset area.

You are required to undertake a number of management actions that will reduce or eliminate the risk of clearing habitat and will increase the conditions of the ecosystems.

You received a Works Amount to enclose the offset area. A portion of this payment covers the additional land that was included in the offset area when the fencing was constructed.

The Minister administering the Environment Protection and Biodiversity Conservation Act 1999 (the Environment Minister) has given the approval required for the arrangement entered into to be a conservation covenant.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 section 20-20

Income Tax Assessment Act 1997 subsection 20-25(1)

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

Income Tax Assessment Act 1997 subsection 43-20(2)

Income Tax Assessment Act 1997 section 43-25

Income Tax Assessment Act 1997 subsection 104-40(1)

Income Tax Assessment Act 1997 subsection 104-40(5)

Income Tax Assessment Act 1997 section 104-47

Reasons for decision

Option

Under subsection 104-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997), CGT event D2 happens if you grant an option to an entity, or renew or extend an option you had granted. The time of the event is when you grant, renew or extend the option.

You make a capital gain if the capital proceeds from the grant of the option are more than the expenditure you incurred to grant it. You make a capital loss if those capital proceeds are less.

Under subsection 104-40(5) of the ITAA 1997, a capital gain or loss you make from the grant of the option is disregarded if the option is exercised. Where the option is exercised, the granting of the option on a particular date and the exercise of the option is treated as a single transaction in relation to the grantor.

In your case you granted an option that was subsequently exercised. Therefore the capital gain from the grant of the option is disregarded and the capital proceeds for the new CGT event include any payment you received for granting the option.

Conservation covenant

Section 104-47 of the ITAA 1997 provides that CGT event D4 happens if you enter into a conservation covenant over land that you own. The time of the event is when you enter into the covenant.

If the capital proceeds from entering into the covenant are more than the part of the cost base of the land that is attributed to the covenant, you make a capital gain. If the capital proceeds are less than the part of the reduced cost base of the land attributable to the covenant, you make a capital loss.

Subsection 31-5(5) of the ITAA 1997 defines a conservation covenant over land as a covenant that:

·  restricts or prohibits certain activities on the land that could degrade the environmental value of the land;

·  is permanent and registered on the title to the land (if registration is possible); and

·  is approved in writing by, or is entered into under a program approved in writing by the Environment Minister.

In your case, the arrangement you have entered into satisfies the definition of a conservation covenant. Therefore when the offset deed was entered into CGT event D4 occurred for the portion of the Offset Area Fee and Works Amount that relates to the conservation covenant over the land.

Management services

Subsection 6-5(1) of the ITAA 1997 provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). However, as there is no definition of 'ordinary income' in income tax legislation it is necessary to apply principles developed by the courts to the facts of each case.

In MIM Holdings Ltd v. Commissioner of Taxation 97 ATC 4420; (1997) 36 ATR 108, Northrop, Hill and Cooper JJ, relying on Hayes v. Federal Commissioner of Taxation (1956) 96 CLR 47 and Reuter v. Federal Commissioner of Taxation (1993) 111 ALR 716; 93 ATC 4037; (1993) 24 ATR 527 said that 'amounts paid in consideration of the performance of services will almost always be income'.

The question of whether an amount is a product of the taxpayer's services (that is, paid in consideration of the performance of the taxpayer's services) has been considered in a number of High Court decisions. The following guidance is afforded by those decisions:

·  the whole of the circumstances must be considered;

·  a generally decisive consideration is whether the receipt is the product in a real sense of any employment of, or services rendered by the recipient, or of any business, or any revenue production activity carried on by the recipient;

·  other considerations that are relevant but not decisive include:

-  the motive of the donor (payer) in paying the amount;

-  the regularity and periodicity of the payment however a payment in a lump sum does not require a conclusion that the payment is capital; and

-  the recipient's expectation that an amount will be received.

In your case, you have entered into an agreement under which you provide management services on your land. Accordingly, the portion of the Offset Area Fee and Works Amount you receive under the agreement that relates to the management services is ordinary income and is assessable under section 6-5 of the ITAA 1997.

Works Amount

The meaning of an assessable recoupment is set out in section 20-20 of the ITAA 1997.

Subsection 20-25(1) of the ITAA 1997 states that a recoupment of a loss or outgoing includes any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery however described and a grant in respect of the loss or outgoing.

An amount will be an assessable recoupment under subsection 20-20(2) of the ITAA 1997 if it is considered to be received by way of insurance or indemnity and the taxpayer can deduct or has already claimed a deduction for it. It is clear in this case that the recoupment will not be received by way of insurance.

Indemnity is not a defined term and therefore must be given its ordinary meaning. The ordinary meaning of the word 'indemnity' gleaned from dictionary definition includes 'a sum of money paid to compensate a person for liability, loss or expense incurred by the person' (Butt PJ (ed), Butterworths Concise Australian Legal Dictionary (3rd ed, LexisNexis, 2005) (at 217)).

Division 43 of the ITAA 1997 allows a deduction for capital expenditure incurred in constructing income producing capital works including building and structural improvements. The deduction is referred to as a capital works deduction.

Under subsection 43-20(2) of the ITAA 1997 a deduction is available on the cost of constructing structural improvements or extensions, alterations or improvements to structural improvements if the construction started after 26 February 1992.

Section 43-25 of the ITAA 1997 states that for structural improvements, the annual capital works deduction allowable is 2.5% of the construction expenditure for a period of 40 years. Construction expenditure is the actual cost of constructing the capital works

In your case, a portion of the Works Amount that you receive compensates you for the outgoing of enclosing the offset area. Consequently it is an amount received by way of indemnity. You will receive assessable income for the management activities you undertake on the offset area. The works undertaken to construct the fence are considered to be capital works for the purposes of Division 43 of the ITAA 1997. Consequently, you can deduct an amount for the loss or outgoing under a provision of the ITAA 1997. Therefore, the portion of the Works Amount received that relates to enclosing the offset area is considered an assessable recoupment under subsection 20-20(2) of the ITAA 1997.

Apportionment

Taxation Ruling TR 95/35 deals with the issue of compensation and outlines when it may be relevant to consider the compensation in the context of an underlying asset.

If the compensation is received in relation to multiple heads of claim, TR 95/35 allows a reasonable apportionment of that payment. For example, if a payment is intended to replace both an income stream and other potential benefit entitlements, the payment may be apportioned between the two heads of claim on a reasonable basis.

In your case, the payments you received cover multiple items. Therefore the payments will need to be apportioned between their component parts on a reasonable basis.