Edited version of private advice

Authorisation Number: 1051668947892

Date of advice: 6 May 2020

Ruling

Subject: Income tax - assessable income

Question

Are the amounts received for management actions under the conservation covenant assessable income?

Answer

Yes

Question

Are the expenses for the required management actions plan deductible?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2020 to 30 June 2024

The scheme commences on:

1 July 2019

Relevant facts and circumstances

You and your spouse (the land owners) own a property located in a relevant State (the property).

The property is not used to produce income.

On XX August 20XX the land owners executed a conservation covenant covering a portion of the property.

The land owners agree to carry out the management activities.

The land owners will receive payments starting after the agreement date in perpetuity (each payment thereafter received after each subsequent reporting period). These payments are received for undertaking the management actions.

The land owners agree to undertake several management actions to maintain conserve and restore species and habitats of the land.

The land owners are required to provide an annual report after each reporting period demonstrating satisfactory completion of each management action that has been completed together with supporting evidence.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Subsection 6-5(4)

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 division 40

Income Tax Assessment Act 1997 division 43

Reasons for decision

Assessable Income

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (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.

Whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 (the Pipecoaters case), the Full High Court stated:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

In MIM Holdings Ltd v. Commissioner of Taxation 97 ATC 4420; (1997) 36 ATR 108 (the MIM case), Northrop, Hill and Cooper JJ, relying on Hayes v. FCT (1956) 96 CLR 47 and Reuter v. FC of T 111 ALR 716; 93 ATC 4037 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:

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

o   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

o   the recipient's expectation that an amount will be received

The conservation covenant includes management actions the land owners are required to meet to receive the payment.

Under the conservation covenant the land owners agreed to provide conservation management services while they continue to own the property. Accordingly, the payments are the product, in a real sense, of the services rendered by the land owners.

Consequently, the payments you receive for the management actions are assessable under section 6-5 of the ITAA 1997. Under subsection 6-5(4) of the ITAA 1997 income is derived when it is received. This means the income is assessable in the year it is received.

Deductions

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

There must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL & Tongkah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; (1949) 4 AITR 236), and the expenditure must not be capital, private or domestic in nature.

Section 8-1 - general deductions

The landowners will be able to deduct expenses incurred in the course of producing the assessable income as represented by the ongoing management payments. This would typically include the following expenditure:

·         annual rates and insurance payments (appropriately apportioned where they also relate to property other than the conservation site); and

·         labour and administration costs for management actions.

Division 40 - capital allowances

Division 40 allows a deduction for the decline in value for an income year of a depreciating asset that is held to the extent that it is used for the purpose of producing assessable income. A depreciating asset has a limited effective life and can reasonably be expected to decline in value over the time it is used. Land and items of trading stock are specifically excluded from the definition of depreciating asset.

The decline in value of a depreciating asset starts at the time of its first use, or when it is installed ready for use, for any purpose, including a private purpose. This is known as a depreciating asset's start time.

Although an asset is treated as declining in value from its start time, a deduction for its decline in value is only allowable to the extent it is used for a taxable purpose. A taxable purpose includes the purpose of producing assessable income.

Depreciating assets used in the course of performing the management actions under a conservation covenant satisfy the taxable purpose test because the payments received under the agreement are the direct reward for the land management services rendered. The connection between the landowner's use of a depreciating asset in this manner and the earning of assessable income is also apparent from the terms of the conservation covenant.

An example of a depreciating asset used to perform land management services includes equipment for the slashing and spraying of weeds.

A depreciating asset is also used for the purpose of producing assessable income to the extent it is used to enable the landowner to comply with the reporting and record keeping requirements under the conservation covenant.

An example of a depreciating asset used for this purpose includes a computer used for annual reporting purposes and a camera used for record keeping.

An immediate deduction for the cost of a depreciating asset may be available to the landowners. The immediate deduction is available in the income year the landowner starts to hold the asset if all of the following tests are met in relation to the asset:

·         it cost $300 or less;

·         It was used mainly for the purpose of producing assessable income that was not income from carrying on a business;

·         it was not part of a set of assets a landowner started to hold in the income year that cost more than $300;

·         it was not one of a number of identical or substantially identical assets a landowner started to hold in the income year that together cost more than $300.

The landowners will be able to deduct an amount equal to the decline in value of a depreciating asset used for the purpose of producing the assessable income represented by the annual site management payments. The examples provided above including claiming decline in value for equipment for weed management and record keeping, which align with the management actions.

Division 43 - deductions for capital works

A deduction may be available under section 43-10 for an amount of capital expenditure incurred in respect of the construction of capital works used to carry out management actions under a conservation covenant if:

·         the capital works have a construction expenditure area;

·         there is a pool of construction expenditure for that area; and

·         your area is used in a deductible way in an income year.

Capital works to which Division 43 applies include structural improvements begun after February 1992, such as retaining walls, fences or certain earthworks that are integral to the construction of a structural improvement, or an extension, alteration or improvements to such structural improvements.

Where the landowners incur construction expenditure to construct fences, this is considered to be capital works for the purpose of Division 43 of the ITAA 1997. Section 43-25 of the ITAA 1997 provides that for structural improvements, the annual capital works deduction allowable is 2.5% of the construction expenditure over 40 years.