Edited version of private advice

Authorisation Number: 1051865289508

Date of advice: 16 September 2021

Ruling

Subject: CGT - conservation covenant and biodiversity credits

Question 1

Will capital gains tax (CGT) event D4 occur when the Trustee on behalf of the Trust (the Trust), enters into a biodiversity stewardship agreement (BSA) entitling it to receive biodiversity credits as per section 104-47(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will CGT event A1 occur when the Trust disposes of biodiversity credits via a sale of the credits as per section 104-10 of the ITAA 1997?

Answer

Yes.

Question 3

Does the total fund deposit amount to be paid by the Trust to the Biodiversity Stewardship Payments Fund form part of the Trust's cost base (or reduced cost base) of the biodiversity credits?

Answer

Yes.

Question 4

Does the cost base of the biodiversity credits include an amount equal to the market value of the 'other property' given up (being rights in respect to the Trust's land) in acquiring the biodiversity credits?

Answer

Yes.

Question 5

Will profits from the creation and sale of biodiversity credits be included in the Trust's ordinary income under section 6-5 of the ITAA 1997?

Answer

Yes.

Question 6

Can subsection 118-20(1) of the ITAA 1997 apply to reduce any capital gain made by the Trust from the creation and sale of biodiversity credits?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX to Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Trust

Company A was incorporated to act as the Trustee of Trust A.

Trust A was established as a unit trust for income tax purposes for the purpose of purchasing a property with the intent of creating biodiversity credits so that they could be sold.

Biodiversity credits

Biodiversity credits are created and issued to landowners upon entering into Biodiversity stewardship agreement (BSA) with the Minister responsible for administering the Biodiversity Conservation Act 2016 (NSW) (Biodiversity Act), being the Minister for the Environment of the State of New South Wales.

In practice, the Minister delegates the exercise of his functions under the Biodiversity Act and the BSA to the senior executives of the trustee of the Biodiversity Conservation Trust of New South Wales (BCT).

BSA's are voluntary in-perpetuity agreements entered into by landowners with the Biodiversity Conservation Trust (BCT) to permanently protect and manage an area of land.

Biodiversity credits are created as a result of the BSA. The credits may then be sold to a developer, the BCT or other interested parties or retained at the landowner's discretion.

The sale price of each biodiversity credit will be negotiated between the landowner and the buyer and are therefore affected by supply and demand for the relevant class of biodiversity credit.

In order to affect the registration of the biodiversity credit sale transfer to the new owner, the landowner must pay a fund deposit amount to the BCT.

Each biodiversity credit has a fund deposit amount attributable it. The total fund deposit amount payable by the landowner to the BCT is stated in the schedules of the BSA.

The BCT is the fund manager for the Biodiversity Stewardship Payments Fund. The BCT invests these funds, with proceeds used to make annual biodiversity stewardship payments to the landowner under the BSA being for the ongoing management of the land.

The Property

The Property was identified by one of Trust A's investors as a potential site from which to create biodiversity credits. The Property was for sale at the time.

Contact was made with ecologists to undertake a desktop assessment of the potential biodiversity credits that may be present on the Property land.

From the assessment, it was anticipated that XXX biodiversity credits could potentially be issued from using the Property if Trust A was to enter a BSA.

Investors

An investment proposal was prepared for presentation to potential investors with X investors secured, becoming unit holders in Trust A. Several of the investors having previous experience in the creation and sale of biodiversity credits.

Creation of biodiversity credits

An offer was made to the Vendor to purchase the Property with purchase contracts exchanged a short time later.

Trust A sought a quote for ecologists to prepare BSA's for three sites on the Property. This was provided and accepted by Trust A.

Plans were submitted to a quantity surveyor to arrange for the Property to be subdivided into three titles, matching the proposed BSA sites. Survey work has subsequently commenced, and plans were lodged with the local council for the required subdivision with the subdivision approval currently pending.

The Property purchase settled with a purchase price of $XXX.

Trust A has engaged brokers to find buyers of the biodiversity credits.

The first BSA was finalised ready for submission to the BCT once the subdivision is finalised.

It is anticipated that it will take Trust A up to ten years to sell all the biodiversity credits.

It is intended that Trust A will retain ownership of the Property, in order to generate income from the management of the biodiversity sites, a farming lease and renting the house on the Property.

The investors meet regularly, initially weekly and now fortnightly, to discuss the creation of the biodiversity credits, potential sales, and the general management of the Property.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 21

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

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

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-47

Income Tax Assessment Act 1997 Subsection 108-5(1)

Income Tax Assessment Act 1997 Subsection 110-25(2)

Income Tax Assessment Act 1997 Section 110-35

Income Tax Assessment Act 1997 Subsection 116-20(1)

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Question 1

Summary

As the BSA is a conservation covenant, for the purposes of section 104-47(1) of the ITAA 1997, CGT event D4 will happen at the time Trust A enters into the BSA. The capital gain or loss from CGT event D4 is calculated in accordance with section 104-47 of the ITAA 1997. The capital proceeds being the market value of the biodiversity credits created under the BSA.

Detailed reasoning

A CGT event D4 happens if you enter into a conservation covenant over land you own (subsection 104-47(1) of the ITAA 1997).

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

a)    restricts or prohibits certain activities on the land that could degrade the environmental value of the land; and

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

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

It is recognised that entering into a BSA issued by the BCT satisfies the definition of a conservation under section 31-5 of the ITAA 1997. Consequently, the CGT event D4 will happen at the time when the Trust enters the BSA with the BCT.

The capital gain or capital loss will be determined in accordance with section 104-47 of the ITAA 1997.

The landowner will make a capital gain if the capital proceeds from entering into the BSA are more than that part of the cost base of the land that is apportioned to the covenant (subsection 104-47(3) of the ITAA 1997). If the capital proceeds are less than that part of the reduced cost base of the land that is apportioned to the covenant, the landowner will make a capital loss (subsection 104-47(3) of the ITAA 1997).

Subsection 116-20(1) of the ITAA 1997 provides that the capital proceeds from a CGT event are the total of:

a)    the money you have received, or are entitled to receive, in respect of the event happening; and

b)    the market value of any other property you have received or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

The biodiversity credits are a tradable asset that Trust A will receive from the CGT event D4. The biodiversity credits will therefore constitute property to be received for the purpose of the capital proceeds under paragraph 116-20(1)(b) of the ITAA 1997. The amount of capital proceeds is determined by the market value of the biodiversity credits worked out at the time of the event.

>
> The part of the cost base and reduced cost base of the land that is apportioned to the covenant is worked out under subsection 104-47(4) of the ITAA 1997 as follows:

Question 2

Summary

As the biodiversity credits are a CGT asset, the sale of the credits by Trust A, constitutes CGT event A1.

Detailed reasoning

Subsection 108-5(1) defines a CGT asset as:

a)    any kind of property; or

b)    a legal or equitable right that is not property.

Biodiversity credits fall would fall within the definition of CGT asset under paragraph 108-5(1)(a) of the ITAA 1997.

A CGT event A1 happens on the disposal of a CGT asset. Under section 104-10 of the ITAA 1997, a CGT asset is disposed of when there is a change of ownership, whether because of some act or event or by operation of law.

In this case CGT event A1 will occur when Trust A enter contracts with a purchaser for the sale of biodiversity credits.

Question 3

Summary

The total stewardship fund deposit amount payable by Trust A in order for the sale transfer of the biodiversity credits to be registered by the BCT can be included as part of the biodiversity credit cost base. The total fund deposit amount payable is an incidental cost that will be incurred by Trust A in relation to CGT event A1 being the disposal of the credits.

Detailed reasoning

The second element of the cost base of a CGT asset is the incidental costs (subsection 110-25(3) of the ITAA 1997).

Certain costs incurred are included as incidental costs to acquire a CGT asset or that relate to a CGT event (subsection 110-35(1) of the ITAA 1997). One of the incidental costs included is stamp duty or other similar duty (subsection 110-35(4) of the ITAA 1997).

Stamp duty is defined in Butterworths Australian Legal Dictionary as 'a tax imposed by all Australian States on documents or transactions that affect or record the transfer of the ownership of assets (for example, conveyances of real property, shares and business assets) or the creation of rights in respect of assets (for example, the granting of a lease)'.

The total stewardship fund deposit is a payment to the BCT being an established authority of the NSW state government. The payment, required to affect the record of transfer of ownership of the assets being the sale of the biodiversity credits (CGT event A1), is considered by the Commissioner to be a type of stamp duty or similar duty.

From the above, it is evident that the total stewardship fund deposit amount is an incidental cost that relates to the CGT event being the disposal of the biodiversity credits. Therefore, it can be included in Trust A's second element of the cost base for the biodiversity credits.

Question 4

Summary

The cost base of the biodiversity credits can include an amount equal to the market value of property given up by Trust A (being rights in respect of the land) to acquire the CGT asset (the biodiversity credits).

Detailed reasoning

Subsection 110-25(2) of the ITAA 1997 provides that the first element of the cost base of a CGT asset is the total of:

a)    the money you paid, or are required to pay in respect of acquiring the CGT asset; and

b)    the market value (worked out at the time of the acquisition) of any other property you gave in respect of acquiring the CGT asset.

By subjecting part of the land to a covenant, Trust A will give up its rights to subject that portion of the land to any future conservation covenant as well permanently giving up its rights to carry out certain activities on that portion of the land.

It is reasonable that the giving up of these rights can be recognised as 'property given or required to be given' by Trust A for the purposes of the cost base rules.

The market value of these rights, being property that will be given up by Trust A in acquiring the biodiversity credits (by permanently restricting portion of the land in undertaking certain activities), must then be worked out at the time of the acquisition of the credits.

The tradeable biodiversity credits received by the landowner are akin to consideration received from the BCT, at the time of entering the BSA, being for the giving up their rights to the land. On this basis the Commissioner considers it reasonable that the market value of the rights given up (upon entering the BSA and creating the biodiversity credits should be referrable to the amount of capital proceeds received by Trust A from CGT event D4.

Question 5

Summary

The creation and sale of the biodiversity credits by Trust A have the character of isolated commercial transactions. Profits derived will therefore be assessable income under section 6-5 of the ITAA 1997 and losses deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

Section 6-5 of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Either business income or profits from an isolated transaction would be included in the Trust's assessable income for the income year under section 6-5 of the ITAA 1997.

Carrying on a business

Section 995-1 of the ITAA 1997 states that the term 'business', includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

The question of whether a business is being carried on is a question of fact and degree. Over the years the courts have developed a series of indicators to determine if a business is being carried on.

The Commissioner's view on factors used to determine if an entity is in business for tax purposes is provided by Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides the factors considered important in determining the question of business activity:

•         Whether the activity has a significant commercial purpose or character.

•         Whether the taxpayer has more than just an intention to engage in business.

•         Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity.

•         Whether there is regularity and repetition of the activity.

•         Whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business.

•         Whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit.

•         The size, scale and permanency of the activity.

•         Whether the activity is better described as a hobby, a form of recreation or sporting activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

In this case, Trust A was only recently established and the BSA is yet to be entered into. At this stage the activities of Trust A appear to be preliminary and preparatory to carrying on a business. There is insufficient repetition and regularity of their activities to make a determination that they are carrying on a business.

Profit from isolated transactions

In addition to transactions that occur in the ordinary course of a taxpayer's business, profits derived from commercial transactions entered into by non-business taxpayer's and transactions outside the ordinary course of a taxpayer's business may also be income. These transactions are referred to as an 'isolated transaction'.

As explained in Taxation Ruling TR 92/3: Income tax: whether profits on isolated transactions are income (TR 92/3), a profit from an isolated transaction is generally income when both of the following elements are present:

•         the intention or purpose of a taxpayer in entering into the transaction was to make a profit or gain; and

•         the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying on a business operation or commercial transaction.

Paragraph 49 of TR 92/3 provides that in general terms a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations.

Some factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following:

a)    the nature of the entity undertaking the operation or transaction;

b)    the nature and scale of other activities undertaken by the taxpayer;

c)    the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

d)    the nature, scale and complexity of the operation or transaction;

e)    the manner in which the operation or transaction was entered into or carried out;

f)     the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

g)    if the transaction involves the acquisition and disposal of property, the nature of that property; and

h)    the timing of the transaction or the various steps in the transaction.

Paragraph 16 of Taxation Ruling TR 92/4 Income tax: whether losses on isolated transactions are deductible, provides that a loss from an isolated transaction will generally be deductible under section 8-1 of the ITAA 1997 if:

a)    in entering into the transaction, the taxpayer intended or expected to derive a profit which would have been assessable income; and

b)    the transaction was entered into, and the loss was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

It is evident that Trust A entered into the purchase of the Property with the intention to profit from the creation and subsequent sale of biodiversity credits. The nature, scale and complexity of the scheme has a substantial commercial character.

Based on the overall assessment of the facts in this case, it is the Commissioner's view that profits or losses Trust A derives from the creation and sale of biodiversity credits should be considered as isolated commercial transactions. Profits from the isolated transactions are therefore assessable under section 6-5 of the ITAA 1997 with losses deductible under section 8-1 of the ITAA 1997.

Creation of the biodiversity credits

Section 21 of the Income Tax Assessment Act 1936 (ITAA 1936) provides that where, upon any transaction, any consideration is paid or given otherwise than in cash, the money value of that consideration shall be deemed to have been paid or given.

However, in FC of T v Cooke & Sherden 80 ATC 4140 (Cooke and Sherden) it was found that benefits received by the taxpayer were not income as there were not convertible to money or money's worth.

In this case, as the biodiversity credits are a tradeable asset and therefore readily convertible to cash, Cooke & Sherden would not apply. On this basis, the money value of the biodiversity credits issued to Trust A upon entering the BSA and will form part of its assessable income under section 6-5 of the ITAA 1997 in the income year that the credits are received.

The total stewardship fund deposit amount will need to be paid by Trust A before the sale transfers of the credits are registered. This amount will be the cost to Trust A of converting the credits to cash. In order to accurately reflect the true gain (to Trust A) from the creation of the biodiversity credits, the Commissioner considers it reasonable that the deposit amount be subtracted from their expected sale value.

Other expenses incurred in creating and selling the credits will be expenses incurred in earning Trust A's assessable income. These expenses would therefore be deductible under section 8-1 of the ITAA 1997, to the extent that, it was not capital or of a capital nature, private or domestic nature.

Consultancy, legal, accounting and application fees incurred in entering the biodiversity stewardship agreement in order create the biodiversity credits would be deductible, as an example.

The Property purchase would be a loss or outgoing of capital or capital nature in this case, as the Property would continue to provide enduring benefit to Trust A by way of agistment, rental, and land management income. These costs would therefore not be deductible under section 8-1 of the ITAA 1997.

Sale of the Biodiversity Credits

The conversion of the tradeable biodiversity credits to cash and the payment of the deposit amount would not have further tax consequences (ordinary income under section 6-5 of the ITAA 1997, or deductions under section 8-1 of the ITAA 1997) unless the amounts received under the sale agreements differ from those included in Trust A's assessable income at the time the credits were created.

In the case where the biodiversity credits were sold for a higher amount than previously included in Trust A's income, the additional profit would be assessable income under section 6-5 of the ITAA 1997.

In the contrary case where the biodiversity credits were sold for a lower amount, the loss (on the sale) would be deductible under section 8-1 of the ITAA 1997.

Question 6

Summary

Due to the anti-overlap provisions, Trust A's capital gains from CGT events D4 and A1 can be reduced to the extent that profit from the creation and sale of the biodiversity credits are included in the trust's assessable income under section 6-5 of the ITAA 1997.

Detailed reasoning

Section 118-20 of the ITAA 1997 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 as a result of the sale.

Trust A can reduce any capital gain resulting from CGT event D4 by the amount of profit recorded (from the creation of the biodiversity credits) as assessable income under section 6-5 of the ITAA 1997 in the same income year. Similarly, Trust A can reduce any capital gain resulting from CGT event A1 by the amount of profit recorded (from the subsequent sale of the biodiversity credits) as assessable income under section 6-5 of the ITAA 1997 in the same income year.