Edited version of private advice

Authorisation Number: 1051875359264

Date of advice: 27 August 2021

Ruling

Subject: CGT - conservation covenant and biodiversity credits

Question 1

Will capital gains tax (CGT) event D4 occur when 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 dispose 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 of the Land) by the Trust in acquiring the biodiversity credits?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Trust is the owner of the farming land (the Land) acquired in 20XX.

The Land is leased by a company associated with the Trust for farming operations.

The Land is held by the Trust on the capital account.

The Trust has been investigating the Land's suitability to be used for conservation activities. Those investigations have determined that the Land does meet the requirements to enter into a 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 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 Trust has lodged a BSA application with the BCT and is expected to be in a position to enter into the BSA in the 20XX-XX financial year.

The Trust estimates $XX worth of biodiversity credits will be generated from entering into the BSA.

It is anticipated that the Trust will dispose of credits in the 20XX-XX, 20XX-XX and 20XX-XX financial years.

For the transfer of the sale of the credits to be registered by the BCT, the Total Stewardship Fund Deposit amount determined under the BSA will be payable by the Trust to the BCT.

Relevant legislative provisions

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 subsection 110-25(3)

Income Tax Assessment Act 1997 subsection 110-35(1)

Income Tax Assessment Act 1997 subsection 110-35(4)

Income Tax Assessment Act 1997 subsection 116-20(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 the Trust 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

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

The time of the event is when you enter into the covenant (subsection 104-47(2) 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 covenant under subsection 31-5(5) of the ITAA 1997. Consequently, 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 the Trust is entitled to receive from the CGT event D4. They will therefore constitute property to be received for the purpose of the capital proceeds under paragraph 116-20(1)(b) of the ITAA 1997 with the amount determined by their market value worked out at the time of the event.

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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:

The cost base and reduced cost base of the land are reduced by the part of the cost base or reduced cost base of the land that is apportioned to the covenant.

Question 2

Summary

As the biodiversity credits are a CGT asset, the sale of the credits by the Trust, constitutes a 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 (section 104-10 of the ITAA 1997).

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

Question 3

Summary

The Total Fund Deposit amount payable by the Trust 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 as an incidental cost incurred by the Trust in relation to the disposal of the credits.

Detailed reasoning

The second element of the cost base of a CGT asset comprises the incidental costs incurred by the taxpayer (subsection 110-25(3) of the ITAA 1997) to acquire the CGT asset, or that relate to the 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, is required in order 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 inextricably linked to the disposal of the biodiversity credits. Therefore, it can be included in the Trust's second element of the cost base for the biodiversity credits.

Question 4

Summary

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

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.

By subjecting part of the land to a covenant, the Trust has given 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 the Trust for the purposes of the cost base rules.

The market value of these rights, being property that has been given up by the Trust 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 Trust has assessed that the market value of the rights given up are comparable to the amount of capital proceeds to be received from CGT event D4. Given the timing of the acquisition of the credits is aligned with the timing of the receipt of the capital proceeds under CGT event D4, the Commissioner considers this assessment reasonable.