Edited version of private advice

Authorisation Number: 1051903212989

Date of advice: 24 September 2021

Ruling

Subject: Conservation covenant

Question

Are you entitled to a deduction for entering into the conservation covenant under section 31-5 of the Income Tax Assessment Act 1997 (ITAA 1997) subject to the valuation assessment under paragraph 31-5(2)(d) of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June xxxx

The scheme commenced on:

1 July xxxx

Relevant facts

You purchased property (the property) on xxxx.

The property was purchased as tenants in common in equal shares.

You wanted to subdivide the property to preserve the conservation of the area.

You didn't try to sell the property before subdividing as you wanted the subdivision to go through first to separate the bush area from the other area.

You realised that entering into the conservation covenant was a condition for the subdivision before applying.

An application for a conservation covenant was lodged on xxxx. Only the bushland on the property is to be under the covenant.

The nature conservation covenant was granted and completed by entity A on xxxx.

The restrictive covenant was made pursuant to the listed legislation.

The restrictive covenant is between you and authority xxxx.

The restrictive covenant binds the Owner, and persons deriving title from them, in perpetuity.

It is the intention of the Owner and the relevant authority that certain activities on the Land be restricted in order to protect its natural values and in particular the special natural values listed.

The property was subdivided in xxxx.

Lot xx was eligible for the conservation covenant. xxxx hectares with native vegetation was the land entered into under covenant. xx% of Lot xx is under the conservation covenant.

You did not receive any money or property for entering into the conservation covenant.

The market value of Lot xx has decreased as a result of entering into the covenant, as the covenant restricts the use of the property.

You entered into the contract for the sale of Lot xx on xxxx. You sold Lot xx on xxxx. The property was sold to an unrelated party at market value.

You paid for the administration and legal costs in relation to the conservation covenant. None of these costs have been reimbursed.

After the conservation covenant was granted for Lot xx, you had pest and weed management responsibilities.

The market value of Lot xx has not increased as a result of the covenant.

You sold Lot xx in xxxx.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 31-5.

Reasons for decision

Under Division 31 of the Income Tax Assessment Act 1997 (ITAA 1997) you can deduct an amount if you enter into a conservation covenant over land that you own and you satisfy certain conditions.

As outlined in subsection 31-5(1) of the ITAA 1997, you can deduct an amount if:

(a) you enter into a conservation covenant over land you own; and

(b) the conditions set out in subsection (2) are met.

The conditions that must be satisfied under subsection 31-5(2) of the ITAA 1997 are:

(a) the covenant must be perpetual;

(b) you must not receive any money, property or other material benefit for entering into the covenant;

(c) the market value of the land must decrease as a result of your entering into the covenant;

(d) one or both of these must apply:

(i) the change in the market value of the land as a result of entering into the covenant must be more than $5,000;

(ii) you must have entered into a contract to acquire the land not more than 12 months before you entered into the covenant;

(e) the covenant must have been entered into with:

(i) a fund, authority or institution that meets the requirements of section 31-10; or

(ii) the Commonwealth, a State, a Territory or a local governing body; or

(iii) an authority of the Commonwealth, a State or a Territory.

Under subsection 31-5(5) of the ITAA 1997 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.

Under section 31-15 of the ITAA 1997, you must seek a valuation of the change in market value from the Commissioner.

In your circumstances, paragraph 31-5(2)(b) of the ITAA 1997 needs further consideration to determine if you received any material benefit for entering into the covenant.

The Australian Taxation Office Interpretative Decision ATO ID 2002/678 Income Tax Division 31 - 'material benefit' for entering into a conservation covenant provides relevant information.

Some benefits may arise, without being regarded as material benefits for Division 31 of the ITAA 1997 purposes. It is not enough that a conservation covenant is merely prerequisite to receiving an otherwise unrelated benefit.

In your case the conservation covenant allowed you to proceed with the subdivision of your property. Although this is a benefit to you, it is not considered to be a material benefit for entering into the covenant that prevents a deduction under Division 31 of the ITAA 1997. Accordingly, it is considered that you meet the condition under paragraph 31-5(2)(b) of the ITAA 1997.

You also meet the conditions in paragraphs 31-5(2)(a), 31-5(2)(c) and 31-5(2)(e) of the ITAA 1997. Where paragraph 31-5(2)(d) is met and you seek a valuation of the change in market value from the Commissioner, the conditions in subsection 31-5(2) of the ITAA 1997 will be met and a deduction is allowed.

Where paragraph 31-5(2)(d) of the ITAA 1997 is satisfied, you claim the deduction in the tax return for the year in which you entered into the covenant.

The amount you can claim as a deduction is the difference between the market value of the land just before you entered into the covenant and its decreased market value just after that time, but only to the extent that the decrease is attributable to entering into the covenant (subsection 31-5(3) of the ITAA 1997.

Please note that you cannot use the deduction to add to or create a tax loss (section 26-55 of the ITAA 1997).

Other information - capital gains tax

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

The time of the event is when you enter into the covenant (subsection 104-47(2) of the ITAA 1997).

CGT event D4 applies to conservation covenants entered into on or after 1 July 2002 where you did not receive any material benefit for entering into the covenant.

CGT event D4 does not happen if you did not receive any capital proceeds for entering into the covenant and you cannot deduct an amount under Division 31 of the ITAA 1997 (subsection 104-47(6) of the ITAA 1997). In this case, CGT event D1 will apply instead.

That is, if there are no capital proceeds and no deduction, CGT event D1 will apply instead of CGT event D4.

Where you are allowed a deduction under Division 31 of the ITAA 1997, then CGT event D4 will happen for you in the income year when you entered into the covenant.

Where you are entitled to a deduction under section 31-5 of the ITAA 1997, the capital proceeds are the amount of that deduction (section 116-105 of the ITAA 1997).

The part of the cost base (or reduced cost base) of the land that is apportioned to the covenant is worked out using the formula in subsection 104-47(4) of the ITAA 1997 as below:

Please note the discount capital gain under Division 115 of the ITAA 1997 will apply to a CGT event D4. To avoid doubt, subsection 115-25(2) of the ITAA 1997 provides that the 12-month holding test applies to the land over which the conservation covenant is entered into for CGT event D4.

For the purposes of calculating the gain or loss on any subsequent disposal of the land, the cost base of the entire land is reduced by the amount of the cost base apportioned to the conservation covenant (subsection 104-47(5) of the ITAA 1997).