Edited version of private advice

Authorisation Number: 1052083545411

Date of advice: 21 February 2023

Ruling

Subject: Biodiversity credits

Issue 1: Entry into the Biodiversity Stewardship Agreement (BSA) by the Taxpayer

Question 1

Did CGT event D4 in section 104-47 of the Income Tax Assessment Act 1997 (ITAA 1997) happen when the Taxpayer entered into the BSA under the Biodiversity Offset Scheme (BOS) administered under the Biodiversity Conservation Act 2016 (NSW) (BCA 2016)?

Answer

Yes.

Question 2

Are the capital proceeds for the purposes of CGT event D4 in section 104-47 of the ITAA 1997 equal to the market value of the biodiversity credits received from entering into the BSA?

Answer

Yes.

Issue 2: Sale and retirement of the biodiversity credits generated by the Taxpayer from entering into the BSA

Question 3

Did CGT event C2 in section 104-25 of the ITAA 1997 happen when the Taxpayer retired a biodiversity credit that it generated from entering into the BSA?

Answer

Yes.

Question 4

If CGT event C2 in section 104-25 of the ITAA 1997 happened when the Taxpayer retired a biodiversity credit that it generated from entering into the BSA, are the capital proceeds equal to the market value of the retired biodiversity credit as at the time it was retired?

Answer

Yes.

Question 5

Does the cost base (and reduced cost base) for the purposes of CGT event A1 in section 104-10 of the ITAA 1997 (in respect of a transfer or sale) and CGT event C2 in section 104-25 (in respect of retirement) of each biodiversity credit generated from entering into the BSA include a proportionate amount of the market value of the 'other property' given up (being rights in respect of the Property) in acquiring each biodiversity credit?

Answer

Yes.

Question 6

Does the cost base (and reduced cost base) for the purposes of CGT event A1 in section 104-10 of the ITAA 1997 (in respect of a transfer or sale) and CGT event C2 in section 104-25 (in respect of retirement) of each biodiversity credit generated from entering into the BSA include a proportionate amount of the Total Fund Deposit (TFD) paid by the Taxpayer to the Biodiversity Conservation Trust (BCT)?

Answer

Yes.

Question 7

Does the cost base (and reduced cost base) for the purposes of CGT event A1 in section 104-10 of the ITAA 1997 (in respect of a transfer or sale) and CGT event C2 in section 104-25 (in respect of retirement) of each biodiversity credit generated from entering into the BSA include a proportionate amount of the fees paid to consultants and legal and other advisors to assess site biodiversity values, calculate site biodiversity credits, prepare site management plans and provide other advice related to entering into the BSA?

Answer

Yes.

This ruling applies for the following period:

The 20XX income year

The scheme commenced on:

XX June 20XX

Relevant facts and circumstances

1.    The Property was originally acquired by the Taxpayer in 20XX.

The BSA

2.    In 20XX, a BSA was executed over the Property. The BSA was entered into between the Taxpayer and the Minister for the Environment of the State of NSW under the Conservation Agreement and Biodiversity Stewardship Agreement Program.

3.    The BSA initially highlights that, by entering into the BSA, the Taxpayer has agreed to:

(a)  carry out Management Actions which includes refraining from carrying out certain activities; and

(b)  meet certain Reporting Obligations,

(c)   in relation to the Biodiversity Stewardship Site, and as a result:

(d)  is entitled to Biodiversity Credits determined in accordance with the Biodiversity Assessment Method (BAM); and

(e)  may be entitled to receive payments from the Fund Manager,

in accordance with the law and the terms and conditions set out in this Deed.

4.    The Management Plan is contained in an attachment to the BSA and sets-out various management actions that the owner must undertake and the frequency of these actions. These actions relate to fire management, grazing management, native vegetation management, threatened species habitat management and enhancement, integrated feral pest control, integrated weed management and control of high threat exotic plants, management of human disturbance and monitoring.

5.    The BSA over the Property generated biodiversity credits, which were registered on a Biodiversity Credits Supply Register managed by the BCT and issued to the Taxpayer in 20XX.

6.    The Taxpayer did not receive, and is not entitled to receive, any other form of consideration for entering into the BSA.

7.    The Property owned by the Taxpayer for the purposes of satisfying its biodiversity obligations and the biodiversity credits generated via entry into the BSA over such land, is held by the Taxpayer on capital account for income tax purposes and the Taxpayer has not acquired such land or biodiversity credits with a view to profit.

TFD

8.    A central component of the BOS is the requirement to pay a TFD into a Biodiversity Stewardship Payments Fund, managed by the BCT, which is effectively invested for the ongoing management and maintenance of the relevant stewardship site. The value of the TFD for each stewardship site is broadly determined based on the present value of the costs of the management actions required to manage the stewardship site in-perpetuity.

9.    Once paid, the TFD account is used to fund payments to the stewardship site landowner in the form of annual management payments to cover the costs of site management actions under the agreed site management plans. The first annual management payment under the BSA is effectively due upon payment of the full amount of the TFD. Thereafter, future management payments are scheduled to be paid on each anniversary of the first payment date, but only if:

(a)  The biodiversity stewardship site account has sufficient funds to cover the payment;

(b)  The landowner has submitted the required annual report (due within 14 days after the end of each 12 month reporting period) for the most recent 12 month reporting period; and

(c)   The Minister has reviewed the relevant annual report and is satisfied both with its content and that the landowner has complied with its obligations under the BSA.

10.  Importantly, payment of the TFD (either in full or in part, depending on the circumstances) to the Biodiversity Stewardship Payments Fund is also a necessary prerequisite to registration of the first transfer or retirement of the relevant biodiversity credits.

11.  The TFD computed in respect of the Property stewardship site was $X. This sum was paid by the Taxpayer to the Biodiversity Stewardship Payment Fund in 20XX.

Total Costs associated with the BSA and the Biodiversity Credits

12.  The Taxpayer also incurred various costs in connection with acquisition of the Property, entry into the BSA over the Property and retirement/sale of biodiversity credits to date generated from the Property. These included environmental consulting and credit assessment costs relating to various services performed by a Biodiversity Assessor accredited under the BCA 2016 to apply the BAM.

Sale of the Biodiversity credits associated with the Property

13.  In 20XX, the Taxpayer transferred a number of the Property biodiversity credits to a third party by way of an arm's length sale. The Taxpayer received total consideration of $X in respect of the transfer.

Retirement of the Biodiversity credits associated with the Property

14.  In 20XX, the Taxpayer also retired a number of the Property biodiversity credits. The Taxpayer did not receive, and was not entitled to receive, any consideration in respect of the retirement. Retirement of biodiversity credits under the BOS must occur pursuant to a formal application and requires payment of an application fee. Once retired, the biodiversity credits are removed from the Biodiversity Credits Supply Register and can no longer be traded.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 31-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 104-47

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 110-35

Income Tax Assessment Act 1997 Section 116-20

Reasons for decision

Issue 1: Entry into the BSA by the Taxpayer

Question 1

Summary

1.     As the BSA is a conservation covenant, for the purposes of subsection 104-47(1) of the ITAA 1997, CGT event D4 happened at the time the Taxpayer entered into the BSA.

Detailed reasoning

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

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

4.     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.

5.     It is recognised that entering into a BSA made under the BCA 2016 with the Minister for the Environment of the State of NSW satisfies the definition of a conservation covenant under section 31-5 of the ITAA 1997. Consequently, CGT event D4 happened at the time when the Taxpayer entered into the BSA.

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

7.     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)).

Question 2

Summary

8.     The capital proceeds for the purposes of the CGT event D4 of the ITAA 1997 will equal the market value of the biodiversity credits received (worked out at the time of the CGT event) from entering into the BSA.

Detailed reasoning

9.     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).

10.  Under the terms of the BSA (which caused CGT event D4 of the ITAA 1997 to happen), the Taxpayer was entitled to receive biodiversity credits. The biodiversity credits are a tradable asset that is 'property' for the purpose of the capital proceeds under paragraph 116-20(1)(b). Accordingly, the market value of the biodiversity credits, worked out at the time of the CGT event, will constitute capital proceeds from CGT event D4 happening.

11.  It is noted that section 116-105 of the ITAA 1997 contains a special rule in relation to the capital proceeds where CGT event D4 happens. This special rule, however, does not apply in relation to the BSA as the Taxpayer could not deduct an amount under Division 31 of the ITAA 1997.

Issue 2: Sale and retirement of the biodiversity credits generated by the Taxpayer from entering into the BSA

Question 3

Summary

12.  CGT event C2 of the ITAA 1997 happened in 20XX when the Taxpayer retired a biodiversity credit that it generated from entering into the BSA and it was removed from the Biodiversity Credits Supply Register.

Detailed reasoning

13.  CGT event C2 of the ITAA 1997 happens if a taxpayer's ownership of an intangible CGT asset ends in certain ways, including because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited (subsection 104-25(1)).

14.  The time of the event is when a taxpayer enters into the contract that results in the asset ending. If there is no contract, the event happens when the asset ends (subsection 104-25(2) of the ITAA 1997).

15.  In the current circumstances, CGT event C2 of the ITAA 1997 happened in 20XX when the Taxpayer retired a biodiversity credit that it generated from entering into the BSA and it was removed from the Biodiversity Credits Supply Register.

Question 4

Summary

16.  The capital proceeds for the purposes of the CGT event C2 of the ITAA 1997 are equal to the market value of the retired biodiversity credit as at the time it was retired.

Detailed reasoning

17.  Under the general rules, the capital proceeds from a CGT event are the total of the money you have received, or are entitled to receive, in respect of the event happening; and 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) - subsection 116-20(1) of the ITAA 1997.

18.  If, however, you received no capital proceeds from a CGT event, subsection 116-30(1) of the ITAA 1997 provides that you are taken to have received the market value of the CGT asset that is the subject of the event. The market value is worked out as at the time of the event.

19.  Subsection 116-30(3) of the ITAA 1997 limits the application of subsection 116-30(1) in the context of CGT event C2 as it provides that this subsection does not apply where CGT event C2 occurs as a result of:

(i)            the expiry of a CGT asset you own; or

(ii)           the cancellation of your statutory licence.

20.  Subsection 116-30(3A) of the ITAA 1997 further explains that if you need to work out the market value of a CGT asset that is the subject of CGT event C2, work it out as if the event had not occurred and was never proposed to occur.

21.  In the current circumstances, the Taxpayer did not receive, and was not entitled to receive, any consideration in respect of the retirement of each biodiversity credit that it generated from entering into the BSA.

22.  Accordingly, the market value substitution rule in subsection 116-30(1) of the ITAA 1997 will apply to deem the capital proceeds in respect of the CGT event C2 to be the market value of the biodiversity credit at the time of the CGT event (worked out as if the event had not occurred and was never proposed to occur).

Question 5

Summary

23.  The cost base (and reduced cost base) of each biodiversity credit generated from entering into the BSA includes a proportionate amount of the market value of the 'other property' given up (being rights in respect of the Property) in acquiring each biodiversity credit.

Detailed reasoning

24.  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.

25.  No money was paid by the Taxpayer to acquire the biodiversity credits.

26.  However, as highlighted in the BSA, by entering into the BSA the Taxpayer has agreed to:

(a)  carry out Management Actions which includes refraining from carrying out certain activities; and

(b)  meet certain Reporting Obligations,

(c)   in relation to the Biodiversity Stewardship Site, and as a result:

(d)  is entitled to Biodiversity Credits determined in accordance with the BAM; and

(e)  may be entitled to receive payments from the Fund Manager,

in accordance with the Law and the terms and conditions set out in this Deed.

27.  Accordingly, the Taxpayer, as the landowner of the Property, has created rights in the Minister for the Environment of the State of NSW and this is considered the giving of property in respect of acquiring the biodiversity credits.

28.  The market value of any other property given respect of acquiring the CGT asset is worked out at the time of the acquisition (per paragraph 110-25(2)(b) of the ITAA 1997).

29.  As such, the first element of the cost base of a biodiversity credit is that portion of the market value of the property given that is reasonably attributable to the acquisition of each biodiversity credit (subsection 112-30(1) of the ITAA 1997).

Question 6

Summary

30.  The TFD paid by the Taxpayer to enable the transfer or retirement of the biodiversity credits to be registered by the BCT, can be included as part of the cost base of the biodiversity credits. The TFD paid is an incidental cost incurred by the Taxpayer in relation to the disposal of or the ending of the ownership of the credits.

Detailed reasoning

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

32.  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).

33.  Relevantly, of the incidental costs listed in section 110-35 of the ITAA 1997:

•         subsection 110-35(3) includes 'costs of transfer'; and

•         subsection 110-35(11) includes 'termination or other similar fees incurred as a direct result of your ownership of a CGT asset ending'.

34.  Regarding subsection 110-35(11) of the ITAA 1997, it is noted that this subsection was added in 2010 with paragraph 2.84 of the Explanatory Memorandum (EM) to the Tax Laws Amendment (2010 Measures No. 4) Bill 2010 explaining that: 'Typically, termination fees (and exit fees) are contractual fees imposed by one party on the other as a result of the second party breaking the contract.'

35.  This provision was introduced to, in part, deal with issues pertaining to the irrigation industry and water entitlements and, in this context, paragraph 2.88 of the EM notes that: 'In the context of the irrigation industry, a termination fee is typically any fee or charge payable to an operator for either terminating access or surrendering a water delivery right'. Example 2.22 of the EM also provides the following example:

Dean sells his statutory licence to an irrigator outside Liquid Water's irrigation district and elects to terminate his access to Liquid Water's irrigation network, through the cancellation of his 100 Class B shares.

Liquid Water charges Dean a $5,000 termination fee to cancel his shares.

Dean includes the $5,000 fee in the cost base and reduced cost base of the shares as an incidental cost on a pro-rata basis. That is, $50 per share.

36.  The TFD is a payment into a Biodiversity Stewardship Payment Fund, managed by the BCT, being an established authority of the NSW state government. The TFD is effectively invested for the ongoing management and maintenance of the relevant stewardship site. The value of the TFD for each stewardship site is broadly determined based on the present value of the costs of the management actions required to manage the stewardship site in-perpetuity.

37.  Relevantly, the payment of the TFD (either in full or in part, depending on the circumstances) to the Biodiversity Stewardship Fund is a necessary prerequisite to registration of the first transfer or retirement of the relevant biodiversity credits. This feature is highlighted in a note in the Payment schedule of the BSA which states: 'Section 6.21 of the Biodiversity Conservation Act 2016 (NSW) requires that the Total Fund Deposit (or a portion thereof if not all credits generated in connection with the Biodiversity Stewardship Site are being transferred) must be paid into the Biodiversity Stewardship Payments Fund before the first transfer (or retirement without transfer) of each Biodiversity Credit can be registered.'

38.  Accordingly, given that the payment of the TFD is required to affect the record of transfer/change of ownership of the assets from the sale or retirement of the biodiversity credits, it is accepted that the TFD is:

(a)  a 'cost of transfer' where a biodiversity credit is transferred or sold and CGT event A1 happens (subsection 110-35(3)); and

(b)  'a termination or other similar fees incurred as a direct result of your ownership of a CGT asset ending', where a biodiversity credit is retired and CGT event C2 happens (subsection 110-35(11)).

39.  Consequently, the TFD paid is an 'incidental cost', as described in section 110-35 of the ITAA 1997, incurred by the Taxpayer that can be included in the cost base of each biodiversity credit generated from entering into the BSA.

40.  The TFD should be reasonably apportioned across the biodiversity credits generated from entering into the BSA pursuant to subsection 112-30(1A) of the ITAA 1997.

Question 7

Summary

41.  The environmental consulting and credit assessment costs are incidental costs, as described in subsection 110-35(2) of the ITAA 1997, and therefore form part of the cost base of each biodiversity credit generated from entering into the BSA.

Detailed reasoning

42.  As previously noted, the second element of the cost base and reduced cost base of a CGT asset is the incidental costs incurred to acquire a CGT asset. The first type of incidental cost under subsection 110-35(2) of the ITAA 1997 is the remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal advisor.

43.  The payment of fees to consultants and legal and other advisors to assess site biodiversity values, calculate site biodiversity credits, prepare site management plans and provide other advice related to entering into the BSA are incidental costs as described in subsection 110-35(2) of the ITAA 1997 and therefore form part of the cost base of each biodiversity credit generated from entering into the BSA.

44.  The environmental consulting and credit assessment costs should be reasonably apportioned across the biodiversity credits generated from entering into the BSA pursuant to subsection 112-30(1A) of the ITAA 1997.