Edited version of private advice

Authorisation Number: 1052171270901

Date of advice: 21 September 2023

Ruling

Subject: CGT - disposal - biodiversity credits

Question 1

Will capital gains tax (CGT) event D4 occur when you enter into a biodiversity stewardship agreement (BSA) entitling you 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 you dispose of biodiversity credits via a sale of the credits as per section 104-10 of the ITAA 1997?

Answer

Yes.

Question 3

Do you satisfy the basic conditions for the small business CGT concessions under section 152-10 of the ITAA 1997?

Answer

Yes.

Question 4

Are you eligible for the retirement exemption on entering into the BSA where a written record of the amount chosen to be exempt is kept, the amount is less than or up to your retirement exemption limit, and it is paid into a complying superannuation fund within the required timeframe?

Answer

Yes.

Question 5

Are you eligible for the retirement exemption when you dispose of the biodiversity credits where a written record of the amount chosen is kept, the amount is less than or up to your retirement exemption limit, and it is paid into a complying superannuation fund within the required timeframe?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You are entering into a Biodiversity Stewardship Agreement (BSA) with the Biodiversity Conservation Trust (BCT).

You have a contract to sell biodiversity credits through a 'reverse auction'. This transaction will take place when your BSA is finalised.

You will not know how many credits the BSA will generate or the Total Fund Deposit (TFD) until the BSA is finalised.

The TFD is the amount that is set aside to manage the BSA in accordance with the management plan and is the present value of all costs associated with managing the biodiversity stewardship site in perpetuity.

The land has always been used for primary production activities.

You currently run the primary production business on the land in partnership with some relatives. Each partner has an equal share in the partnership.

Your total assets, including affiliates and connected entities, is less than $6m. The current turnover from the partnership primary production business is less than $2m per year.

You are under 55 years of age.

You have had employment off farm. Recently you resigned from your position to instead take up occasional casual work to ease into retirement. You have also significantly reduced the scale of your primary production business. The BSA is part of your retirement plan.

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 subsection 108-5(1)

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 110-35

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-305

Income Tax Assessment Act 1997 subsection 152-310(1)

Income Tax Assessment Act 1997 subsection 152-320(1)

Reasons for decision

Question 1

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 covenant under section 31-5 of the ITAA 1997. Consequently, CGT event D4 will happen at the time when you enter the BSA with the BCT.

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

You 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 you 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 you 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:

Cost base of the land × (capital proceeds from entering the covenant ÷ (those capital proceeds + the market value of the land just after you enter into the covenant))

Question 2

Subsection 108-5(1) of the ITAA 1997 defines a CGT asset as:

a)    any kind of property; or

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

Biodiversity credits fall within the definition of a CGT asset.

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.

On the sale of biodiversity credits, you will dispose of a CGT asset at the time you enter into the sale contract. Under subsection 104-10(4) of the ITAA 1997, you will make a capital gain if the capital proceeds from the sale are more than the cost base of the biodiversity credits. If the capital proceeds are less than the reduced cost base of the biodiversity credits, you will make a capital loss.

The capital proceeds from the disposal of the biodiversity credits is the money or the market value of property you receive or are entitled to receive in respect of the disposal.

In your case, the capital proceeds will be the sale price you receive from the purchaser of the biodiversity credits.

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, or are required to give, in respect of acquiring the CGT asset.

In your case, the first element of the cost base of the biodiversity credits is the money you paid or are required to pay in respect of acquiring the biodiversity credits. This is the amount specified in the BSA as having been applied in respect of the issue of the biodiversity credits to you.

Question 3

Subsection 152-10(1) of the ITAA 1997 provides that a capital gain you make may be reduced or disregarded if the following basic conditions are satisfied:

(a)  a CGT event happens in relation to a CGT asset of yours in an income year;

(b)  the event would (apart from this Division) have resulted in a gain;

(c)   at least one of the following applies:

(i)            you are a small business entity for the income year;

(ii)           you satisfy the maximum net asset value test;

(iii)          you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership;

(iv)          you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate, or an entity connected with you;

(d)  the CGT asset satisfies the active asset test.

Active asset

Section 152-40 of the ITAA 1997 states:

(1) A CGT asset is an active assetat a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a * business that is carried on (whether alone or in partnership) by:

(i) you; or

(ii) your affiliate; or

(iii) another entity that is connected with you; or

(b) if the asset is an intangible asset-you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

It must be demonstrated that, under paragraph 152-40(1)(b) of the ITAA 1997, the biodiversity credits, as an intangible asset, are inherently connected with the primary production business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

The conservation covenant is a permanent burden on the land, that would also burden the purchaser should the land be sold at a future point in time.

The biodiversity credits would not be received but for the conservation covenant on the land, which is used in the primary production business. The credits are therefore inherently connected with that business and the land it uses to undertake that business. As the land is used in the business, it is an active asset for the purposes of section 152-40 of the ITAA 1997.

As a result, the biodiversity credits will be active assets under paragraph 152-40(1)(b) of the ITAA 1997 for the purpose of the small business CGT concessions.

In your case, a CGT event will occur which will result in a capital gain. You satisfy the maximum net asset value test and the asset was an active asset for at least half of the ownership period. Therefore, you satisfy the basic conditions for the purposes of the small business CGT concessions.

Questions 4&5

The small business retirement exemptions provides that if you are an individual, you can choose to disregard all or part of a capital gain if:

(a)  the basic conditions in Subdivision 152-A are satisfied for the gain; and

(b)  if you are under 55 just before you make the choice - you contribute an amount equal to the asset's CGT exempt amount to a complying superannuation fund or an RSA; and

(c)   the contribution is made:

(i)            if the relevant CGT event is CGT event J2, J5 or J6 - when you made the choice; or

(ii)           otherwise - at the later of when you made the choice and when you received the proceeds.

Where an individual makes the choice to apply the small business retirement exemption, the amount of capital gain chosen will be disregarded from your assessable income (subsection 152-310(1) of the ITAA 1997).

The choice made must be made in a way that ensures the individual does not exceed the CGT retirement exemption limit (paragraph 152-315(2)(a) of the ITAA 1997).

Subsection 152-320(1) of the ITAA 1997 states an individual's CGT retirement exemption limit at a time is $500,000 reduced by the CGT exempt amounts of CGT assets specified in choices previously made by or for the individual under Subdivision 152-E of the ITAA 1997.

In this case, you are under 55 and satisfy the basic conditions. You are eligible to reduce your gain by applying the small business retirement exemption up to your lifetime limit of $500,000 on the capital gain that arises when you enter into the BSA and when you sell the biodiversity credits. As you are under 55 years old you must make a personal contribution equal to the exempt amount into a complying superannuation fund or retirement savings account, you must also keep a record of the amount you choose to disregard.