Edited version of private advice

Authorisation Number: 1052271053879

Date of advice: 9 July 2024

Ruling

Subject: Capital gains tax

Question 1

Will CGT event D4 happen when a Partner enters into a biodiversity stewardship agreement ('BSA') over a Conservation Lot?

Answer

Yes.

Question 2

Will CGT event C2 happen when a Partner retires a BSA Credit or a Purchased Credit to comply with the planning approval requirements for the Development Land?

Answer

Yes.

Question 3

Are the Excess Credits trading stock of the Partnership?

Answer

Yes.

Question 4

Will the Partnership include an amount, equal to the arm's length value of a BSA Credit (determined under section 21A of the ITAA 1936), as ordinary income under section 6-5 derived at the time this credit is issued?

Answer

No.

RELEVANT FACTS AND CIRCUMSTANCES

Background information

1.      The Partnership was formed to acquire land and carry out a major land development project, expected to generate about $xx million in gross proceeds. The Partnership is a tax law partnership which will lodge tax returns accordingly, with each Partner including its share of net Partnership income.

2.      The Partnership acquired a parcel of land located in XXX ('the Development Land') via the exercise of a call option agreement which settled on DD MM YYYY, at a total price of about $xx million.

3.      The Partners in the Partnership acquired the Development Land as tenants in common in equal shares.

4.      A condition of the development approval applicable to the Partnership's development activities in respect of the Development Land is that the Partnership will create a number of biodiversity conservation stewardship sites (together 'the Conservation Lots').

5.      The Conservation Lots will be subdivided into lots as part of the overall development, along with the Development Land. Each Conservation Lot will have its own title and building envelopes and will be sold to third parties (same as all the other future residential lots within the estate).

6.      The Partnership has commenced its property development business and holds the Development Land and the Conservation Lots as trading stock.

Biodiversity Stewardship Agreements (BSA)

7.      Under the Biodiversity Conservation Act 2016 (NSW) ('the BCA'), the Minister of Environment (the Minister responsible for administering the Act) ('the Minister') may enter into an agreement called a Biodiversity Stewardship Agreement ('BSA') with landowners relating to their land for the purpose of establishing a biodiversity stewardship site.

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

9.      Under a BSA, the landowners agree to restrictions on the use of the land comprising the biodiversity stewardship site, including to not do anything that may have a negative impact on the biodiversity of the site. The landowner also agrees to carry out management actions (which includes refraining from carrying out certain activities) and to meet certain reporting obligations in respect to a biodiversity stewardship site intended to preserve or enhance the biodiversity of the site. The landowner also agrees on the amount which is required to be paid to the Biodiversity Stewardship Payments Fund ('BSPF') upon transfer or retirement of the credits and the amount Landowners are entitled to receive from the BSPF for carrying out the specified management actions. Generally, the BSA will require the landowners to carry out any management action in perpetuity, unless otherwise specified in the agreement. BSAs are registered on the title to the land.

10.   In order to enter into a BSA, a landowner must have the proposed site assessed by an Accredited Assessor who will determine the biodiversity value of the site and determine the class, number and types of credits to be generated by the BSA and the proposed management plan for the site.

11.   BSAs under the BCA are approved conservation covenants for the purposes of the ITAA 1997: https://www.dcceew.gov.au/environment/biodiversity/conservation/covenants/approved-programs

Biodiversity credits

12.   Under a BSA, biodiversity credits are created and registered to landowners upon entering into the BSA, at any later time provided by the agreement or when an amendment of the agreement that increases the number of credits takes effect. There are two categories of credits, being, species credits or ecosystem credits (there are over 1,500 different types of credits). Once the credit is created, it must be registered in the register of credits to be maintained under the BCA and record the owner of the land as the holder of the credit.

13.   The BSA is the legal basis for issuing the credits to the Landowner and the credits exist until they are cancelled or retired under the BCA.

14.   For a development that involves clearing of land and a significant impact on the biodiversity of the land, it is generally a requirement that the developer (eg. government or private companies) offset the loss of biodiversity caused by the development (eg. the impacts of clearing native vegetation and habitat) by retiring like-for-like biodiversity credits under the scheme. Credits can also be purchased to invest in conservation outcomes for philanthropy, corporate social responsibility or as part of a government program.

15.   The scheme established by the BCA provides for a system for biodiversity credits to be traded. This enables credits to be acquired by developers or other persons who have an obligation to retire biodiversity credits under the scheme.

16.   The biodiversity credits cannot be transferred by the landowner to a buyer until a total fund deposit (TFD) amount is paid into the BSPF. The TFD amount payable is stated in the schedules of the BSA. The amount payable into the BSPF is:

•           where all the biodiversity credits created in relation to a biodiversity stewardship site are transferred, the TFD, or

•           where a portion of the biodiversity credits created in relation to a biodiversity stewardship site are transferred, the relevant proportion of the TFD for the biodiversity stewardship site (where the relevant proportion is the number of biodiversity credits to be transferred in comparison to the number of biodiversity credits created in respect of the biodiversity stewardship site), or the consideration for the transfer of the biodiversity credits, whichever is the greater.

•           However, the payment of an amount into the BSPF in respect of a first transfer of biodiversity credits is not to result in the total amount paid into the fund, in respect of all the biodiversity credits created in respect of the biodiversity stewardship site, exceeding the TFD for the site.

17.   If a landowner wishes to use the biodiversity credits themselves to meet development obligations, they may retire the credits and pay the required TFD into the BSPF. Once the credits have been 'used' to offset negative biodiversity impacts and to permanently secure the conservation of biodiversity, they are 'retired' such that they can no longer be used for any other purpose.

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

19.   Once the TFD has been paid into the BSPF, the site moves into active management and the landowner becomes entitled to receive annual payments in respect of the management actions.

Sale of Biodiversity credits

20.   The biodiversity credits created upon entering a BSA and registered to a landowner may be sold to a developer, the BCT or other interested parties; used by the landowner to offset a loss of biodiversity resulting from a development that they are undertaking or retained by the landowner until such time as the landowners wish to sell or retire the credits.

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

22.   Any additional money that is made from the sale of the biodiversity credits when the TFD has been paid into the BSPF can be retained by the Landowner.

23.   Unless a biodiversity credit has been suspended, and that suspension is in force at the time, the holder of a biodiversity credit (including Landowners) can transfer the credits to any person.

24.   The holder of the credits and the purchaser of the credits must apply to register the transfer of the credits, and the transfer will not have effect until the transfer is registered by the Secretary of the Department of Climate Change, Energy, the Environment and Water (the "Environment Agency Head") in the register of credits.

25.   Where an application to transfer the credits is made, it must be registered by the Environment Agency Head unless they are required or authorised to refuse the application. The Environment Agency Head must refuse to register the transfer of a biodiversity credit unless satisfied that the amount that is required to be paid to the BSPF (ie. the TFD) has been paid.

26.   In this regard, as set out above, the BCA provides that an amount is required to be paid into the BSPF before the first transfer (or retirement, if there is no transfer) of credits can be registered, known as the TFD (or relevant proportion) for the biodiversity stewardship site.

Retirement of Biodiversity credits

27.   The holder (including Landowners) of a credit may make an application to the Environment Agency Head to retire a credit for the following broad reasons:

•           to comply with a requirement to retire credits;

•           to comply with an order of a court;

•           on a voluntary basis; or

•           any other circumstances authorised by the BCA or the Regulations.

28.   Credits must be retired to offset the impact of a development on biodiversity values.

29.   If the Landowner choses to retire (rather than transfer) the credits they must pay any TFD into the BSPF before the retirement is approved and processed. The amount of the TFD payable by the Landowner in this case is the amount that would have been payable had the credits been transferred rather than retired.

30.   Where the credits are retired, the Environment Agency Head records the retirement in the public register of credits.

31.   Again, once the entire TFD has been paid, the Landowner must carry out the management actions set out in the BSA, and in return receives annual payments from the TFD deposited in the BSPF.

Ongoing management actions and annual payments

32.   Under the BSA, the Landowner is required to perform a number of specified management actions on the biodiversity stewardship site. A management action is an action, or refraining from an action, on the biodiversity stewardship site in respect of which a biodiversity credit is created and is generally aimed at protecting and improving the biodiversity of the biodiversity stewardship site. Annual payments will be made to the Landowner from the BSPF in respect of management actions which are carried out, or to be carried out, in accordance with the BSA once the entire TFD has been paid to the BSPF.

33.   Management actions are typically split into two phases, being passive and active management actions:

•           'Passive management actions' commence from the date the BSA is signed and before receiving the first annual management payment. This includes actions aimed at maintaining the existing condition of the biodiversity stewardship site, and which have little or no cost (eg. not removing fallen logs or clearing vegetation), and

•           'Active management actions' commence once the TFD has been satisfied and after receiving the first annual payment. The first annual payment is automatically released by the BCT from the BSPF into the Landowner's nominated bank account following payment of the TFD. Active management actions include actions which are aimed at improving the biodiversity of the biodiversity stewardship site (eg. weed control and management of human disturbance).

34.   Landowners are required to submit an annual report, which provides details on how the Landowner has complied with their obligations under the BSA.

35.   Subclause 10.1 (a)(iii)(C) of the BSA provides that the Minister will only permit the annual payment to be made to a Landowners where, inter alia, the Landowner has submitted an annual report, and the Minister is satisfied with its contents and that the Landowner complied with their obligations under the BSA (eg. management actions).

36.   Unless waived by the Minister, Landowners are required to make an annual contribution toward:

•           the costs of management and administration of the BOS,

•           the costs ensuring compliance with the BOS, and

•           any other costs relating to the BOS.

Establishment of biodiversity stewardship sites

37.   The Landowner must lodge an application in an approved form to the Minister and pay the relevant processing fee (currently waived) to enter into a BSA. Subject to the satisfaction of various criteria (discussed below) and where the Minister approves the application, the BSA with the Minister establishes the biodiversity stewardship site on eligible land pursuant to the Act.

38.   Landowners can decide which areas of their land they will include as the biodiversity stewardship site, allowing for different economic activities to continue on other parts of their land.

Biodiversity Stewardship Agreements (BSA) - Partnership

39.   In order to create the stewardship sites, the Partners in the Partnership will enter into a number of Biodiversity Stewardship Agreements (ie. one 'BSA' for each Conservation Lot) with the NSW government entity administering the NSW conservation program - currently the Biodiversity Conservation Trust ('the BCT').

40.   The Partnership has incurred various consulting costs in relation to entering into these BSAs.

41.   Under the BSA, the owner of the Conservation Lot is committed to managing the land for conservation and to undertaking all necessary actions (control of weeds, management of human disturbance etc.) to improve the Land's biodiversity values, with annual reporting obligations to demonstrate compliance with the terms of the BSA.

42.   For the avoidance of doubt, while the conservation covenant is permanent and will be registered on the title to the Conservation Lot; the entry into such a covenant does not preclude the sale of the underlying land. The Partnership is already marketing the Conservation Lots for sale. The sale price will reflect the fact that the terms of the BSA bind the buyer, who will be required to undertake the management actions stipulated in the BSA, but will also receive ongoing payments from the BCT to cover the cost of the management actions.

43.   By entering into the BSA over each Conservation Lot, the Partnership is entitled to receive a stipulated number and type of biodiversity credits as set out in the BSA. The BSA also sets out, the amount of the "total fund deposit" ('TFD') that the Partnership must deposit into the BSPF, as well as the amount and timing of the periodic payments to be made by the BCT to the present and future owners of the stewardship site.

44.   The TFD must be paid whenever any of the following events occur:

•           credits are sold (all sale proceeds must go into the TFD until it is maxed out)

•           credits are retired (the TFD must be funded up to the proportion of the retired credits to the total amount of credits on issue)

•           the land is sold (the TFD must be funded in full)

45.   Broadly, signing the several BSAs will generate xx credits of x different kinds for the Partnership (the BSA Credits).

46.   Once a BSA is executed, the Partnership intends to sell the Conservation Lot as soon as possible, but will retain the corresponding BSA Credits, as they do not need to be sold together with a Conservation Lot.

47.   The Partnership will be required to retire biodiversity credits to comply with the planning approval for the development. The number of biodiversity credits required to be retired totals xyz credits of different types.

48.   Practically, the Partnership will not be able to finalise the sale of any lot (in respect of either the Development Land or the Conservation Lots) until it has retired the necessary credits.

49.   Based on the biodiversity assessments for the Conservation Lots, this land itself will not generate a sufficient number and type of biodiversity credits for the Partnership to retire in order to satisfy the planning approval requirements.

50.   Therefore, the Partnership expects it will need to:

•           retire xx of the xyz credits generated upon signature of the BSAs

•           purchase from the BCT or third parties, and retire, another xyz credits in order to meet its requirements (the Purchased Credits)

•           sell the remaining yy credits generated from the BSAs that are not required to be retired (the Excess Credits).

51.   As long as xyz credits are retired in total (i.e. the certification requirement), the Partnership may choose which credits to keep, retire or sell on the market.

Information provided

52.   You have provided a number of documents containing detailed information in relation to the Partnership's private ruling application, including:

•           Private Binding Ruling ('PBR') Application, dated DD MM YYYY

•           Copies of several Biodiversity Stewardship Agreements

53.   We have referred to the relevant information within these documents in applying the relevant tests to your circumstances.

Assumption(s)

Not applicable.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 21A

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 70-10

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 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 118-25

Income Tax Assessment Act 1997 Section 995-1

Further issues for you to consider

Not applicable.

REASONS FOR DECISION

All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.

SUMMARY Question 1

CGT event D4 will happen when a Partner enters into a BSA over a Conservation Lot.

SUMMARY Question 2

CGT Event C2 will happen when a BSA Credit or a Purchased Credit is 'retired' by a Partner to comply with the planning approval requirements for the Development Land.

SUMMARY Question 3

The Excess Credits acquired (either upon signing of a BSA or purchased from a third party) and held for resale are trading stock of the Partnership.

SUMMARY Question 4

The Partnership will not include an amount, equal to the arm's length value of a BSA Credit (determined under section 21A of the ITAA 1936), as ordinary income under section 6-5 derived at the time this credit is issued.

DETAILED REASONING

Question 1 - CGT Event D4

54.   CGT Event D4 happens if you enter into a conservation covenant over land that you own (subsection 104-47(1)).

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

56.   Subsection 31-5(5) 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.

57.   It is recognised that entering into a BSA made under the BCA with the Minister for the Environment of the State of NSW satisfies the definition of a conservation covenant under section 31-5. Accordingly, CGT event D4 will happen when a Partner enters into a BSA over each Conservation Lot.

Question 2 - CGT Event C2

58.   CGT Event C2 in subsection 104-25(1) 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.

59.   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)).

60.   A biodiversity credit is an intangible CGT asset.

61.   CGT event C2 will happen when a Partner makes an application to the Environment Agency Head to retire a BSA Credit or a Purchased Credit, and the Environment Agency Head approves the application and makes a recording in the register of biodiversity credits that indicates that the biodiversity credit has been retired.

Question 3 - Excess Credits acquired and held for resale

62.   Trading stock is defined in subsection 70-10(1) to include 'anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business'.

63.   In the current circumstances, the Excess Credits are generated from entering into a BSA or purchased from third parties as part of the Partnership's property development business. The Partnership intends to sell these credits at a profit. It is therefore considered that in these circumstances, the Excess Credits are trading stock of the Partnership.

64.   In respect of the Excess Credits generated from entering into a BSA, it is noted that, although the acquisition of these credits is not the primary purpose of entering into the BSA by the Partnership, their acquisition and sale is nevertheless an incidental part of the Partnership's business operations. This treatment is analogous with the treatment of 'by-products' which as described in paragraph 130 of TR 98/2 are 'secondary products obtained during the course of production or manufacture, having relatively small importance when compared with the principal product or products'. By-products are nevertheless treated as trading stock (see paragraph 133 of TR 98/2).

Question 4 - Inclusion of BSA Credits as income

65.   In the Partnership's specific circumstances, it is considered, on balance, that the receipt of the BSA Credits is capital in nature. Accordingly, it is considered that, on balance, the receipt of the BSA Credits is not income derived by the Partnership and therefore does not result in an amount being included in the assessable income of the Partnership under section 6-5 and section 21A at the time they are derived.

CONCLUSION

SUMMARY Question 1

CGT Event D4 will happen when a Partner enters into BSA over land that it owns an interest in i.e. each Conservation Lot.

SUMMARY Question 2

CGT Event C2 will happen when a biodiversity credit is 'retired' by a Partner to comply with the planning approval requirements for the Development Land.

SUMMARY Question 3

The Excess Credits acquired (either upon signing of a BSA or purchased from a third party) and held for resale are trading stock of the Partnership.