ATO ID 2004/718: Forest operations and carbon sequestration activities: deductibility of costs of planting and maintaining forests
Date of decision: 27 August 2004
Year of income: Year ended 30 June 2004
Business line: Public Groups and International

Issue
Is the taxpayer entitled to a deduction, under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), for the costs of planting and maintaining trees in forests, where those forests are planted and maintained in the ordinary course of forestry activities, whilst also carrying on carbon sequestration activities?

Decision
Yes. The taxpayer is entitled to a deduction, under section 8-1 of the ITAA 1997, for the costs of planting and maintaining trees in forests, where those forests are planted and maintained in the ordinary course of forestry activities. The deductibility of these expenses is not altered by the fact that the taxpayer also derives income from carbon sequestration activities that are carried on in conjunction with the forestry activities.

Facts
The taxpayer has acquired several thousand hectares of land and has commenced forestry operations on the land. The forest is managed on a continuing cycle of planting, harvesting and replanting. The planting is staggered so that a similar area of forest is planted each year until the first age class is ready for final harvesting. The carbon accounts for the planted estate are measurable over one rotation (usually around 30 years for a certain type of planted forest managed for the relevant timber product). Carbon emissions from harvesting are balanced by growth elsewhere in the forest estate. The taxpayer retains title to the trees and carbon sequestration rights from those trees. The taxpayer derives income from the harvesting of the timber products from the trees that it manages in its forest. The taxpayer enters into contracts for the sale of the carbon sequestration rights with various third parties who require the rights to offset carbon dioxide emissions from their business operations. The taxpayer is required to maintain the level of sequestered carbon in the forest, over which carbon sequestration rights have been created, for at least 100 years.

Reasons for decision
Summary: Section 8-1 of the ITAA 1997 allows a deduction for all losses or outgoings to the extent that they are incurred in gaining or producing the taxpayer's assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, no deduction is allowed to the extent that the losses or outgoings are of a capital, private or domestic nature or are necessarily incurred in gaining or producing exempt income. The costs of planting and maintaining the trees in the forest are incurred in producing the taxpayer's assessable income as the costs have a sufficient connection with the income that is earned from the forestry operations carried on by the taxpayer. This is because the trees that are planted and maintained will eventually be felled and sold as timber thus producing the taxpayer's assessable income. The costs of planting and maintaining the trees in the forest are not capital as the continual planting and harvesting of trees is part of the ongoing business operations of the taxpayer. The planting of the trees does not establish a capital asset as the trees are planted for the purpose of timber production and the trees will eventually become trading stock of the taxpayer when they are felled. A taxpayer who is engaged in 'forest operations' is a primary producer for income tax purposes if those forestry activities constitute the carrying on of a business. The definition of a 'primary production' business in section 995-1 of the ITAA 1997 includes: Where a taxpayer plants or tends trees in a forest with the intention to fell them they will be engaged in 'forest operations' and will be entitled to the various deductions described in Taxation Ruling TR 95/6. As the taxpayer is planting the trees with the intention to fell them for timber in the normal course of forestry operations a deduction is allowed, under section 8-1 of the ITAA 1997, for the costs of planting and maintaining the trees in those forests. The deductibility of these expenses is not altered by the fact that the taxpayer also derives income from carbon sequestration activities that are carried on in conjunction with the forestry activities.

Legislative references: Income Tax Assessment Act 1997 section 8-1 section 995-1
Related public rulings and determinations: Taxation Ruling TR 95/6
Related ATO interpretative decisions: ATO ID 2004/320 | ATO ID 2004/321 | ATO ID 2004/714 | ATO ID 2004/768
Subject references: Afforestation expenses Carbon sequestration rights Forestry Plantation forestry Primary production