Private ruling: CGT - conservation covenant and biodiversity credits
Date of advice: 27 August 2021
Published: November 2021
Ruling period: Financial year ending 30 June 20XX | Financial year ending 30 June 20XX | Financial year ending 30 June 20XX | Financial year ending 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Did capital gains tax (CGT) event D4 occur when the Partners entered into a Biodiversity Stewardship Agreement (BSA) entitling it to receive biodiversity credits as per section 104-47(1) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Will CGT event A1 occur when the Partners dispose of biodiversity credits via a sale of the credits as per section 104-10 of the ITAA 1997? | A2: Yes | Q3: Does the Total Fund Deposit amount to be paid by the Partners to the Biodiversity Stewardship Payments Fund form part of the Partners' cost base (or reduced cost base) of the biodiversity credits? | A3: Yes | Q4: Does the cost base of the biodiversity credits include an amount equal to the market value of the 'other property' given up (being rights in respect of the Land) by the Partners in acquiring the biodiversity credits? | A4: Yes

Relevant facts and circumstances: The Partners are the owners of the farming land (the Land) acquired in 20XX as tenants in common. Farming activities have been conducted on the Land by a trust associated the Partners since acquisition to the present day. The Land is held on capital account. The Partners have agreed to designate part of the Land on which conservation activities will be taken out. In the 20XX-XX financial year, the Partners entered into a Biodiversity Stewardship Agreement (BSA) with the Minister responsible for administering the Biodiversity Conservation Act 2016 (NSW) (Biodiversity Act), being the Minister for the Environment of the State of New South Wales. In practice, the Minister delegates the exercise of his functions under the Biodiversity Act and the BSA to the senior executives of the trustee of the Biodiversity Conservation Trust of New South Wales (BCT). BSA's are voluntary in-perpetuity agreements entered into by landowners with the BCT to permanently protect and manage an area of land. Biodiversity credits are created as a result of the BSA. The credits may then be sold to a developer, the BCT or other interested parties or retained at the landowner's discretion. The sale price of each biodiversity credit will be negotiated between the landowner and the buyer and are therefore affected by supply and demand for the relevant class of biodiversity credit. In order to affect the registration of a biodiversity credit sale transfer to the new owner, the landowner must pay the attributed fund deposit amount to the BCT. Each biodiversity credit has a fund deposit amount attributable it. The total fund deposit amount payable by the landowner to the BCT is stated in the schedules of the BSA. The BCT is the fund manager for the Biodiversity Stewardship Payments Fund. The BCT invests these funds, with proceeds used to make annual biodiversity stewardship payments to the landowner under the BSA being for the ongoing management of the land. XXX credits were issued in total from the BSA with an estimated value of $XXXX. The Partners entered into a sale agreement to dispose of XX credits in the 20XX-XX financial year with the disposal of the remaining credits expected to occur in the 20XX-XX, 20XX-XX and 20XX-XX financial years. The BSA requires a total fund deposit amount of $XXXX to be paid by the Partners to the BCT before the transfer of the sale of the biodiversity credits will be registered.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 31-5(5) | Income Tax Assessment Act 1997 section 104-10 | 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 subsection 110-25(3) | Income Tax Assessment Act 1997 subsection 110-35(1) | Income Tax Assessment Act 1997 subsection 110-35(4) | Income Tax Assessment Act 1997 subsection 116-20(1)

Reasons for decision: Summary: As the BSA is a conservation covenant, for the purposes of section 104-47(1) of the ITAA 1997, CGT event D4 will happen at the time the Partners entered into the BSA. The capital gain or loss from CGT event D4 is calculated in accordance with section 104-47 of the ITAA 1997. The capital proceeds being the market value of the biodiversity credits created under the BSA. | Detailed Reasoning - Detailed reasoning: CGT event D4 happens if you enter into a conservation covenant over land you own (subsection 104-47(1) of the ITAA 1997). The time of the event is when you enter into the covenant (subsection 104-47(2) 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 subsection 31-5(5) of the ITAA 1997. Consequently, CGT event D4 will happen at the time when the Partners entered the BSA with the BCT. The capital gain or capital loss will be determined in accordance with section 104-47 of the ITAA 1997. 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) 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 the Partners received from CGT event D4. They will therefore constitute property received for the purpose of the capital proceeds under paragraph 116-20(1)(b) of the ITAA 1997 with the amount determined by their market value 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: The cost base and reduced cost base of the land are reduced by the part of the cost base or reduced cost base of the land that is apportioned to the covenant. | Summary: As the biodiversity credits are a CGT asset, the sale of the credits by the Partners constitutes CGT event A1. | Detailed Reasoning - Detailed reasoning: Subsection 108-5(1) defines a CGT asset as: a) any kind of property; or b) a legal or equitable right that is not property. Biodiversity credits fall would fall within the definition of CGT asset under paragraph 108-5(1)(a) of the ITAA 1997. 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 (section 104-10 of the ITAA 1997). In this case CGT events A1 occurs whenever the Partners enter contracts with purchasers for the sale of biodiversity credits. | Summary: The Total Fund Deposit amount payable by the Partners in order for the sale transfer of the Biodiversity Credits to be registered by the BCT can be included as part of the Biodiversity Credit cost base as an incidental cost incurred by the Partners in relation to the disposal of the credits. | Detailed Reasoning - Detailed reasoning: The second element of the cost base of a CGT asset comprises the incidental costs incurred by the taxpayer (subsection 110-25(3) of the ITAA 1997) to acquire the CGT asset, or that relate to the CGT event (subsection 110-35(1) of the ITAA 1997. Stamp duty is defined in Butterworths Australian Legal Dictionary as 'a tax imposed by all Australian States on documents or transactions that affect or record the transfer of the ownership of assets (for example, conveyances of real property, shares and business assets) or the creation of rights in respect of assets (for example, the granting of a lease)'. The Total Stewardship Fund is a payment to the BCT being an established authority of the NSW state government. The payment is required in order to affect the record of transfer of ownership of the assets being the sale of the biodiversity credits (CGT event A1), is considered by the Commissioner to be a type of stamp duty or similar duty. From the above, it is evident that the Total Stewardship Fund Deposit amount is an incidental cost that relates to the CGT event being inextricably linked to the disposal of the biodiversity credits. Therefore, it can be included in the Partners' second element of the cost base for the biodiversity credits. | Summary: The cost base of the biodiversity credits includes an amount equal to the market value of property given up by the Partners (being rights in respect of the Land) to acquire the CGT asset. | Detailed Reasoning - Detailed reasoning: 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. By subjecting part of the land to a covenant, the Partners have given up its rights to subject that portion of the Land to any future conservation covenant as well permanently giving up its rights to carry out certain activities on that portion of the Land. It is reasonable that the giving up of these rights can be recognised as 'property given or required to be given' by the Partners for the purposes of the cost base rules. The market value of these rights, being property that has been given up by the Partners in acquiring the biodiversity credits (by permanently restricting portion of the land in undertaking certain activities), must then be worked out at the time of the acquisition of the credits. The Partners have assessed that the market value of the rights given up are comparable to the amount of capital proceeds received from CGT event D4. Given the timing of the acquisition of the credits is aligned with the timing of the receipt of the capital proceeds under CGT event D4, the Commissioner considers this assessment reasonable.