Private ruling: Biodiversity credits and capital gains tax
Date of advice: 19 November 2020
Published: January 2021
Ruling period: 1 July 20XX to 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Are biodiversity credits issued by Biodiversity Conservation Trust a CGT asset? | A1: Yes. | Q2: Can biodiversity credits be active assets under the small business CGT concessions? | A2: Yes. | Q3: Assuming the answer to the first question is yes, when are the biodiversity credits deemed acquired? | A3: When the Biodiversity Agreement is entered.

Relevant facts and circumstances: The business The X partnership is comprised of X% X, X% X and X% X Pty Ltd. This partnership has been the trading entity for the farming business from the early 19XX's. The taxpayer's have been operating a farming business on the land since 19XX. The gross income of the company and associated entities is less than $XXX for both the 30 June 20XX income year and 30 June 20XX income year. Since acquisition, the land has been used in the course of carrying on the farming activities. Since 1974 this primarily focused on the sale of X, however from 201X on, there was significant activity for a X - which was also operated on the farming land. The Biobanking Agreement The taxpayers propose to enter into four Biobanking Agreements with the Minister for the Environment of the State of New South Wales (Minister) in accordance with the Biodiversity Act 2016 (NSW). The Biobanking Agreement is a statutory covenant recording the establishment of a Biobank Site registered on the land (binding future successors in title). The agreement is between the Minister and the landowner and is in force in perpetuity. It is a conservation covenant for the purposes of subsection 104-47(1) of the Income Tax Assessment Act 1997 (ITAA 1997). The Biobanking Agreement specifies the amount that the landowner is entitled to receive on signing that agreement. This amount is satisfied in full by the creation of the biodiversity credits listed in the Biobanking Agreement. This amount is the best estimate of the market value of the biodiversity credits at the time of their creation. On each anniversary date of the first sale of biodiversity credits (if any), the landowner will receive an annual payment from the Biobanking Trust Fund. This payment is subject to the landowner completing the management actions set out in its Biobanking Agreement. Land ownership Each Biobanking Agreement covers a different parcel of land described as follows: X X is on one title of land and the remaining X parcels cover more than one title of land each. The land titles which relate to the X Biobanking Agreement were acquired by X in 1989 and therefore this parcel of land is not a pre-CGT asset. The land titles which relate to the X Biobanking Agreement were acquired by X prior to 1985. There has been no change to the nature of shares or shareholdings in X since it acquired the land titles which relate to the X Biobanking Agreement. X issued X ordinary shares in 19XX, one to X, and the other to X. In 197X it issued an additional X shares to X. There have not been any other forms of equity on issue, nor any changes to the nature of shares or shareholders since incorporation. The land titles which relate to the X Biobanking Agreement were acquired by X X prior to 1985. The land titles which relate to the X Biobanking Agreement were acquired by X prior to 1985. Each entity has held each land title continuously since it was acquired. Accordingly, the land titles which relate to the X, X, and X Biobanking Agreements are pre-CGT assets for the purposes of section 149-10 of the ITAA 1997. The sale of biodiversity credits Once the biodiversity credits have been issued to a landowner, they can immediately be sold to any purchaser pursuant to section 127Z of the Threatened Species Conservation Act 1995 . The taxpayers propose to sell the biodiversity credits to a broker. The sale price is negotiated between the parties and will include the Trust Fund Deposit amount plus any upfront residual amount. The required Trust Fund Deposit for each individual Biobank Site must be met before any upfront residual payment is made to the landowner in accordance with the proposed Threatened Species (Biodiversity Banking) Regulation 2008 . The landowners will hold the biodiversity credits on capital account.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 100-45 | Income Tax Assessment Act 1997 section 100-50 | Income Tax Assessment Act 1997 section104-10 | Income Tax Assessment Act 1997 section104-47 | Income Tax Assessment Act 1997 section 152-10

Reasons for decision: Summary: Yes | Detailed Reasoning - Detailed reasoning: Subsection 108-5(1) of the ITAA 1997 defines a Capital Gains Tax (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 under paragraph 108-5(1)(a) of the ITAA 1997 as it is a form of intangible property. | Detailed Reasoning - Question 2: Can biodiversity credits be active assets under the small business CGT concessions? | Summary: Yes | Detailed Reasoning - CGT event A1 on sale of biodiversity credits: CGT event A1 happens when the landowner disposes of biodiversity credits at the time the landowner enters the sale contract. (section 104-10 of the ITAA 1997). As the biodiversity credits will be held on capital account by the taxpayers, any profit made by the landowners on sale of their biodiversity credits will not be assessable income under section 6-5 of the ITAA 1997. Under subsection 104-10(4) of the ITAA 1997, the landowner 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, the landowner will make a capital loss. A capital gain made from CGT event A1 happening will qualify for the small business CGT concessions provided the land is an active asset and the other relevant requirements in Division 152 of the ITAA 1997 are met. | Detailed Reasoning - Active asset test: Section 152-40 of the ITAA 1997 states: (1) A * CGT asset is an active asset at 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. ... (4) However, the following * CGT assets cannot be active assets: (e) an asset whose main use by you is to * derive interest, an annuity, rent, royalties or foreign exchange gains unless: (i) the asset is an intangible asset and has been substantially developed, altered or improved by you so that its * market value has been substantially enhanced; or (ii) its main use for deriving rent was only temporary. (emphasis added) 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 farming business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you. The biodiversity credits arise as satisfaction of the amount the landowner is entitled to receive on signing the Biobanking Agreement which creates a conservation covenant over their land. 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 was and is used in the farming 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 farming, 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. The remaining relevant requirements in Division 152 of the ITAA 1997 must be met to qualify for the small business CGT concessions. | Detailed Reasoning - Question 3: Assuming the answer to the first question is yes, when are the biodiversity credits deemed acquired? | Summary: When the Biobanking Agreement is signed. | Detailed Reasoning - Detailed reasoning: Biodiversity credits are created when the Biobanking Agreement is signed and issued to the landowner. As a result, they are acquired for the purposes of the CGT provisions on the date the contract is entered.

Reasons for Decision: These reasons for decision accompany the Notice of private ruling for X, X and X (the taxpayers). | While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.