Private ruling: Credit Trading Agreement
Published: July 2012
Ruling period: Year ending 30 June 2013 | Year ending 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Questions and Answers | Will a capital gains tax (CGT) event happen when you enter into the Credit Trading Agreement (CTA)? | Yes. | Does the CGT event happen at the time that you enter into the CTA? | Yes. | Will a CGT event happen when you dispose of the vegetation credits (herein referred to as the credits) that you acquire by entering into the CTA? | Yes. | Can the expenditure that you incur in entering into the offset scheme, such as payments to accountants and lawyers for advice related to the CTA be included in the cost base of the conservation covenant? | Yes. | Will the annual payments that you receive as a result of entering into the CTA be assessable income? | No. | If you allocate part of the annual payment as compensation 'for the management works required to meet the obligations of the Agreement' will this influence how the Australian Taxation Office (ATO) considers that amount for tax purposes? | No. | Will a CGT event happen if the land to which the CTA relates is sold to a third party within the 10 year period of the CTA? | Yes. | Are you able to claim a deduction for the expenditure that you incur in entering into the offset scheme, such as payments to accountants and lawyers for advice related to the CTA? | No. | Is expenditure incurred by you in implementing the CTA, such as managing the offset area as required by the management plan, able to be deducted in the income year in which the expenditure is incurred? | No. | Will a capital gain made from CGT event D4 and CGT event A1 qualify for the small business concessions where the land is an active asset and the other relevant requirements in Division 152 of the ITAA 1997 are met? | Yes.

Relevant facts and circumstances: You are the majority owner of a farm. You acquired your interest in the farm some time after 20 September 1985. You live on the farm and are a primary producer. You have an Australian Business Number (ABN) and are registered for the Goods and Services Tax (GST). Your relative is the minority owner of the farm. They do not live on the farm, are not a primary producer and are not registered for GST. The farm contains native grassland with animal and plant species listed as endangered under Commonwealth legislation. You registered the farm with an organisation as part of an Offset Program. You did this with the aim of obtaining a conservation offset that would provide you and your relative with annual income over 10 years. After registering your farm, the organisation gave you copies of drafts of a Memorandum of Understanding (MOU) and CTA as the agreements to be used should you be able to provide an offset area that meets the requirements of a land developer. You have provided copies of these agreements and they are to be read in conjunction with, and form part of, this private ruling. The MOU is used to confirm that the developer, landowner and the organisation agree to work towards the signing of a CTA. The CTA defines the legal basis on which the offset is created and how payment is made, as well as other rights and responsibilities. The main points of the CTA are as follows: The agreement is between the organisation, a purchaser and an owner. The agreement facilitates a land developer known as 'the purchaser' to buy from a landowner known as 'the owner' services in the form of Vegetation Credits so the land developer can comply with a planning permit that requires it to obtain an Offset area to compensate for the destruction of vegetation at its development site. The agreement facilitates the establishment of a Conservation Covenant on the owners land to protect the Offset area in perpetuity. The organisation is the beneficiary of the creation of a Conservation Covenant on the owner's land that contains and permanently protects the Offset area, which is the source of the Vegetation Credits used as evidence of the creation and supply of an Offset area. The agreement contains an Agreed Price, which is the amount of money as listed in Schedule 1 of the Agreement. By signing the agreement, a landowner agrees to (amongst other things): Establish a Conservation Covenant on the landowner's property to provide permanent protection for the Offsets area; Sell the vegetation credits to the developer when the developer pays the Agreed Price to the organisation; Manage the land in the Offset area as per relevant schedules of the agreement, one of which includes a Plan for managing the Offset area over 10 years. The purchaser pays the Agreed Price to the organisation, upon the presentation of a tax invoice from the organisation usually after the execution of the Conservation Covenant by the landholder. The organisation registers the Conservation Covenant that is applied to the Offset area to secure the Offset. After receiving payment of the amount equivalent to the Agreed Price, the organisation holds that money minus certain fees on behalf of the landholder (the 'Payment to Owner' amount) in an interest bearing account, and makes annual payments to the landholder over the following 10 years until the 'Payment to Owner' plus interest is paid to the landowner. For the purpose of this agreement, a Conservation Covenant is defined as "an encumbrance registered on the title to the Subject Land in favour of the organisation, executed in furtherance of the purposes of the organisation under the Act. It includes any Management Plan or other document which the Owner is required to comply with under the Conservation Covenant including this agreement". Schedule 1.4 contains an "Optional Breakdown of Payment to Owner". This table contained in this schedule may be completed by the Owner to illustrate the financial value to the Owner of each component of the payment. Those components are: compensation for decreased land values caused by establishing a conservation covenant; compensation for conducting required management works as part of the agreement; and compensation for managing risks and liability caused by the agreement. However, this schedule also states that completing the table in the schedule is done "without prejudice to the legal obligations created by the Agreement". The Owner agrees to ensure that any new Owner gives effect to the Agreement and executes a deed agreeing to be bound by the terms of the Agreement. The Agreement ends after 10 years. The Agreement does not provide any specific right for the Owner who signs the Agreement to any money held by the organisation after that owner sells or otherwise transfers ownership of the Offset area to a new Owner.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1, | Income Tax Assessment Act 1997 Section 102-20, | Income Tax Assessment Act 1997 Section 103-10, | Income Tax Assessment Act 1997 Section 104-10, | Income Tax Assessment Act 1997 Section 104-47, | Income Tax Assessment Act 1997 Subsection 104-47(4), | Income Tax Assessment Act 1997 Section 108-5, | Income Tax Assessment Act 1997 Section 110-25, | Income Tax Assessment Act 1997 Section 110-35, | Income Tax Assessment Act 1997 Subsection 112-30(3), | Income Tax Assessment Act 1997 Section 115-5, | Income Tax Assessment Act 1997 Section 115-10, | Income Tax Assessment Act 1997 Section 115-15, | Income Tax Assessment Act 1997 Section 115-20, | Income Tax Assessment Act 1997 Section 115-25, | Income Tax Assessment Act 1997 Section 115-100, | Income Tax Assessment Act 1997 Section 116-20, | Income Tax Assessment Act 1997 Section 116-30, | Income Tax Assessment Act 1997 Section 152-10, | Income Tax Assessment Act 1997 Section 152-35 and | Income Tax Assessment Act 1997 Section 152-40.

Reasons for decision: Detailed Reasoning - Entering into the CTA: Section 104-47 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that CGT event D4 happens if you enter into a conservation covenant over land that you own. The time of the event is when you enter into the covenant. If the capital proceeds from entering into the covenant are more than the part of the cost base of the land that is attributed to the covenant, you make a capital gain. If the capital proceeds are less than the part of the reduced cost base of the land attributable to the covenant, you make a capital loss. The capital proceeds from entering into the CTA is the amount received or entitled to be received under the agreement. The amounts that are applied in respect of entering into the covenant and the annual payments are amounts that you will receive or are entitled to receive. The part of the cost base and reduced cost base of the land that is apportioned to the conservation covenant is worked out using the following formula: cost base or reduced cost base of land multiplied by capital proceeds from entering into to the covenant divided by those capital proceeds plus the market value of the land just after entering into the covenant. Example: Lisa receives $10,000 for entering into a conservation covenant that covers 15% of the land she owns. Lisa uses the following figures in calculating the cost base of the land that is apportioned to the covenant: The cost base of the entire land is $200,000. The market value of the entire land before entering into the covenant is $300,000, and it market value after entering into the covenant is $285,000. Lisa calculates the cost base of the land that is apportioned to the covenant to be: $200,000 x $10,000 ¸ [$10,000 + $285,000] = $6,780 She reduces the cost base of the land by the part that is apportioned to the covenant: $200,000 - $6,780 = $193,220. The cost base and reduced cost base also includes any application fees and fees to consultants or legal advisers that you incur. In your case, CGT event D4 applies to the total payment for entering into the CTA including any annual payments that you are expected to receive in subsequent years. As the annual payments that you will receive are considered to be capital proceeds in respect of CGT event D4, they will not be assessable income. You are able to apply the CGT 50% discount to any capital gain made from CGT event D4 happening as the land was acquired at least 12 months before entering into the agreement and the other conditions are met. | Detailed Reasoning - Sale of Vegetation Credits: A vegetation credit is a CGT asset as defined by section 108-5 of the ITAA 1997. In accordance with section 104-10 of the ITAA 1997, CGT event A1 will happen when you dispose of your Vegetation Credits that you receive under the CTA. The capital proceeds from the disposal of your Vegetation Credits is the money or the market value of property that you receive or are entitled to receive in respect of the disposal of the credits. The money that you receive or are entitled to receive does not include the amount (the total fund deposit) that the buyer is required to pay the organisation. If you do not receive any money or property, the capital proceeds will be the market value of the credits disposed of. The first element of the cost base of the Vegetation Credits is the money that you will pay or are required to pay in respect of acquiring the credits. This is the amount specified in the CTA as having been applied in respect of the issue of the Vegetation Credits (provided for in schedule 1 as the "offset management plan"). This may be an amount that the organisation applies on your behalf in respect of the acquisition of the Vegetation Credits. | Detailed Reasoning - Sale of land to third party: The conservation covenant and the land itself are two separate CGT assets. CGT event A1 happens when you dispose of a CGT asset. Therefore if the land to which the CTA relates is sold to a third party CGT event A1 will happen. You are able to apply the CGT 50% discount to any capital gain made from CGT event A1 happening as the land was acquired at least 12 months before entering into the agreement and the other conditions are met. | Detailed Reasoning - Deductibility of expenses: Section 8-1 of the ITAA 1997 provides that you can claim a deduction for expenses that you incur in gaining or producing assessable income unless the expenses are private, domestic or capital in nature. The expenses that you have incurred in entering into the CTA, such as payments to accountants and lawyers are capital in nature and, as previously advised, are included in the cost base of the Vegetation Credits. As the annual payments that you will receive will be capital in nature, the expenses that you incur in respect of managing the offset area in accordance with the management plan are not able to be deducted as they are not expenses that you have incurred in gaining or producing your assessable income. | Detailed Reasoning - Small business concessions: Division 152 of the ITAA 1997 provides CGT concessions that are available to a small business entity provided that certain conditions are met. Section 152-10 of the ITAA 1997 provides that a capital gain (except a capital gain from CGT event K7) you make may be reduced or disregarded if the following basic conditions are satisfied: · a CGT event happens in relation to a CGT asset of yours in an income year; · the event would (apart from this Division) have resulted in the gain; · at least one of the following applies; · you are a small business entity for the income year; · you satisfy the maximum net asset value test; · 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; · the CGT asset satisfies the active asset test. | Detailed Reasoning - Active asset: The asset disposed of must satisfy the active asset test under section 152-35 of the ITAA 1997 and must not be excluded from being an active asset under subsection 152-40(4). A CGT asset satisfies the active asset test if: · you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period specified in subsection (2); or · you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 years during the period specified in subsection (2). The period in subsection (2): · begins when you acquired the asset; and · ends at the earlier of: · the CGT event; and · if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows the cessation of the business. A CGT asset is an active asset at a time if, at that time; · you own the asset (whether the asset is tangible or intangible) and · you use it, or hold it ready for use, in the course of carrying on a business; or · it is used, or held ready for use, in the course of carrying on a business by your affiliate, or by another entity that is connected with you; or · if the asset is an intangible asset you own it and it is inherently connected with a business that you, your affiliate, or another entity that is connected with you carries on (for example, goodwill or the benefit of a restrictive covenant). In your situation, you are using the land in carrying on the business of farming and therefore you will be able to apply the small business concessions provided that the land meets the active assets requirements.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.