Private ruling: Income tax and capital gains tax - sale of pre-CGT trees
Date of advice: 24 November 2015
Published: February 2016
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Do the terms of the agreement amount to a profit a prendre as contemplated by Taxation Determination TD 93/81? | A1: No. | Q2: Are the advance payment and payments based on volumes for standing timber taxable income to the company? | A2: Yes.

Relevant facts and circumstances: The Company has entered into an agreement with Forestry to grant that business the exclusive right, for the term, to harvest and take all of the commercially viable standing hardwood timber on the land. Forestry agrees to purchase the timber for a price upon the terms and conditions of the agreement. The term will commence and will continue for a period of X months unless terminated or extended under the clauses contained in the agreement. The price payable for the grant of the exclusive right to harvest and take the timber (the Grant Price) is $X. An additional $X payment will also be made before the commencement date. This payment will be deducted from any future payments that may be otherwise made. Timber that is successfully harvested will be paid to the Company based on an accounting method documenting volumes of timber sold and paid within 30 days. Forestry has advised that a profit a prendre has not been registered for the land as the land became freehold. A copy of the executed agreement between the Company and Forestry has been provided.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5

Reasons for decision: Detailed Reasoning - Profit a prendre: Taxation Determination TD 93/81 concerns a taxpayer owning pre-CGT trees and selling timber according to two post-CGT contracts:- a contract for granting the purchaser of the timber the right to enter the taxpayer's property over a period of time and remove timber as and when required; and a contract for the sale of the uncut timber. It states that even though the right to remove timber and the sale of uncut timber are subject to two contracts, the transactions together are taken to constitute a p rofit a prendre . The grant of a profit a prendre gives rise to the disposal of a post-CGT asset created by the grantor ie the taxpayer (IT2 561). The proceeds from the 'sale' of the timber are treated as part of the consideration received for the grant of the profit a prendre . The example provided in TD 93/81 contemplates a profit a prendre exists for: • Granting the right to enter and remove the uncut timber; and • A contract for the sale of the uncut timber at a total price. You have stated that the Company has entered into an agreement with Forestry to grant that business the exclusive right, for the term of X months (unless extended or terminated prior), to harvest and take all of the commercially viable standing hardwood timber on pre-CGT land. The price payable for the grant of the exclusive right to harvest and take the timber (the Grant Price) is $X. An additional $X payment will also be made before the commencement date. This payment will be deducted from any future payments that may be otherwise made. Timber that is successfully harvested will be paid to the Company based on an accounting method documenting volumes of timber sold and paid within 30 days. Forestry agrees to purchase the timber for a price upon the terms and conditions contained in the agreement. You have advised that Forestry have not registered a profit a prendre over the land. The situation considered in Taxation Determination TD 93/81 differs from the Company's circumstances in that the example in that Taxation Determination covers the granting of the right and contemplates a total price to be paid for the sale of the uncut timber. It does not contemplate the situation where there are advance payments (to be deducted from future payments) and further payments based on volumes. In the Company's situation the total price payable for all the timber taken cannot be determined. Consequently TD 93/81 cannot be applied to the Company's circumstances in relation to the grant price of $X and the advance payment of $X. To determine if a profit a prendre arises, the test in Marshall v Green [1875] 1 CPD 35 should be applied - that is, where at the time of the contract it is contemplated that the purchaser will derive a benefit from the further growth of the thing sold, then the purchaser acquires an interest in the land ie a profit a prendre : Ashgrove & Ors v FC of T (1994) 124 ALR 315; 94 ATC 4549; (1994) 28 ATR 512. Statutory provisions may also be relevant to determining whether a right is a profit a prendre . There are several clauses in the agreement that indicate a forestry right exists including restrictions on the landowners use and dealings with the land. Further, the agreement provides that Forestry has an unrestricted right to enter onto the land for harvesting operations, haulage operations, construction of roads and tracks, planning of harvesting operations and conducting post harvesting ameliorative measures. Consequently, we consider that a profit a prendre exists as defined in the agreement. That is the grant of the exclusive right to enter, harvest and take the timber. Taxation Ruling IT 2561 provides at paragraph 16 that an easement, profit a prendre or licence (or other comparable right) is an asset created at the time it is granted. Paragraph 18 states that if the grant of an easement, profit a prendre or licence (or other comparable right) occurs on or after 20 September 1985, there is an acquisition by the grantor of a new asset created after that date. Therefore, the capital gains provisions apply on the disposal of the new asset. This is so notwithstanding that the underlying asset, for example the land, may have been acquired before 20 September 1985. Therefore the Grant Price of $X paid to the Company for Forestry's exclusive right will be capital in nature and the capital gains provisions will apply. | Detailed Reasoning - Proceeds of sale of trees: Ordinary income 'Ordinary income' is defined in section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) to mean income according to ordinary concepts. The legislation does not provide any specific guidance on what is meant by 'income according to ordinary concepts'. However a substantial body of case law has evolved over time that identifies various factors that are taken into account in determining when an amount is 'income according to ordinary concepts'. Ordinary income includes income that arises in the normal scope of a taxpayer's business. In addition, in limited circumstances, gains not within the ordinary scope of the taxpayer's business may form part of ordinary income. Forest operations Income derived by a person who is conducting a primary production business of forest operations is assessable income under section 6-5 of the ITAA 1997. A person who merely sells standing timber without tending or felling those trees is not conducting a primary production business of forest operations (paragraph 14 of Taxation Ruling TR 95/6). We do not consider that you are conducting a primary production business of forest operations. Isolated profit making transaction Receipts from the disposal of trees by a person who is not carrying on a primary production business of forestry operations may be assessable income under section 6-5 of the ITAA 1997 if the receipts are from an isolated profit making transaction. If a taxpayer carrying on a business makes a profit from a transaction or operation, that profit is income if the transaction or operation is in the course of the taxpayer's business, although not within the ordinary course of that business, and the taxpayer entered the transaction or operation with the intention or purpose of making a profit (paragraph 15 of TR 92/3). A profit from an isolated transaction is generally assessable income when both of the following elements are present: (a) The intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; (b) The transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction. In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations. The intention or purpose of the taxpayer is discerned from an objective consideration of the facts and circumstances of the case. If the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income. Paragraph 13 of TR 92/3 lists factors that the Commissioner will take into account in considering whether an isolated transaction amounts to a business operation or commercial transaction. These factors are: (a) The nature of the entity undertaking the operation or transaction; (b) The nature and scale of other activities undertaken by the taxpayer; (c) The amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained; (d) The nature, scale and complexity of the operation or transaction; (e) The manner in which the operation or transaction was entered into or carried out; (f) The nature of any connection between the relevant taxpayer and any other party to the operation or transaction; (g) If the transaction involves the acquisition and disposal of property, the nature of that property; and (h) The timing of the transaction or the various steps in the transaction. You have advised that a $X payment will be made before the commencement date. This payment will be deducted from any future payments that may be otherwise made. Timber that is successfully harvested will be paid to the Company based on an accounting method documenting volumes of timber sold and paid within X days. Whilst an initial $X will be paid as an advance payment, this amount does not cover the potential profit that will be made from sale of the uncut timber and, as the agreement can be extended, the total amount of potential profit cannot be discerned. The agreement Recitals state that Forestry wishes to acquire additional hardwood timber from the Company's land for supply to persons that mill and process hardwood timber and the Company has agreed to sell the timber to Forestry. The terms of the agreement between the Company and Forestry allow for Forestry to harvest and take all the timber it may require from the land identified on the plan with a small non-harvest area indicated as 'non-commercial, inaccessible'. The information provided indicates this is a commercial transaction entered into by the Company for the purpose of profit or gain but not in the Company's ordinary course of business. On balance, we consider that this is an isolated profit making transaction. Consequently, any income received by the Company from Forestry for the sale of the timber on its land will be assessable income of the Company. | Detailed Reasoning - Conclusion: A profit a prendre exists and a post-CGT asset (the granting of the right) was created and disposed of at the time of the creation of the agreement between the Company and Forestry. The income received for the sale of the timber is assessable income to the Company as we consider the agreement to constitute an isolated profit making transaction.