This section summarises the material in Appendix B, which is an independent summary of the taxation status of carbon offsets projects. Appendix B was prepared by Norton Rose Fulbright, and the following summary was prepared by the Kondinin Group.
The first question that should be considered is in relation to the legal right to undertake an ERF project, which will ultimately determine how taxation is handled. As stated by the CER, an ERF participant:
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is responsible for carrying out their registered project, and
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must have the legal right to carry out their project.
Furthermore:
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it is a participant's responsibility to ensure they have the legal right to carry out an ERF project, and
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the participants may collectively have this legal right or each participant may have the legal right to carry out the project
For more details on this aspect of legal right, visit this section in chapter one and this section in chapter seven. Please also visit this CER page.
Following this detemination, the matter of taxation begins with whether an ERF project carried on by a taxpayer constitutes a business. A taxpayer who carries on a business is subject to income tax and needs to consider whether the receipts of the business are assessable income and the outgoings of the business are allowable deductions.
It is likely that a project proponent who undertakes an approved ERF project, such as a farmer, will be carrying on a business, but this should be considered in each case.
For those that are, the ERF project will simply be an extension of their business, provided that the project is conducted through the same entity as the primary business.
9.7.1 Income tax treatment of CFI project costs
Costs incurred to establish and operate a CFI project
The costs incurred by a taxpayer to establish and operate a CFI project are subject to the normal deductibility rules under the Income Tax Assessment Act 1997 (ITAA). This is confirmed by the explanatory memorandum to the Clean Energy (Consequential Amendments) Act 2011 (Cth), which states at paragraph 2.33:
Where an entity is undertaking activities under the Carbon Farming Initiative the normal deduction provisions apply to work out the deductibility of expenses they incur in those activities. The activities are effectively regarded as directed towards establishing an eligible offset project rather than towards producing ACCUs.
The general deduction provision under section 8-1 of the ITAA allows a deduction for losses and outgoings that are incurred as part of income-producing activities, but only to the extent that the losses or outgoings are not of a private, domestic or capital nature.
Therefore, where a CFI project is conducted for the purpose of generating ACCUs (which give rise to assessable income, as discussed below), the costs incurred in respect of the project should be deductible (that is, on revenue account) unless the cost is capital in nature.
The ordinary common law tax principles for determining whether expenditure is on revenue or capital account will apply to CFI project costs. Expenditure that has an enduring benefit and is once-and-for-all is likely to be on capital account, whereas expenditure that is recurring and does not provide an enduring benefit is likely to be on revenue account.
The general principles of deductibility will apply regardless of whether the CFI project is undertaken by an existing business or through a special purpose vehicle.
The types of CFI project costs that a taxpayer may be able to claim a general deduction for include certain input materials (such as stockfeed or fertiliser), project operating expenses (such as management fees) and administrative costs. The general deduction can be claimed in full in the year in which the loss or outgoing is incurred.
Capital assets and expenditure
A capital asset acquired in respect of a CFI project will be a ‘depreciating asset' or simply a ‘CGT asset' under the capital gains tax (CGT) provisions.
A depreciating asset is an asset that has a limited effective life and can reasonably be expected to lose its overall value by the end of its effective life. Machinery and equipment are examples of the types of depreciating assets that may be acquired for a CFI project.
A deduction for the decline in value of a depreciating asset is provided for under the capital allowance provisions in Division 40 of the ITAA. Depending on the circumstances (in particular, the size of the business and the quantum of the expense), the decline in value of a depreciating asset may be deductible over a number of income years based on the depreciating asset's effective life or as an upfront deduction.
The capital gains tax rules under the ITAA apply to a CGT asset that is not a depreciating asset. An example of a CGT asset is real property that is acquired to undertake a CFI project, such as a carbon sequestration project. No deduction is available for the costs of purchasing and holding a CGT asset. Instead, such costs form part of the cost base of the asset. The cost base (or ‘reduced cost base') will be compared against the ‘capital proceeds' to determine the capital gain or capital loss when the CGT asset is disposed of.
Capital expenditure of a business that is not otherwise deductible (referred to as ‘black hole expenditure') may qualify for a deduction at a rate of 20% a year.9 An example of black hole expenditure is the costs incurred to establish a business structure for the CFI project, such as costs to incorporate a company.
Costs incurred to become a holder of an ACCU
Aside from incurring costs for the establishment and operation of a CFI project, a project proponent may also incur costs in becoming a holder of an ACCU.
Expenditure that is incurred in becoming the holder of an ACCU in accordance with the Carbon Credits (Carbon Farming Initiative) Act 2011 is deductible only if it is incurred in preparing or lodging an application for a certificate of entitlement or an offsets report.10
However, no deduction is allowed unless the proceeds from any potential sale of the ACCU would be assessable,11 which should generally be the case.
The expenditure is deductible in the income year that the taxpayer starts to hold the ACCU.2
9.7.2 Income derivation and tax treatment of ACCUs
Project proponents generate ACCUs through their CFI project activities. The ACCUs may often be the primary or sole source of income from a CFI project. ACCUs are issued to a project proponent for free, provided that the CFI project satisfies the requirements under the Carbon Credits (Carbon Farming Initiative) Act.
The tax treatment of registered emissions units (including ACCUs) is dealt with under Division 420 of the ITAA. A summary of the application of Division 420, as it applies to ACCUs, is in Appendix B.
9.7.3 Goods and services tax
GST treatment of CFI project costs
A project participant that is registered, or required to be registered, for GST should be able to claim input tax credits for GST paid on acquisitions associated with a CFI project, provided that the acquisitions are for a ‘creditable purpose'.
Generally, an acquisition will be for a creditable purpose to the extent that it is made by a taxpayer in the course of carrying on the taxpayer's enterprise, the acquisition does not relate to the making of input taxed supplies and the acquisition is not of a private or domestic nature.3
GST treatment of ACCUs
For GST purposes, the supply of ACCUs is GST-free.4 This means that no GST is payable on the supply of ACCUs, but input tax credits can be claimed for GST paid on acquisitions made in relation to the supply of ACCUs.
9.7.4 Is a CFI project a ‘primary production business'?
The Australian Tax Office (ATO) is of the view that a CFI project is not a primary production business. The office states on its website, under the heading ‘Tax implications of the Carbon Farming Initiative':
Your assessable income from and deductions attributable to an eligible offset project are not income or deductions incurred in relation to a primary production business.
However, the ATO confirms in ATO Interpretative Decision 2004/718 that a business of primary production may be carried on where a taxpayer undertakes forestry activities (such as planting or tending trees, which are intended to be felled, in a plantation or forest) in conjunction with carbon sequestration activities.
The definition of a ‘primary production business' under section 995-1 of the ITAA includes ‘cultivating or propagating plants, planting or tending trees in a plantation or forest that are intended to be felled' and ‘felling trees in a plantation or forest'.5
Therefore, a CFI carbon sequestration project that involves planting trees for harvest, such as the establishment of new farm forestry plantations (for harvest) or new longrotation hardwood plantations (for harvest), may qualify as a primary production business.
A CFI project (such as feeding supplements to livestock) should be distinguished from any underlying business of the taxpayer (such as a farming business) that may qualify as a primary production business. A taxpayer who undertakes a non-primary production CFI project should still be able to claim tax concessions for their underlying primary production business, subject to the comments set out in Appendix B.
9.7.5 Other taxes, incentives and specific deduction provisions
Issues related to the CFI and land tax, research and development incentives and stamp duty are examined in detail in Appendix B.
In relation to specific deductions and provisions, Appendix B sets out information on special deductions for ‘environmental protection activities' and for expenditure for establishing trees in a carbon sink forest.
NOTE: Because of the specific and detailed nature of taxation affecting ERF projects, the illustrations provided in this manual are all expressed on a pre-tax basis. Specialist advice should be sought on the tax implications of particular ERF projects.
1- Section 420-15(4) of the ITAA.
2- Section 420-15(5) of the ITAA.
3- Section 420-15(2) of the ITAA.
4- Section 11-15 of the A New Tax System (Goods and Services Tax) Act 1999 (Cth) (GST Act).
5- Section 38-590 of the GST Act.
