Carbon sequestration rights: deductibility of expenditure for revegetation

Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for expenditure incurred on seedlings and fencing for the purpose of revegetating land?

No. The taxpayer, is not entitled to a deduction under section 8-1 of the ITAA 1997 for expenditure incurred in revegetating the land, as the expenditure is capital in nature.

The taxpayer is a landholder and conducts a business of cattle farming on more than 400 hectares of land.

The taxpayer has revegetated 20 hectares of land with indigenous species to encourage the return of native wildlife and ameliorate land degradation. The taxpayer has spent a significant amount of money in revegetating (that is, seedlings and fencing), with the intention of selling the carbon sequestration rights that will be generated to recover some of these costs.

The taxpayer has entered into a profit á prendre agreement with an entity for the sale of the carbon sequestration rights relating to the 20 hectares of land.

Section 8-1 of the ITAA 1997 allows a deduction for all losses or outgoings to the extent that they are incurred in gaining or producing the taxpayer's assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, no deduction is allowed to the extent that the losses or outgoings are of a capital, private or domestic nature or are necessarily incurred in gaining or producing exempt income.

A profit á prendre is considered to be a capital asset at common law: see, for example, Kauri Timber Co Ltd v. Comr of Taxes [1913] AC 771. Whether a profit a prendre arises is a question of fact which can only be answered by reference to the terms of the agreement entered into in each particular case.

The amount that the taxpayer receives for the sale of the carbon sequestration rights by way of a profit a prendre agreement is a capital receipt. Therefore, the outgoings in relation to the seedlings and fencing cannot be claimed as a general deduction under section 8-1 of the ITAA 1997 because they are capital in nature.