Carbon sequestration rights: rights trading - deduction for costs

Is the taxpayer, a state forestry management body, entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the costs of planting and maintaining forests where those forests are planted and maintained for the purpose of trading in the carbon sequestered in the trees?

Yes. The taxpayer is entitled to a deduction under section 8-1 of the ITAA 1997 for the costs of planting and maintaining forests, where those forests are planted and maintained for the purpose of trading in the carbon sequestered in the trees.

The taxpayer is a state forestry management body. The taxpayer has acquired several thousand hectares of land and has forested the land for the purpose of selling the rights to the carbon sequestered in the trees. The taxpayer intends to continue acquiring land on a regular ongoing basis for this purpose.

The taxpayer enters into contracts for the sale of the carbon sequestration rights with various third parties who require the rights to offset carbon dioxide emissions from their business operations. The taxpayer regularly enters into these contracts as it acquires more land for this purpose.

The contracts require the taxpayer to maintain the trees for the duration of the contracts.

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.

The activities conducted by the taxpayer have a significant commercial purpose and character, they are conducted with both the purpose and prospect of profit, and are conducted on a regular basis. These factors along with the size, scale and permanency of the operation indicate that the taxpayer is conducting a business of trading in carbon sequestration rights (see note). As such, receipts from the sale of the carbon sequestration rights will not be capital in nature but will be assessable income of the taxpayer under section 6-5 of the ITAA 1997.

Expenditure incurred in the planting and maintaining of the forests will therefore be deductible under section 8-1 of the ITAA 1997 as these expenses were incurred for the purpose of producing assessable income. Note: Taxation Ruling 97/11 outlines the factors to be taken into consideration in determining whether a business exists.