1 Is the partnership carrying on a business of undertaking its environmental stewardship activities?
1 Yes. Question 2 Will the land held by the partners pass the 'active asset' test for the purposes of the small business capital gains tax provisions? Answer 2 Yes This ruling applies for the following period: XXXX
1. Person A and Person B established a partnership in XXXX and acquired two rural properties (Property 1 and Property 2). The partners acquired the properties to undertake a land stewardship business under the Commonwealth Caring for our Country Stewardship program. 2. Both stewardship agreements operate for 15 years, and applying for each involved a competitive market bid (a reverse auction). 3. Person A and Person B didn't prepare a formal business plan beyond entering the stewardship agreements. 4. Person A and Person B both have qualifications in agriculture and environmental science, and both have employment experience in conducting environmental management activities on rural land and nature reserves. 5. Managing Property 2 and Property 1 according to the stewardship agreements uses the same skills Person A and Person B use in their employment, including: • assessing property for emerging weed and pest threats • identifying control methods • employing and supervising contractors to undertake control activities
• liaising with neighbours about fencing, access, and other issues. 6. Person A and Person B submit that their purpose for entering the stewardship agreements was purely financial. They considered that the returns on the stewardship agreements would be superior to returns from alternative investments such as rental properties. From their analysis, they concluded that funding over the first few years would recoup the purchase price for the property. 7. Person A and Person B's partnership has reported significant income and profits, and over the past 5 years have produced (on average) annual income of approximately $X and profits/net income of about $X. 8. When buying Property 1, Person A and Person B carried out the following steps before entering the contract. They: • inspected the property with an expert botanist to verify it qualified for the stewardship program • started negotiations about property access and fencing • met with accountants to discuss the tax law and commercial issues involved with the proposed purchase and environmental management contract
• applied for an ABN and registered for GST. When buying Property 2, Person A and Person B: • obtained a preliminary costing for several properties for stewardship (opportunity cost, grazing returns, predicted management costs for identified issues) • agreed to purchase the property, conditional on being accepted for the stewardship program • had the site assessed for the program before entering contracts. 9. For Property 1, Person A and Person B entered the deed of stewardship within 3 months after settlement, and for Property 2, within 1 month after settlement. See the dates in Table 1. Table 1 - contract, settlement, and stewardship deed dates Property Property 1 Property 2 Contract date XXXX YYYY Settlement date about 2 months later about 5 months later Signed deed of stewardship less than 3 months after settlement less than 1 month after settlement 10. In acquiring both properties, Person A and Person B: • assessed and compared properties: e.g. grazing, history, environmental attributes, cost per hectare, infrastructure, management and program risks
• calculated possible costs and profits (using a spreadsheet) for the best properties • calculated foregone profits based on gross margins for stock and previous stocking rates and other opportunity costs • calculated management costs • prepared a bid, taking account of their knowledge (from informal discussions with associates) about successful bids for comparable properties • calculated the likely income from the program (including opportunity costs and risks). 11. Person A and Person B have carried out the following activities in managing the business. • Engaging weed contractors. Person A and Person B typically use contractors who live locally to carry out weed control activities. Person A and Person B rely more heavily on contractors to complete weeding activities than many landholders. The weeding activities typically take place for about X months of the year.
• Weed inspection activities. They undertake a joint weed inspection early in the season and agree with the contractor on priorities and pricing. They typically carry out inspections several times a year • Person A and Person B have arranged for tree planting in some years (usually in winter). • Liaising with contractors for pest control activities. • Visiting the properties (Property 2 between 3 and 5 times a year, and Property 1 more frequently) for monitoring, weed programming, inspections, and heavy plant work. • Submitting annual management reports, monitoring reports, and financial reports for the program (detailing management actions, itemising costs for each activity, and monitoring transects in all specified management zones, with photos).
Income Tax Assessment Act 1997 section 152-35 Income Tax Assessment Act 1997 section 152-40
Question 1 Is the partnership carrying on a business of undertaking its environmental stewardship activities? Answer Yes Explanation 13. TR 97/11 [1] gives guidance about whether an activity amounts to carrying on a business. Determining whether an activity is a business involves weighing relevant indicators that must be considered in combination. The weighting of each indicator may vary from case to case, and the ultimate decision may depend on its facts. Relevant indicators include purpose and intention to make a profit, repetition and regularity, whether the activity is carried on in a businesslike manner, or in a similar manner to that of the ordinary trade, size and scale, whether a business plan exists, relevant knowledge and skill, and whether the activity might be better described as a hobby or recreation. See paragraphs 11-18. 14. Considering the guidance in TR 97/11, we characterise Person A and Person B's partnership as carrying on a business of generating income from environmental stewardship agreements.
• Person A and Person B entered the stewardship agreements seeking to make a profit and succeeded in making a profit. We think that indicator dominates here and gives a commercial flavour to the activity. • Some other indicators are consistent with this being a business: for example, we see regularity and system (following a regular cycle of inspections and engaging contractors, and completing administrative tasks), and Person A and Person B have made use of their professional expertise in conducting environmental management activities. • We don't place much weight on the absence of a formal business plan in this situation as Person A and Person B have carried out their environmental management activities under the stewardship agreements in a systematic way, much as if they had prepared and followed a formal plan. • While Person A and Person B may have departed from the typical manner of conducting a stewardship agreement in some respects (such as engaging contractors rather than carrying out weed or pest control activities directly), we think their activities still have a business character. Question 2
Will the land held by the partners pass the 'active asset' test for the purposes of the small business capital gains tax provisions? Answer Yes Explanation 15. One of the conditions for the CGT small business concessions is that the CGT asset passes the 'active asset' test in section 152-35 (see section 152-10). 16. A CGT asset will satisfy the active asset test if the asset was an active asset of yours for certain periods. • Where you owned the asset for 15 years or less, the asset must be an active asset of yours for at least half of the specified period. • Where you owned the asset for more than 15 years, the asset must be an active asset of yours for a total of at least 7.5 years during the specified period. • In either case, the specified period is between a) when you acquired the asset, and b) the earlier of the CGT event, or the cessation of the business (if the business ceased to be carried on in the 12 months before the time of the CGT event, or if the Commissioner allows, a longer period).
17. A CGT asset will be an 'active asset' (under section 152-40) if you both own and use the asset in carrying on a business (whether alone or in partnership). 18. A CGT asset will nevertheless be excluded from being an active asset if it meets any exception in subsection 152-40(4). Some of the exceptions apply to interests in other entities (e.g. shares in companies and units in trusts). The other exceptions are for financial instruments, and assets whose main use is to derive interest, annuities, rent, royalties, or foreign exchange gains. 19. Both properties were active assets while used in Person A and Person B's business. • Person A and Person B each own interests in the properties, either as joint tenants or tenants in common. • We've established that their partnership carries on a business of carrying out environmental management activities under a stewardship agreement. • The land was used in that business, because all the activities under the agreement took place on or related to the land.
• For the purposes of section 152-40, Person A and Person B were each carrying on a business as partners. • The exceptions in subsection 152-40(4) aren't relevant. 20. Each property may stop being an active asset once the relevant stewardship agreement has ended, or if Person A and Person B otherwise stopped carrying out stewardship activities before that time. (Property 1 may have already stopped being an active asset as the stewardship agreement was to last 15 years and started in XXXX. Property 2 may stop being an active asset during the ruling period as the stewardship agreement started in YYYY.) 21. Although the properties will or may stop being active assets before sale, Person A and Person B will still pass the active asset test if the properties were active assets for the relevant part of the specified period in section 152-35. 22. Person A and Person B will meet the active asset test for both properties. • They bought each property around 15 years ago.
• They entered stewardship agreements almost immediately after acquiring each property, with each agreement to last 15 years, and carried out environmental management activities on each property under each agreement. • Person A and Person B have held Property 1 for more than 15 years (starting XXXX) and the property would have been an active asset from XXXX until shortly before applying for this ruling (from entering the agreement until the agreement expired). This will be more than 7.5 years of the specified period, so they will pass the active asset test for Property 1. • Person A and Person B have currently held Property 2 for less than 15 years (starting YYYY), and the property would have been an active asset from YYYY until when they applied for this ruling. This is both a) more than half of the specified period if they sell Property 2 after holding it for less than 15 years, and b) will be more than 7.5 years if they sell it after holding it for more than 15 years. > [1] Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production?