Understand how new carbon credit tax rules will affect you

Recent amendments to tax laws provide clarity for primary producers regarding carbon credits. The amendments provide much-needed clarity by categorising income from Australian Carbon Credit Units (ACCUs) as primary production income for the purposes of income tax averaging and the Farm Management Deposit (FMD) scheme.

Eligible ACCUs will only be taxed at the point of sale - a contrast from the previous periodic taxation of other ACCUs under the rolling balance mechanism. Despite these advantageous changes, it is important to note that the new rules are not without complexities. We outline the key points to be aware of, to ensure primary producers make the most of these amendments.

The primary production income definition applies to ACCUs issued on or after 1 July 2022

When first announced by former Agriculture Minister David Littleproud, the amendments were expected to take effect from 1 July 2022. Many within the industry interpreted this to mean that from 1 July 2022, income from the sale of ACCUs would be classified as primary production income.  In reality, the amendments indicate that the changes only apply to the sale of ACCUs issued on or after 1 July 2022.

This means that ACCUs issued before 1 July 2022 are not affected by the amendments. Income from selling them remains non-primary production income, and holding the ACCUs longer term requires the rolling balance mechanism to be applied.

It is essential to recognise that the eligibility of an ACCU for these benefits is still determined by several other factors. Contact your local BDO adviser to determine your eligibility.

Not all ACCUs can create primary production income

For ACCUs to give rise to primary production income, they must meet the tax law definition of a “primary producer registered emissions unit”. There are several parts to this definition, but the key points are:

  • The ACCU must be newly issued and held by an individual or carbon service provider,
  • The registered carbon project giving rise to the ACCU must be on land which is at all times used or connected with a primary production business (as defined for tax purposes),
  • The primary production business must be carried on by an individual (alone or in partnership), or by a trust that the individual benefits from.

There are several important points to take from this, including:

  • If a company carries out primary production business on land connected with the carbon project, ACCUs will be ineligible – even if the individual ACCU holder controls the company
  • ACCUs purchased on the secondary market by a primary producer are ineligible
  • If a primary production business is not carried on for each year of the permanence period of the carbon project, ACCUs will be ineligible
  • The law is unclear about how to establish whether carbon project land is ‘connected with’ primary production land, however we expect that physical proximity will be important. For example:
    • ACCUs obtained through an Emissions Reduction Fund (ERF) method which excludes other land use for a carbon project, on a carbon project area physically distant from the primary production land, may not meet the eligibility criteria.
    • ACCUs issued under ERF methods that permit primary production activity (such as grazing) on the same land, or an exclusive land use carbon area next door to the primary production land, are likely to be eligible.

It is crucial to understand that the tax law definition of primary production business is relatively narrow and doesn’t always extend to other on-farm activities. For example, farm-based hospitality is not a primary production business, and does not give rise to primary production income.

Carbon Service Providers

Primary producers should be aware of specific rules applicable to arrangements with carbon service providers. Broadly, a carbon service provider is an entity that provides services relating to carbon projects, and includes project developers. Under these rules:

  • Income derived from selling an ACCU issued to and sold by a developer is classified as primary production income when paid to the primary producer, but with a condition: The ACCU must still meet the criteria of an eligible ACCU had it been directly issued to the primary producer. This usually holds true for most profit-split arrangements.
  • If an ACCU is initially issued to a developer and later transferred to a primary producer, it will be considered an eligible ACCU provided it meets the eligibility requirements it would have had if it were directly issued to the primary producer. This typically applies to ACCU share arrangements.
  • Income flowing through partnerships and trusts is included.

These concessions do not apply in cases where the payment from the carbon service provider to the individual is considered payment under a lease.

Navigating the intricacies of ACCU income within partnerships and trusts can be complex. We advise individuals involved in such arrangements to seek professional advice to ensure they are compliant.

Rolling balance still applies to everybody, except individual primary producers

These amendments effectively disable the rolling balance mechanism so that it doesn’t apply to ‘primary producer registered emissions units’. Since an ACCU only falls into this definition if it is held by an individual, the rolling balance mechanism continues to apply to all other legal entities and structures that hold ACCUs.

This gives rise to a conundrum when ACCUs are held by trusts or partnerships. Technically, these entities must continue to calculate gains and losses annually under the rolling balance mechanism. A distinction arises when rolling balance gains and losses are shared among partners, or rolling balance gains are distributed by a trust. In these cases, the amendments do not classify such amounts as primary production income or deductions in the hands of individual partners or beneficiaries. This is because the rules only pertain to income from the sale of eligible ACCUs.

Rolling balance still applies to other units

If an ACCU does not qualify as a ‘primary producer registered emissions unit’ (for example, when a company conducts a primary production business adjacent to the carbon project land), the rolling balance mechanism still applies to the ACCU. This situation can introduce further complexity when determining the tax implications.

BDO Comment

Rather than providing clarification, these amendments have introduced more questions than answers. The government’s intention in enacting these laws - and others – is to encourage primary producers to engage in carbon sequestration activities.

We believe the amendments are unlikely to persuade an otherwise undecided primary producer to undertake a carbon project. The added complexity may complicate financial and structuring decisions, leading to higher costs for farmers - either in advisory fees to ensure compliance, or in potential tax penalties and interest if they get it wrong. We are particularly concerned by the limited benefit to primary producers operating multiple carbon projects through complex, multi-generational structures.

These issues, combined with the failure to increase the $250,000 income cap for the availability of tax losses to individuals, suggests that carrying out carbon projects may be of greater benefit when not in the name of an individual primary producer. However, a decision would require prior consideration of all of the facts, circumstances and projections.

If you have any questions about how the new carbon credit tax rules might affect you, please contact your local BDO adviser for further guidance.