Edited version of private ruling

Authorisation Number: 1011466362960

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Ruling

Subject: Non commercial losses- Assessable income test

Question 1

Were you carrying on a business of primary production in the 2008-09 income year?

Answer

No.

Question 2

Did you satisfy the assessable income test in section 35-30 of the Income Tax Assessment Act 1997 (ITAA 1997) in the 2008-09 income year?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2009

The scheme commenced on

1 December 1988

Relevant facts and circumstances

You are conducting a mixed farming enterprise in partnership. You and your spouse own the property as joint tenants.

The mixed farming activity comprises of two components, the first component and the second component.

The property was purchased in the relevant income year.

You tried various primary production activities before you settled to continuing the first and the second components.

You have improved the property by installing fences, a dam, inground reticulation pipe and constructed a workshop. You have sufficient water for the primary production activity. You also have an area which you intend to develop for a new primary production component.

You have stated that the soil is suitable for the primary production activity. You have sufficient infrastructure in place to conduct the activities. Your property is classified as 'rural agriculture' for local council purposes. This current zoning prohibits subdivision.

The partnership has first commenced the first activity on the relevant date. The whole land had been used for this activity until a covenant was put in place.

You do not have a contract to market the produce from the first component but you sell through auctions. You also have a business account with them.

You have provided information with regards to your trading stock.

Many years ago you formed a partnership with another person to conduct the second activity. That partnership ceased and you and your spouse formed a new partnership to carry on the activities.

You commenced the second component in the relevant year. You had plans to increase this component of your activity, however, due to unavoidable circumstances you were not able to increase the activity. You have stated that you recently started increasing the activity.

You first received income from the second component in the stated income year.

You had an agreement with a company to provide your products. The agreement has expired and you expect to negotiate a new contract soon.

You have provided a sketch map of the property indicating the areas used for various activities, the residence and the conservation covenant.

The income and expense details have been received from the income tax returns and from the information you have provided.

The income tax returns available in the ATO show that you have incurred losses for some time.

You have consulted various government and non government organisations in relation to the primary production activities. You are also a member of one of the organisations.

You have obtained the necessary registrations/licenses and permits to conduct the activity.

You expect the primary production activity to be commercially viable in the 2011-12 income year. Depending on the success of the second activity, you expect to expand that activity.

You have made losses in excess of ten income years. You have stated that a number of unavoidable circumstances affected your primary production activity.

You have borrowed funds to purchase the property. You have received a development loan to start off the second component of your activity. You work off-farm to support your business at present.

You have developed a business plan using a template from a government organisation. You have participated in collaborative feedback sessions with other farmers and you have received continuous advice from field officers from relevant organisations and you also contribute to research.

Both you and your spouse have relevant educational qualifications and had previous experience in the farming industry.

You have spent in excess of $100,000 on the primary production activity.

The other farmers in the area are involved with the first component of your activity. There are no farmers involved in the second component of the activity.

You and your spouse attend to the property. You employ casual labour when necessary.

Your spouse spends X hours per week on the primary production activity and Y hours per week on other employment.

You spend a number of hours a week on the primary production activity and a number of hours on other employment.

You record the sales by recipient created invoices then enter the information into your computer system.

You consider your selves as carrying on a business operating in a commercial manner. You state that you had some set backs.

You have provided a copy of the Enterprise Budget for the relevant income years. You have provided copies of necessary documents:

The valuation report by a valuer states that a part of the property they have valued comprises fairly unattractive land that has very limited agricultural capability. It further states that a part of the property has become isolated and that it needs to be fenced if it is to be used for primary production.

You have stated that you entered into an agreement over a part of the farm land. Due to this the capital gains tax (CGT) event D4 has occurred and applies for the 2008-09 year. The land had been used for primary production. The proceeds are used in the continued operations of the farming business. You have received income for entering the agreement. You have calculated the cost base of the land using the formula in section 104-47 of the ITAA1997 and the amount available for each individual.

You have stated that as a consequence of receiving this additional income the partnership has satisfied the assessable income test in section 35-30 of the ITAA 1997. You have explained that although sale of land may not be part of the normal operations of the business activity, it may still be part of the operations of that business activity carried on in that year.

You have requested the Commissioner to determine whether you have satisfied the assessable income test in section 35-30 of the Income Tax Assessment Act 1997 (ITAA 1997) in the 2008-09 income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 35-30.

Income Tax Assessment Act 1997 paragraph 35-10(2).

Reasons for decision

Division 35 of the ITAA 1997 applies to losses from certain business activities for the 2000-01 income year and subsequent years. Under the rule in subsection 35-10(2) of the ITAA 1997, a 'loss' made by an individual (including an individual in a general law partnership) from a business activity will not be taken into account in an income year unless:

- the 'Exception' in subsection 35-10(4) of the ITAA 1997 applies

- one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 is met, or

- if one of the tests is not satisfied, the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

Generally, a 'loss' in this context is, for the income year in question, the excess of a taxpayer's allowable deductions attributable to the business activity over that taxpayer's assessable income from the business activity.

Losses that cannot be taken into account in a particular year of income, because of subsection 35-10(2) of the ITAA 1997, can be applied to the extent of future profits from the business activity, or are deferred until one of the tests is passed, the discretion is exercised, or the exception applies.

As stated above, your primary production activity will only be potentially subject to the provisions of Division 35 if it is carried on as a business either on your own or in a general law partnership (section 35-5 of the ITAA 1997).

Were you carrying on a business in the 2008-09 income year?

Whether a business is being carried on depends on the 'large or general impression gained' (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all the indicators of carrying on a business, and no one indicator will be decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). These indicators are described in Taxation Ruling TR 97/11. Outlined below are matters that would generally be taken into account in weighing-up the indicators to establish whether a taxpayer is carrying on a business.

Carrying on a business

Whilst Taxation Ruling TR 97/11 relates to primary production activities, the factors can also be applied to non-primary production activities as well. Whether an activity constitutes a business or a hobby must be determined according to the facts of the individual case.

Paragraph 13 of the Taxation Ruling TR 97/11 outlines the main factors which the courts have held as relevant indicators of carrying on a business. No one indicator is decisive and there is often a significant overlap of the indicators.

Outlined below are matters that are taken into account in weighing the factors one against the other in order to establish whether you are carrying on a business.

Significant commercial purpose or character

Your mixed farming activity is comprised of two components.

One of the components commenced in the relevant income year. The second component commenced in another income year.

The information provided in your tax returns show that you have made tax losses for the last X years. The average income received from the primary production activity for the last X years is less than $5,000 per annum. This level of income suggests that you have been carrying on your activity on a very small scale. This is further evidenced from the trading stock accounts that show your activity is conducted in a small scale.

The above information demonstrates that your activity does not have a significant commercial purpose.

An intention to engage in business

An intention to carry on business is an important but not determinative indicator. As well as an intention, there must also be activities that indicate that the person concerned is carrying on a business. In the case of Inglis v. FC of T 80 ATC 4001; (1979) 10 ATR 493 Brennan J said that:

The carrying on of a business is not a matter merely of intention. It is a matter of activity. … At the end of the day, the extent of activity determines whether a business is being carried on. That is a question of fact and degree.

You have stated that the initial purpose of setting up the farm. This purpose has changed and diversified into other farming enterprises. You finally settled to the two components of your activity. You expect to introduce a new component in the future.

This indicates that you had an intention to engage in a business although you did not have a firm business plan.

A purpose of profit as well as a prospect of profit

In Case H11 76 ATC 59 at 61; (1976) 20 CTBR (NS) Case 65 at 603, the Chairman of Board of Review No 1 said:

In determining whether a business is being carried on it is, in my view, proper to consider, as one of the elements, whether the activities under consideration could ever result in a profit.

The income and expense statements for the last years show that you have never made a profit from your primary production activity.

You have stated that unavoidable factors contributed for not receiving profits. However, the Commissioner does not accept these factors to be the only factors that prevented you from receiving a profit for the past X years.

You have stated that fairly recently you expanded the second component of your activity. However, it did not succeed. The valuers have also made a comment that the part of the property they have valued comprises fairly unattractive land that has very limited agricultural capability.

The enterprise budget you have provided indicates that the total revenue expected from the second component is expected to be in excess of $10,000 in the relevant income year and in excess of $Y in the following income year. However, the actual income received for the two years is much smaller than expected. This shows that your actual income is considerably less than the projected income and there is no possibility in being profitable at the current scale.

In Cecil Crees v Federal Commissioner of Taxation [2001] AATA 70 the Administrative Appeals Tribunal suggested that it would be a most unusual business operator who would expend large amounts of money and labour, for more than ten years, on a business which was not likely to give a reasonable return for effort. For more than ten years you have made losses.

In view of the above the Commissioner is not satisfied that you have satisfied this indicator.

Repetition and regularity

The taxpayer's activities should involve repetition and regularity and have an air of permanence about them.

The repetition of activities by the same person over a period of time on a regular basis helps to determine whether there is the carrying on of a business. For example, in Hope v. Bathurst City Council (1980) 144 CLR 1; 80 ATC 4386; (1980) 12 ATR 231 per Mason J the 'transactions were entered into on a continuous and repetitive basis', such that the taxpayer's activities 'manifested the essential characteristics required of a business'.

The information you have provided indicate that the repletion and regularity of your activity has been very low. You have maintained your trading stock but have not purchased new stock to generate additional income.

The income generated from the second component has also been very low.

The above information indicates that there was minimal repetition in the primary production activity.

Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business

The taxpayer's activities or those conducted on the taxpayer's behalf should, unless circumstances dictate otherwise, be based around business methods and procedures of a type ordinarily used in ventures that would commonly be said to be businesses. The activities should be carried out using accepted practices.

You and your spouse both have experience in primary production and you state that the property is suitable for your activity. You are carrying on the activity in a similar manner but in a very small scale compared to the industry norm.

Organisation, systematic, business like manner

In Newton v. Pyke (1908) 25 TLR 127 the court suggested that business should be conducted systematically. A business is characteristically carried on in a systematic and organised manner rather than on an ad hoc basis.

You have a business plan for the relevant income year and future income years for the second component of your activity. However, the income you have received is far less than the amounts you have forecasted for the prior income years indicating that your business plan does not reflect the actual status of your activity.

You record the sales by recipient created invoices and enter the information into your computer system.

Although there are some indications of the activities being carried on in a business like manner, the above facts make that decision inconclusive.

The size and scale of the activity

Paragraph 77 of TR 97/11 notes that 'the larger the scale of activity, the more likely it will be that the taxpayer is carrying on a business of primary production'. It is noted though, that a person may carry on a business in a small way (see Thomas v. FC of T 72 ATC 4094; (1972) 3 ATR 165).

You have been incurring losses in the past income years.

We do not accept that your activity was operated in a scale and size to be a viable and productive business in the relevant income year. This indicator has not been satisfied.

Overall conclusion on whether a business is being carried on

Whether a business is being carried on depends on the 'large or general impression gained' (Martin v, Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all of the above indicators, and whether these factors provide the operations with a 'commercial flavour' (Ferguson's Case at ATC 4271; ATR 884). The general impression gained from looking at the above indicators in relation to your activity is that it is not carried on as a business in the 2008-09 income year.

Your activity has not satisfied most of the indicators and we have concluded that your activity is not carried on as a business.

In terms of subsection 35-5(2) of the ITAA 1997, Division 35 of the ITAA 1997 is not intended to apply to activities that do not constitute carrying on a business.

As your activity is not carried on as a business, non commercial loss provisions in Division 35 of the ITAA 1997 do not apply to your primary production activity.

Accordingly, the capital gain received from the agreement has not been considered in this ruling.

Summary of reasons for decision

You are not carrying on a business of primary production in the 2008-09 income year. Therefore, the assessable income test in section 35-30 of the ITAA 1997 does not apply to your activity

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