Edited version of private ruling

Authorisation Number: 1011468302362

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Ruling

Subject: Non-Commercial Losses Special Circumstances & Lead Time

1. Will the Commissioner exercise the discretion under paragraph 35-55(1)(a) (special circumstances) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include a share of losses from the crop growing activity in the calculation of your taxable income for the 2009-10 income year?

Yes.

2. Will the Commissioner exercise the discretion under paragraph 35-55(1)(b) (lead time) of the ITAA 1997 to allow you to include a share of losses from the crop growing activity in the calculation of your taxable income for the 2010-11 to 2011-12 income years?

Yes.

This ruling applies for the following periods

Year ended 30 June 2010

Year ending 30 June 2011

Year ending 30 June 2012

Relevant facts

You both operate a crop growing business.

The crop is harvested and turned into another product on your behalf by a local producer. The end product is then stored and sold on the bulk market. You are paid for your crop when the final product is sold. On occasions the end product held from a previous year is sold in the next financial year.

As a result of oversupply of the crop, the end product is stored waiting to be sold. The local producer will not take any more of your product.

In the year ended 30 June 2010 the combination of the drought, and a restriction on your water allocation, devastated the crop and production was severely reduced.

In order to receive more stable income you have decided to use the current crop to graft different varieties which will eventually be turned into another end product.

The first full production crop of the new crop is expected in the year ended 30 June 2013.

You each earned over $40,000 from activities not associated with the crop growing business and each of your incomes for the income requirement test contained under 35-10(2E) of the ITAA 1997 was under $250,000.

None of the four tests under Division 35 of the ITAA 1997 were passed in the 2009-10 income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 35-10(2)

Income Tax Assessment Act 1997 Subsection 35-10(2E)

Income Tax Assessment Act 1997 Subsection 35-55(1)

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 you satisfy subsection (2E) (Income requirement) and one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 is met:

· the 'exception' in subsection 35-10(4) of the ITAA 1997 applies, 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 (and subsection (2E) is met), the discretion is exercised, or the exception applies.

Exception

Under subsection 35-10(4) of the ITAA 1997, there is an 'exception' to the general rule in subsection 35-10(2) of the ITAA 1997 where the loss is from a primary production business activity or a professional arts business activity and the individual taxpayer has other assessable income for the income year from sources not related to that activity, of less than $40,000 (excluding any net capital gain).

The exception does not apply as you both earned over $40,000 from sources other than your primary production business in the 2009-10 income year.

Tests

In broad terms, the tests require:

(a) at least $20,000 of assessable income in that year from the business activity (section 35-30 of the ITAA 1997)

(b) the business activity results in a taxation profit in three of the past five income years (including the current year) (section 35-35 of the ITAA 1997)

(c) at least $500,000 of real property, or an interest in real property, (excluding any private dwelling) is used on a continuing basis in carrying on the business activity in that year (section 35-40 of the ITAA 1997), or

(d) at least $100,000 of certain other assets (excluding cars, motor cycles and similar vehicles) are used on a continuing basis in carrying on the business activity in that year (section 35-45 of the ITAA 1997).

In addition to the above tests an income requirement must be met (subsection (2E)) for 2009-10 and later income years. You will satisfy that test for an income year if the sum of the following is less than $250,000:

· your taxable income for that year

· your reportable fringe benefits total for that year

· your reportable superannuation contributions for that year

· your total net investment losses for that year.

Are you carrying on a business?

Your activity will only be subject to these provisions if it is carried on as a business. You stated in your private ruling application that your activity was carried on as a business. This ruling is made on the basis of accepting this claim.

Special Circumstances

Paragraph 35-55(1)(a) of the ITAA 1997 sets out the Commissioner's discretion as follows:

The Commissioner may, on application, decide that the rule in subsection 35-10(2) does not apply to a business activity for one or more income years if the Commissioner is satisfied that it would be unreasonable to apply that rule because the business activity was, or will be, affected in that or those income years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster.

A note to this paragraph states:

Note: This paragraph is intended to provide for a case where a business activity would have satisfied one of the tests if it were not for the special circumstances.

In your case you have requested that the Commissioner exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 in the 2009-10 financial year.

A drought severely reduced production in the 2009-10 income year. Your water allocation entitlement has been reduced during the past four financial years. The drought, combined with the reduced water allocation, has severely restricted the output of the crop in 2009-10.

You have stated you did not pass any of the four tests under Division 35 of the ITAA 1997 during the 2009-10 income year. You would have satisfied the assessable income test if it were not for the drought and the restricted water allocation.

The Commissioner will exercise his discretion. Consequently you are not required to defer your losses in the 2009-10 income year.

Lead Time

The second arm of the discretion in paragraph 35-55(1)(b) of the ITAA 1997 may be exercised for one or more income years where for an applicant who carries on the business activity who satisfies subsection 35-10(2E) for the most recent income year ending before the application is made - the business activity has started to be carried on and, for the excluded years:

(a) because of its nature that it has not satisfied, or will not satisfy, one of the tests set out in section 35-30, 35-35, 35-40 or 35-45, and

(b) there is an objective expectation, based on independent evidence (where available) that, within a period that is commercially viable for the industry concerned the activity will either meet one of those tests or will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C).

The note to this paragraph states:

Note: This paragraph is intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. For example, an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

In your case, you have decided to stop producing your current crop and graft stock onto your existing crop for a different crop which are suitable to be turned into a different end product. You are anticipating that these grafts will take a few years to re-grow and produce the new crop. You are also anticipating that this activity will not produce any assessable income until 2012-13. As it will take a few years for the grafts to produce a suitable crop none of the tests under sections 35-30, 35-35, 35-40 or 35-45 will be satisfied and there is an objective expectation that the assessable income will be greater than the deductions attributable to it in 2012-13. You passed the income requirement under subsection 35-10(2E) of the ITAA 1997.

The Commissioner will exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997 for the 2010-11 and 2011-12 income years. You are not required to defer your losses in those years.

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