Edited version of private ruling

Authorisation Number: 1011555793937

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Ruling

Subject: Non Commercial Losses- Commissioner's discretion - Special circumstances

Question 1

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your primary production activity in your calculation of taxable income for the 2009-10 income year?

Answer

No

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include any losses from your primary production activity in your calculation of taxable income for the 2009-10 income year?

Answer

No

This ruling applies for the following period:

1 July 2009 to 30 June 2010

The scheme commenced on

1 July 2000

Relevant facts and circumstances

You are conducting a mixed primary production activity in partnership. The activity has been carried on for many years.

At the time of purchase, the property had been in a run-down state. You were required to develop the property prior to commencing the primary production activity.

The primary production activity has several components. The first component is the main component of your activity. The first and the second components commenced at the same time. In addition to the two components, you have added another component to diversify and to generate further income. You have received income in excess of $20,000 from the third component in a recent year.

The activity is carried on as a business and not a hobby.

You do not have a specific business plan, however, the objectives have been very clearly set out whereby necessary expenditure has occurred in order to bring a very rundown property to a profitable state. You have also stated that given the nature of farming, it is not possible to predict with any accuracy when a tax profit will be produced.

You have provided letters from independent sources regarding your business activity.

You have stated that unavoidable circumstances have also affected the activity in the past preventing you to generate a profit from the activity.

As you may not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997, you have requested the Commissioner to exercise the discretion in paragraph35-55(1)(a) and 35-55(1)(c) of the ITAA 1997 for the relevant income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 paragraph 35-55(1)(a).

Income Tax Assessment Act 1997 paragraph 35-55(1)(c).

Income Tax Assessment Act 1997 sub paragraph 35-55(1)(c)(ii).

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

Income Tax Assessment Act 1997 paragraph 35-10(3).

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

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, or

· satisfy subsection 35-10(2E) of the ITAA 1997 for that year and one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 is met, or

· the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

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 (in conjunction with the income requirement), the discretion is exercised, or the exception applies.

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 the context of section 35-35 of the ITAA 1997 ((b) above), a 'taxation profit' for the income year in question is where the amount of assessable income from the business activity for that year, is greater than the sum of the deductions attributable to it for that year (apart from the operation of subsection 35-10(2) of the ITAA 1997).

Section 35-1 of the ITAA 1997 provides that an income requirement must be met (along with certain tests) in order to include losses from a business activity in your taxable income calculation. If the income requirement is not met, the Commissioner may exercise discretion to allow the inclusion of the losses. However, the discretion can only be granted in particular circumstances as detailed below.

The income requirement in subsection 35-10(2E) of the ITAA 1997 is satisfied if the sum of the following is less than $250,000:

(a) your taxable income for that year;

(b) your reportable fringe benefits total for that year;

(c) your reportable superannuation contribution for that year;

(d) your total net investment losses for that year.

In your case you have stated that you may not satisfy the income requirement in the 2009-10 income year.

Your mixed primary production activity will only be potentially subject to these provisions if it is carried on as a business. You have stated that your primary production activity is carried on as a business and this ruling is made on the basis of accepting this claim.

Application of paragraph 35-55(1)(a) of the ITAA 1997 for the 2009-10 income year

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

The Commissioner may, on application, decide that the rule in subsection 35-10(2) of the ITAA 1997 does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

(a) the business activity was or will be affected in the excluded years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster; or

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.

Paragraph 35-55(1)(a) of the ITAA 1997 refers to 'special circumstances' outside of the control of the operators of the business activity. No exhaustive definition is given of 'special circumstances' but the paragraph does include drought, bushfire and other natural disasters.

It can be seen that to determine what is 'special circumstances', we need to look at the context in which the phrase is used. Also, it is clear that 'special circumstances' will be something out of the ordinary or unusual. 'Special circumstances' in paragraph 35-55(1)(a) of the ITAA 1997 is used in the context of a situation occurring such that it would be unreasonable for the Commissioner to apply the loss deferral rule for a particular year or years. For this to be the case, it will not only be necessary that an event or situation has occurred which is of itself unusual, but that it has resulted in the business activity failing to pass a test. Clearly, if the business activity would not have passed a test even if the event or situation had not arisen, we cannot say that the business activity was affected by 'special circumstances' in the sense in which this term is used in paragraph 35-55(1)(a) of the ITAA 1997, as the Note to the paragraph indicates.

For the Commissioner to exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner should be satisfied that the business activity was affected in the relevant income year by the special circumstances.

You have stated that unavoidable circumstances affected your business activity.

Paragraph 13 of the Taxation Ruling TR 2007/6 reads 'Ordinarily, special circumstances are those which have materially affected the business activity, causing it to not satisfy any of the four tests in Division 35 of the ITAA 1997'.

Your income and expense statements show that the income from the activity has been in excess $20,000 for the past income years. You have advised that the income is expected to be in excess of $ 20,000 in the relevant income year. This indicates that the above stated conditions have not affected your activity in terms of its income.

The unavoidable circumstances have not affected your primary production activity causing it to not satisfy the assessable income test in section 35-30 of the ITAA 1997. Therefore, the Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 has not been exercised for the relevant income year.

Application of paragraph 35-55(1)(c) of the ITAA 1997 for the 2009-10 income year

In order to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997, the Commissioner must be satisfied that there is an objective expectation, based on evidence from independent sources, that your business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period for the industry (paragraph 35-55(1)(c) of the ITAA 1997).

The Commissioner's discretion in subsection 35-55(1) of the ITAA 1997 reads -

The Commissioner may, on application, decide that the rule in subsection 35-10(2) of the ITAA 1997 does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

(a) for an applicant who carries on the business activity who does not satisfy subsection 35-10(2E) of the ITAA 1997 (income requirement) 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:

i. because of its nature, it has not produced, or will not produce, assessable income greater than the deductions attributable to it; and

ii. there is an objective expectation, based on evidence from independent sources (where available) that, within a period that is commercially viable for the industry concerned, the activity 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) of the ITAA 1997).

Note:

Paragraphs (b) and (c) are 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.

Your primary production activity commenced many years ago. Subsequently you have added another component to the activity.

The Note to paragraph 35-55(1)(c) of the ITAA 1997 states that the particular 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. The Commissioner accepts that the primary production activity has a lead time between the commencement and producing any assessable income.

Paragraph 21 of the Taxation Ruling TR 2007/6 states that the period that is commercially viable for the industry concerned is the period in which it is expected that any business activity of that type, which is carried on in a commercially viable manner, would be expected to satisfy one of the tests or produce a tax profit.

For your mixed primary production activity the commercially viable period cannot be more than x-y years.

Although you have not provided independent evidence regarding the commercially viable period for the mixed primary production industry, the income and expense statements for the activity confirm that you have been generating income in excess of $20,000 at least for the past ten years.

You have subsequently added a third activity to diversify the activity and generate further income. This activity is also conducted in the same property and is not considered a separate activity. You have stated that it takes a couple of years to generate income from this activity. In fact you have generated income in excess of $20,000 from this activity in the relevant income year.

Your mixed primary production activity has commenced at least in excess of 15 years ago. Therefore, the commercially viable period has lapsed.

Where the business would not produce a profit within the commercially viable period, the Commissioner would not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997. Therefore, the discretion has not been exercised for your mixed primary production activity for the relevant income year.

Accordingly, it would be reasonable to apply the rule in subsection 35-10(2) of the ITAA 1997 in relation to your business activity for the relevant income year.

Summary of reasons for decision

The Commissioner will not exercise the discretion in paragraph 35-55(1)(a) or 35-55(1)(c) of the ITAA 1997 for the relevant income year because, on the facts provided:

· it is not accepted that your activity has been affected by special circumstances in the sense in which this term is used in paragraph 35-55(1)(a) of the ITAA 1997.

· the Commissioner is not satisfied that it is because of the nature of your mixed primary production activity that it has not produced a taxation profit within the commercially viable period; and

· the commercially viable period for the mixed primary production activity has lapsed.

As you do not expect a taxation profit in the relevant income year, the rule in subsection 35-10(2) of the ITAA 1997 will apply to defer to a future income year any loss that arises from your mixed primary production activity for that year. A deferred loss is not disallowed and will be deductible against any taxation profit from your primary production activity, or similar business activity, in future years.

If your primary production activity, or similar activity should satisfy an exception or satisfy the income requirement and one of the tests in Division 35 of the ITAA 1997 in any given year, then the whole of the deferred loss will be deductible in that year.

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