Edited version of private ruling

Authorisation Number: 1011562874654

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Ruling

Subject: Non-commercial losses - Commissioner's discretion - Commercially viable period

Question 1

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your farming enterprise in your calculation of taxable income for the 2009-10 to 2012-13 income years?

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 agricultural enterprise in your calculation of taxable income for the 2009-10 to 2012-13 income years?

Answer: No

This ruling applies for the following period:

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commences on:

I July 2009

Relevant facts and circumstances

You and your spouse purchased a property to operate a primary production business.

The business will involve a combination of animal farming and agriculture.

You and your spouse will operate the business, with casual staff employed at peak times.

In the medium to long term, the business will be developed from standard production to organic based production to increase profitability.

Initially you will lease part of the property for agistment to generate some initial income. You have secured an agistment agreement with another landowner for a period.

You state that the business will meet the assessable income test in 2011-12 and has already met the real property test and the other assets test.

You have provided a business plan, which includes a business financial analysis and a 10-year financial projections, showing a target profit to be achieved.

You state that the business will be built up in stages.

You have provided some advice from independent qualified sources on your business plan and you state that the lead times to develop each stage of this business have been supported by these experts, but you have not provided evidence of a commercially viable period of time for the industries concerned to produce a tax profit.

The following documents form part of the scheme under consideration:

- Your Private Ruling

- Independent evidence and comments on your plans from industry specialists and individuals with a similar business activity

- Your business plan

- Income and expenditure projections for your business activity

- Your income for non-commercial loss purposes for the 2009-10 income year was more than $250,000.

- You expect that your income for non-commercial loss purposes for the 2010-11 to 2012-13 income years will be more than $250,000.

- You expect your business activity will become commercially viable in the 2013-14 income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 8-1.

Income Tax Assessment Act 1997 - Section 35-1.

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

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

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

Income Tax Assessment Act 1997 - Section 40-880.

Reasons for decision

Summary

We do not consider that you have commenced business in the 2009-10 income year. We consider that you have an intention to carry on a business and you are in the course of establishing the property to enable the commencement of a business.

Even if it was accepted that your business had commenced, which is not accepted, the reason your activities are expected to produce losses is because of the delayed commencement due to your agricultural program and the staged expansion of the activities, which is not inherent to the nature of your business activities.

Detailed reasoning

Section 35-1 of the ITAA 1997 provides that an income requirement must be met (along with certain other 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.

You satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 if your income for non-commercial loss purposes is less than $250,000.

In your case, you do not satisfy the income requirement as your income for non-commercial loss purposes is above $250,000.

In order to exercise the discretion, the Commissioner must be satisfied 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 (paragraph 35-55(1)(c) of the ITAA 1997).

Paragraph 35-55(1)(c) only applies to a business activity which has started to be carried on.

Paragraphs 69A and 97 to 105 of Taxation Ruling TR 2001/14 consider when a business activity has started to be carried on.

In determining when a business commences, there are three indicators that must be present before it can be said that a business has commenced. These are:

- purpose, intention and decision;

- acquisition of a business structure; and

- commencement of business operations

Purpose, intention and decision:

The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity. This is developed by researching the proposed business and, in some instances, by experiment. This process culminates in a final decision on whether to commence business. However, not all businesses commence in such an orderly manner.

It is apparent from the information you have provided that you had decided the form of the business and you had a plan for your activities but you have not provided evidence that you had shown a commitment to either of the activities.

Acquisition of a business structure:

Most business activities have a structure that provides the framework of the business. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity.

For a business activity to commence, an appropriate business structure should be in place. As to what this structure will consist of, and its size, this will be a question of fact and degree, and depend on the nature of the business activity.

Your proposed business activity is animal farming and agriculture. You have planned the requirements you need for this activity. However, we do not consider you will have acquired the minimum amount of business assets needed to commence your business activity until you have have sufficient infrastructure to support the activities.

Commencement of Business Operations:

The degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the relevant business is being conducted: see Inglis v Federal Commissioner of Taxation (1979) 10 ATR 493; 80 ATC 4001.

It is clear that proposing to carry on a business is not sufficient to satisfy that a business has commenced.

To satisfy that a business is 'proposed to be' carried on, you need to be able to sufficiently identify the business and there needs to be a commitment of some substance to commence the business. Examples of such a commitment are establishing business premises, investment in capital assets and development of a business plan. We acknowledge that you are proposing to carry on a business.

However, the degree of activity required for a business to have commenced will be not be established until the taxpayer's activities show that the taxpayer is committed to proceed with the implementation of their proposal to carry on a business and actually commences operations.

In Calkin v. CIR [1984] 1 NZLR 440 (Calkin's Case)Richardson J said at 446-447:

Clearly it is not sufficient that the taxpayer has made a commitment to engage in business: he must first establish a profit-making structure and begin ordinary business operations . (emphasis added)

The decision in Calkin's Case confirms that both the acquisition of the minimum level of business assets and the commencement of 'business operations' are necessary to be able to conclude that a business has commenced.

It is important in evaluating these activities to have a proper regard to the characterisation of your business. For example, as your business activity is a primary production activity, involving animals, then the purchasing of the animals could be seen as the commencement of that business.

We hold the view that income from agistment alone does not constitute a business of primary production for tax purposes (Taxation Ruling IT 225)

The reason for this is that agistment income will rarely equate to the running costs of the property, therefore the activity of agistment lacks a commercial character. We consider that, in most cases, the agistment of the property occurs as a prelude to the use of the property for some other purpose, for example a business of primary production or private use. It is usual to apportion these cases to allow expenses to the extent of income received.

This view is supported by the decision in AAT Case 38/97 97 ATC 397; (1997) 36 ATR 1154, which specifically dealt with the treatment of interest expenses incurred in relation to agistment income. Agistment income is assessable (section 6-5 (ITAA 1997)), however as the leasing out of land for agistment does not constitute the carrying on of a business, expenses are only deductible to the extent of the income derived.

Based on the information you have supplied, we have formed the opinion that you had not commenced carrying on a business in the 2009-10 income year, as there were no animal farming or agricultural activities in 2009-10 and you do not plan to purchase animals until late in 2010 when your current agistment contract is completed. We do not consider that you will have commenced business until you have shown some commitment to purchase animals and/or committed to the agricultural activity.

Further, even if you were able to satisfy that your business had commenced, for the Commissioner to exercise the discretion you must be able to show that the reason your business activity is producing a loss is inherent to the nature of the business and is not peculiar to your situation. For example, the discretion will not be available where the failure to make a profit is for reasons other than the nature of the business such as, a consequence of starting out on a small scale, the hours worked or the need to build a client base.

Although you have submitted documents from experts generally endorsing your business plan and providing support, you have not provided any evidence from an independent source of the commercially viable period for your industry/business.

TR 2007/6 recognises, at paragraph 23, that not all businesses will commence immediately at the start of an income year and allows a tolerance of one year.

In our view the commercially viable period for animal animal fattening is dependent on the period of time you plan to hold the animals and the commercially viable period for your agricultural activity is 1 year.

You plan to fatten the animals for a period of 12 months. Based on your information, the lead time for your fattening activities to become commercially viable would be 1-2 years.

Where the business does not produce a profit within the commercially viable period, the Commissioner is not able to exercise the discretion.

In your projected income and expenditure statement you have projected that your business activity will not produce income greater than deductions attributable to it until the 2013-14 income year. This is three years after you plan to purchase your initial animals, which is outside the commercially viable period for your business.

The reason your business activities will not produce a profit within the commercially viable period is because of the delayed commencement due to your weed eradication program and the planned staged expansion of your business. It is not due to anything inherent in the nature of those business activities.

Therefore the Commissioner will not exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(c) of the ITAA 1997.

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