Edited version of private ruling

Authorisation Number: 1011592648377

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Commissioner's discretion - $250,000 income earner

1. In relation to your farming business, will the Commissioner exercise his discretion under section 35-55 of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to deduct your losses due to nature of your activity?

No.

2. In relation to your yachting business, will the Commissioner exercise his discretion under section 35-55 of the ITAA 1997 to allow you to deduct your losses due to nature of your activity?

No.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You earn over $250,000 per annum in combined employment and trust income. In your prior year tax returns, you also lodged losses attributable to a yacht charter business and a farming business.

When you purchased your farm, it had existing commercial quantity of trees, however, the trees were neglected. The trees were never fertilised and consultant advice indicated the five to six year old trees would require three years to bring them back to an acceptable state of health.

For your farming business, you have sought the Commissioner's discretion, on the basis that your trees do not fully produce until after twelve years of age; that they start producing from five to six years of age depending on the type and conditions; and that the trees were neglected by the previous owner.

Your yacht is chartered through an agreement with a charter company. For your yacht business, you have sought the Commissioner's discretion, on the basis that the 30% depreciation of the Simplified Tax System results in annual losses, however, over six years, due to a balancing adjustment, the business is profitable once the boat is sold.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 35-10

Income Tax Assessment Act 1997 Section 35-55

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

For your farm business, the Commissioner may only exercise the discretion based on an objective commercially viable period. It is not permissible for the Commissioner to consider subjective factors, such as the condition of trees at purchase, hours of operation, location, climate or soil conditions or the level of debt funding. Following the guidance published by the Department of Primary Industries, the objective commercially viable period is eight years. Your trees were least five to seven years old, possibly six to eight years old, when you purchased your farm. It follows the commercially viable period of eight years has now expired.

For your yacht business, you requested the Commissioner's discretion based on the method of depreciation you have chosen. Your chosen method of depreciation is neither a 'special circumstance' nor a factor contributing to a lead time between the commencement of your activity and the production of assessable income. For your yacht charter business, there is no lead time for the production of assessable income because the term 'assessable income' refers to gross receipts rather than net profit. It follows the Commissioner cannot exercise his discretion in relation to your yacht business.

Detailed reasoning

Division 35 of the ITAA 1997 is about non-commercial losses. Subsection 35-10(1) of the ITAA 1997 provides the loss deferral rule in subsection (2) applies for an income year unless:

a. you satisfy subsection (2E) for that year and one of the tests set out in any of the following provisions is satisfied for the business activity for that year:

(i) section 35-30 (assessable income test)

(ii) section 35-35 (profits test)

(iii) section 35-40 (real property test)

(iv) section 35-45 (other assets test), or

b. the Commissioner has exercised the discretion set out in section 35-55 for the business activity for that year, or

c. the exception in subsection (4) (for where assessable income from other sources is less than $40,000) applies for that year.

You satisfy subsection 35-10(2E) of the ITAA 1997 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.

For an applicant who carries on a business activity and does not satisfy subsection 35-10(2E) for the most recent income year ending before the application is made, paragraph 35-55(1)(c) of the ITAA 1997 states the Commissioner may decide that the loss deferral rule in subsection 35-10(2) 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 the business activity has started to be carried on and, for the excluded years:

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

· 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)).

The phrase 'objection expectation' was discussed in the Administrative Appeals Tribunal case of Scott v. Commissioner of Taxation [2006] AATA 542; VS2005/31-33, where it was said:

…in determining a commercially viable period, the test is primarily an objective one based on independent sources. According to the Commissioner, this approach was taken by the Federal Court in Commissioner of Taxation v Eskandari (2004) 134 FCR 569 where Stone J said, at 581-582:

In some cases it may be a straight forward exercise to identify the industry in which the business activity takes place. Some industries are well-established and the basis for an ''objective expectation'' can readily be based on a comparison between the tax payer's business and other businesses within that industry, particularly where businesses or business associations within the industry produce material such as annual reports or industry papers ...

Despite what Stone J said, Mr Scott contended that there were other circumstances which had to be taken into account when determining the commercially viable period expressed in the Olives Australia document. However, according to the Commissioner, this is impermissible because, as the Federal Court held in Eskandari, in most cases only objective material will be considered. It is only where, because of the nature of the industry, there is very little or no objective evidence that recourse may be had to the circumstances of the tax payer. That is not the case in the olive industry, which has been established for centuries. I agree with that submission. It seems to me that if it were permissible to take into account subjective considerations of each individual grower, there might be an almost infinitely variable period which could be described as the commercially viable period.

Further, in the case of Scott, additional plantings made at a later time were not permitted to be included in the commercially viable period, as follows:

The fact that a grower elects not to plant sufficient trees at the outset to ensure the business is commercially viable is a decision for that individual grower. Such a grower could not expect the Commissioner to exercise his discretion under s 35-55 in his or her favour because, to do so, would effectively render nugatory the rule dealing with losses from non-commercial business activities.

The sole reliance on objection evidence and the impermissibility of subjective considerations was further emphasised in the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 as follows:

2.30 The taxpayer is required to establish objectively that the business is commercial in nature and will become profitable in a commercially viable timeframe. Objective evidence from independent sources can include evidence from an individual or organisation experienced in the relevant industry, such as industry or regulatory bodies, tertiary institutions, industry specialists, professional associations, government agencies or other independent entities with a similar successful business activity. Evidence from independent sources can also include evidence from business advisers (such as business plans), financiers and banks.

2.34 For taxpayers that do not meet the income requirement, the Commissioner may exercise a discretion after an application by a taxpayer, where the Commissioner is satisfied that - based on evidence from independent sources - the business will produce assessable income greater than available deductions, in a timeframe that is considered commercially viable for the industry concerned.

2.35 The discretion is not intended to be available in cases where the failure to make a profit is for reasons other than the nature of the business, such as, a consequence of starting out small and needing to build up a client base, or business choices made by an individual that are not consistent with the ordinary or accepted practice in the industry concerned - such as the hours of operation, location, climate or soil conditions, or the level of debt funding.

Further, the Explanatory Memorandum provides the following relevant example:

Joe earns in excess of $250,000 and has a substantial rural property which he and his wife visit most weekends. The property has a family residence and sheds and, apart from one area of the property where a few goats are kept, is otherwise developed with nut trees.

Joe planted a large number of nut trees on the land in 2007, and has been claiming his losses from this activity, having passed the real property test in prior years. As his income is higher than $250,000, Joe applies to the Commissioner seeking the exercise of the discretion in new paragraph 35-55(1)(c) to allow him to access his losses in 2009-10.

In support of his application, Joe provides a letter from the secretary of the Nut Tree Growers' Association that states that yields from that number and type of trees would ordinarily be sufficient to allow Joe to make a profit within about six years. This is the industry norm for growers of that type of nut tree. However, because the soil on the property is not very fertile and the site does not get a lot of sun, Joe accepts that the lead time for his particular nut-growing activity will be nine years not six years. Joe otherwise manages his nut tree orchards in accordance with industry management practices.

Having examined the case, the Commissioner concludes that, despite the large number of trees on the property and the fact that the business is being conducted in accordance with industry management practices, the discretion should not be exercised in Joe's favour. This is because the lead time for this activity to become profitable is greater than the industry norm: the failure to make a profit within a commercially viable period is due to factors that are peculiar to Joe's local environment. Despite the fact that these factors are out of Joe's control, and the fact that the activities are otherwise carried on in a commercially viable way, the excessive lead time before making a profit for Joe's activities are caused by the poor soil quality and lack of sunlight. The Commissioner does not exercise the discretion in Joe's favour because there is an excessive lead time before making a profit, when compared to other businesses in the industry.

Regarding the commercially viable period, the Commissioner considers this to be eight years, following the guidance in the publication by the Queensland Department of Primary Industries.

In your case, your trees were six to eight years old when you purchased the property. It follows the commercially viable period of eight years has expired. Also, following the decision in the case of Scott, your planting of additional trees does not fall for consideration because you purchased a pre-existing orchard with a commercial number of trees.

As for the neglect of the trees by the previous owner, this is a subjective and impermissible consideration, as affirmed in the cases of Eskandari and Stone. The previous neglect of the trees by the previous owner cannot be used as a determinative factor in this private ruling.

To conclude, your purchase of a farm in a neglected state does not alter the requirement that a commercially viable period of eight years, from planting to maturity, must be used for the purpose of the Commissioner's discretion. It follows the Commissioner cannot exercise his discretion in your case because the objective commercially viable period of eight years has expired.

Yacht business

As for your yacht business, the method of depreciation you have chosen is not a factor that falls for consideration under section 35-55 of the ITAA 1997. Your chosen method of depreciation is neither a 'special circumstance' nor related to 'the nature of your activity. Your chosen method of depreciation is a factor within your control. It follows the Commissioner cannot exercise his discretion in relation to your yacht business.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).