Edited version of private ruling

Authorisation Number: 1011666897671

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Ruling

Will the Commissioner exercise the discretion under paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include losses from your fruit tree growing business in the calculation of your taxable income for the income years in question?

No.

This ruling applies for the following period

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

The scheme commenced on

1 July 2005

Relevant facts

You are in the business of growing fruit trees.

You planted S trees on T hectares.

You intend to sell the majority of your fruit and then re-purchase a percentage of it back after it has been value-added.

You passed the income requirement in the 2009-10 income year, that is, your income for non-commercial loss purposes was less than $250,000.

In your original business plan (from a previous private ruling), you stated you were going to use a certain variety of fruit trees, however following discussions with neighbouring growers it was discovered that this variety had not been a successful variety on their properties. Following further discussions with the local nursery and others you decided to test several other species. You finally settled on several different species of fruit trees.

The circumstances which you believe were special included two weather events, ordering delays, and the failure of several planted varieties as follows:

Rain Storm

U trees were planted in 2007 and a further V trees were planted a month later. A severe rain storm hit your area and dropped approximately Wmm on your property. The large amount of rain saturated the trees' root systems and as a result you lost 10% of your trees. When you had initially planned the trees there was only a predicted average failure rate of 5%. The normal growth of the surviving trees was also materially affected by this event. The rain event was considered to be a 1 in 50 year flood.

Ordering delays

Replacement trees for the trees lost in the rain storm were ordered over six months later, however due to supplier constraints the requested varieties were not available for delivery until over six months later. A second soil analysis was undertaken during this period and steps were taken to improve the growing conditions for the trees. X trees were planted in late 2008.

Continued tree losses

Between early 2008 and late 2009, X trees died. Several were due to ring barking by rabbits. Of the X trees, Y were of a certain variety. You believe the high representation of this variety compared to other varieties suggests this particular variety is not suited for the specific growing conditions. In 2009, an additional X trees were purchased and planted. You decided to plant a different variety for two reasons, firstly this variety constitutes the majority of Australian plantings and is considered a robust variety and secondly the other successful varieties were not available from the pre-eminent supplier in Australia.

Substantial weather event - 2009

For a few days in late 2009 there was a regional weather event that caused considerable loss of fruit and trees. The temperature reached 42 degrees celsius combined with a strong wind. Even though the trees were irrigated both before and during the event, the combination of heat and wind contributed to the death of Z of your trees. Of the Z trees which died, A were of the specific variety. These A were part of the B which were planted two months earlier.

In early 2010 you purchased and planted C trees.

A regional fruit tree Association stated they believe it is accepted that these fruit trees do not mature until they are at least seven years old from the planting date. In many areas, this period may be as long as ten years. The difference in age at maturity as well as productivity would depend on a multitude of factors such as climate, rainfall in the growing years, individual tree farm management and preparation and the varieties planted. Many trees commence bearing in small quantities at age four years but such bearing is erratic and variable. However, in your original application for a private ruling, you provided independent evidence from another Association which stated that most tree varieties will take from four to five years to produce a commercial crop if cared for properly.

Relevant legislative provisions

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

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

Reasons for decision

Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997) prevents losses from non-commercial business activities (being conducted by an individual or a partner in a partnership) being offset against other assessable income in the year the loss is incurred. The loss is deferred unless:

· you satisfy the income requirement under section 35-10(2E) of the ITAA 1997 and pass one of the following four tests:

(a) at least $20,000 of assessable income in that year from the business activity (assessable income test)

(b) the business activity results in a taxation profit in three of the past five income years (profits test)

(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 (real property test), 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 (other assets test), or

· the Commissioner exercises his discretion (special circumstances or lead time), or

· you meet the exception test (can only be met if the activity is a primary production or a professional arts business and your assessable income from that year from other sources that do not relate to that activity is less than $40,000).

The income requirement under section 35-10(2E) of the ITAA 1997 is met 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.

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 (including the income test under subsection 2E), the discretion is exercised, or the exception applies.

Are you carrying on a business?

Your activities 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.

As your activity has commenced, and is carried on as a business, it is subject to the provisions in Division 35 of the ITAA 1997.

Special Circumstances

It appears from your application that you believe special circumstances affected your business. The issue of whether there were special circumstances and whether they prevented you from passing one of the four tests will now be addressed.

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) 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:

(a) 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;

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.

The question of what constitutes 'special circumstances' has been judicially considered on many occasions. In the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation:

Those discretions are intended to be applied to a great variety of situations. In such a context, the core of the idea of 'special circumstances' is that there is something unusual or different to take the matter out of the ordinary course…

Later, in the Federal Court Case of Secretary, Department of Employment, Education, Training & Youth Affairs v. Barrett and Another (1998) 82 FCR 524 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed that:

The word 'special' must be read in context. In normal parlance it signifies that the event or circumstances in question are out of the ordinary or normal course.

Tamberlin J then quoted the following passage with approval from the AAT case of Re Beadle and Director-General of Social Security (1984) 1 AAR 362; (1984) 6 ALD 1:

An expression such as 'special circumstances' is by its very nature incapable of precise or exhaustive definition. The qualifying adjective looks to circumstances that are unusual, uncommon or exceptional. Whether circumstances answer any of these descriptions must depend upon the context in which they occur. For it is the context which allows one to say that the circumstances in one case are markedly different from the usual run of cases. This is not to say that the circumstances must be unique but they must have a particular quality of unusualness that permits them to be described as special.

It can be seen that to determine what are '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), as the Note to the paragraph indicates.

In Taxation Ruling TR 2007/6, the Commissioner provides guidance to taxpayers in what he considers to be special circumstances for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. Apart from drought, flood and bushfire which are specifically mentioned in the legislation, it may also include:

· earthquakes

· hailstorms

· an oil spill

· a chemical spray drift

· a gas plant explosion

· a power plant shutdown

· a water authority malfunction

· government authority restriction imposed on land use, or

· other events (for example, illness of the operator or employee(s)) which have significantly affected the ability of the operator to carry on the business activity.

In application to your case you have requested that the Commissioner exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the years in question as a result of a number of events/variety of circumstances which occurred in earlier years.

The discretion is designed to allow for cases where unusual circumstances occurred to prevent businesses from meeting one of the four tests.

According to your cash flow projection contained in your original Application for a Private Ruling you would have passed the assessable income test from a future income year and in all other years up many years into the future.

There were four factors which you believe impacted on your business. Each of them will now be addressed:

Rain Storm

U trees were planted in early 2007 and a further V trees were planted a month later. These plants were planted on a block with good drainage and in an area recognised as good fruit tree growing country. During 2007 a severe rain storm hit your area. The large amount of rain saturated the trees' root systems and as a result you lost 10% of your trees when you had initially planned that there would only be a predicted average failure rate of 5%. The normal growth of the surviving trees was also materially affected by this event. The rain event was considered to be a 1 in 50 year flood.

The plants which were lost were only two to three months old as you planted all the plants in early 2007. You didn't lose mature trees so if the replacement plants were planted to replace the lost trees you would only have been put back by a few months as 90% of the trees survived (even though they had also been affected by the rain). However, it took over six months for the lost plants to be ordered. Then it took over six months for the requested plants to be supplied and planted.

The fact that you only lost 10% of all your trees and all your plants had only been planted two to three months earlier means that the event would have only delayed your projected crop and subsequent profit by a few months. You also stated in your original Application for a Private Ruling the trees are planted on a with good drainage and in an area recognised as good fruit tree growing country. As you previously stated the block had good drainage, therefore once the rain stopped the excess should have drained away in a reasonable time. Ninety percent of your two to three month old plants survived the rain. These circumstances are therefore not considered special.

Ordering delays

Replacement trees for the lost trees in the rain storm were ordered over six months later, however due to supplier constraints the requested varieties were not available for delivery until over six months later. After a delay of over 12 months from the time you lost 10% of your plants X trees were planted. The fact that it took over six months to order replacement trees and over six months for the trees to be supplied and planted are not considered to be special circumstances.

Continued tree losses

Between early 2008 and late 2009, X trees died. Several were due to ring barking by rabbits. Of the X trees, Y were of a certain variety. You believe the high representation of this particular variety compared to other varieties suggests that this variety is not suitable for the specific growing conditions. You stated in your original Application for Private Ruling stock fencing was required including the protection of individual plants from vermin and pests. The ring barking of some trees by rabbits was preventable as you knew stock fencing and protection from vermin and pests of individual plants was required.

You also stated you believed that the majority of the trees which died were not suitable for the specific growing conditions. You initially held discussions with neighbours, a local nursery and others to ascertain which varieties were most suitable to your situation, these discussions occurred only after you were initially going to plant a specific variety.

The special circumstances contemplated by paragraph 35-55(1)(a) of the ITAA 1997 are exceptional circumstances that are outside the control of the taxpayer. Ring barking by rabbits and the incorrect selection of a fruit tree variety are not considered to be special circumstances that were outside your control.

Substantial weather event

In late 2009 there was a regional weather event that caused considerable loss of fruit and you lost Z trees. The temperature reached 42 degrees celsius combined with a strong wind. Even though the trees were irrigated both before and during the event, the combination of heat and wind contributed to the death of those Z trees. Included in the lost Z trees, were A of the B of a specific variety which were planted two months earlier.

As the vast majority of trees which died (A of the Z) were planted only two months before the weather event, it is considered that this event had a minimal impact on your overall business. At worst it would have set you back a couple of months until such time as you planted replacements. In 2010 you purchased and planted C trees.

Conclusion

It is considered that the rain storm, ordering delays, continued tree losses and the substantial weather event in 2009 are not special circumstances and therefore the Commissioner will not exercise his discretion under paragraph 35-55 (1)(a) of the ITAA 1997.

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