Edited version of private ruling

Authorisation Number: 1011740893895

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

Questions:

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 farming business in the calculation of your taxable income for the 2008-09, 2009-10 and 2010-11 financial years?

Answer: Yes.

2. Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to include any losses from your farming business in the calculation of your taxable income for the 2005-06, 2006-07, 2007-08 and 2011-12 financial years?

Answer: Yes.

This ruling applies for the following period

Year ended 30 June 2006

Year ended 30 June 2007

Year ended 30 June 2008

Year ended 30 June 2009

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commenced on

1 July 2005

Relevant facts

You commenced your farming business in 200X.

Your business activities are conducted under a partnership structure.

You currently have stock on hand with an estimated market value of $XXX,000

Your farming property had experienced periodic drought conditions over the years but had been in continuous drought from 2008 until late winter 2010, with pasture growth not improving until November 2010.

Due to the drought conditions, it was necessary to purchase fodder and hand feed your stock from the winter of 2008 to November 2010.

The availability of fodder during this period decreased and the cost of the available fodder increased.

This had a huge impact on your budget and delayed infrastructure and stock establishment plans and the time taken to hand feed meant that less time could be spent on maintenance and progression of the property.

During the drought, several of the property's dams dried up making it necessary to cart water to maintain the water supply to the stock.

This resulted in higher fuel costs, further impacting on the business budget, and less time available to progress the business.

The sale of your stock was impacted by the drought with less people willing to purchase stock until conditions on their own properties improved.

You did not lose any stock during this period, however, they did lose condition and conception rates dropped. This, in turn, impacted potential sales and breeding stock replacement numbers.

You expect your farming activities to produce at least $20,000 of assessable income in the 2012-13 financial year.

Your assessable income from sources not related to this activity has been, or is expected to be more than $40,000 for the 2005-06 to 2011-12 financial years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 section 35-10

Income Tax Assessment Act 1997 section 35-30

Income Tax Assessment Act 1997 section 35-35

Income Tax Assessment Act 1997 section 35-40

Income Tax Assessment Act 1997 section 35-45

Income Tax Assessment Act 1997 section 35-55

Reasons for decision

Overview of Division 35

Under Division 35 of the ITAA 1997, a loss made by an individual from a business activity will not be deductible in the financial year in which it arises unless certain conditions are met. 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, the discretion is exercised, or the exception applies. 

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 unless: 

· the exception in subsection 35-10(4) of the ITAA 1997 applies; or  

· one of the four tests is met; or  

· if one of the tests is not satisfied, the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

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 financial year from sources not related to that activity, of less than $40,000 (excluding any net capital gain). 

Your farming business is a primary production business activity, however, your assessable income from sources not related to this activity has been, or is expected to be more than $40,000 for the 2005-06 to 2011-12 financial years. Therefore, the exception contained in subsection 35-10(2) of the ITAA 1997 does not apply.

Tests 

Division 35 of the ITAA 1997 sets out four tests to determine the commerciality of a business. These are contained in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) and 35-45 (other assets test) of the ITAA 1997. 

In broad terms, the tests require: 

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

· the business activity results in a tax profit in 3 of the past 5 financial years (including the current year) (section 35-35 of the ITAA 1997);  

· 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  

· at least $100,000 of certain other assets (excluding cars, motor cycles and similar vehicles and real property that is taken into account for the real property test) used on a continuing basis in carrying on the business activity in that year (section 35-45 of the ITAA 1997).  

Your business activities have not satisfied any of the four non-commercial loss tests contained in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) and 35-45 (other assets test) of the ITAA 1997 and are not expected to until the 2012-13 financial year. 

If a business does not pass any of these tests, losses must be deferred except in certain circumstances. 

These circumstances are where the Commissioner exercises the discretion under paragraph 35-55(1)(a) or 35-55(1)(b) of the ITAA 1997. If the Commissioner exercises the discretion an individual whose business activity has not passed any of the tests can offset that business loss against other assessable income in the year of that loss. 

The Commissioner's discretion - special circumstances 

Under paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner's discretion can be exercised where: 

· the business activity is affected by special circumstances such that it is unable to satisfy any of the tests; and  

· the special circumstances affecting the business activity are outside the control of the business activity.  

Taxation Ruling TR 2007/6 sets out the exercise of the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 53 of this Ruling. 

Special circumstances are ordinarily those affecting the business activity such that it is unable to satisfy a test and it would be unreasonable for the loss deferral rule to apply. Ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances. These fluctuations are expected to occur on a regular or recurrent basis and affect all business within a particular industry. 

Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to special circumstances outside the control of the business activity, including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of the paragraph. These events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affected the business activity.

 The Commissioner's discretion - lead time 

Under paragraph 35-55(1)(b) of the ITAA 1997, the Commissioner's discretion can be exercised where: 

· the business activity has started to be carried on but because of its nature it has not satisfied, or will not satisfy, one of the tests set out in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997; and  

· there is an objective expectation that within a period that is commercially viable for the industry concerned the activity will meet one of the tests listed above or produce assessable income for an financial year greater than the deductions attributable to it for that year.  

TR 2007/6 sets out the exercise of the Commissioner's discretion under paragraph 35-55(1)(b) of the ITAA 1997. The following has been extracted from paragraphs 70 to 104 of this Ruling. 

The discretion is provided to ensure that certain individuals who carry on genuine commercial businesses are not disadvantaged due to particular circumstances which prevent them from satisfying tests 1 to 4. 

This arm of the safeguard discretion will ensure that the loss deferral rule in section 35-10 of the ITAA 1997 does not adversely impact on taxpayers who have commenced to carry on activities which by their nature require a number of years to produce assessable income. The 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. Such activities have an inherent characteristic that cannot be overcome by conducting the business activity in a different way but only by changing the nature of the business. 

In order to demonstrate that the objective expectation exists, a business operator should produce evidence showing that the business activity will satisfy one of the tests or produce a tax profit, showing the period within which a commercially viable business would do so. Preferably, this evidence will be documented at the time, and the evidence that the business activity will satisfy one of the tests or produce a tax profit within a certain time will be consistent with evidence from independent sources relating to activities of that type. Appropriate independent sources include industry bodies or relevant professional associations, government agencies, or other taxpayers conducting successful comparable businesses. 

Interaction between the two limbs

TR 2007/6 states that the operation of the first limb is ordinarily confined to those situations in which the business activity has been affected by special circumstances outside the control of the operators of that activity where, had these circumstances not existed, the activity would have satisfied one of the four tests in Division 35 of the ITAA. However, the first limb may also apply to a business activity affected by such circumstances during a time when 'because of its nature' it is not able to satisfy a test. In such cases, the appropriate enquiry will be whether or not the special circumstances, outside the control of the business operators, have meant that there is no longer an objective expectation that within the period that is commercially viable for the industry concerned the activity will satisfy a test. Where the special circumstances are the sole reason why the activity can no longer objectively be expected to satisfy a test within the commercially viable period concerned, but the activity is now expected to consistently satisfy a test within some later time, the discretion may be exercised. (see paragraphs 24 to 27).

Your situation 

You have not provided any independent evidence to establish the commercially viable period for this type of business. However, the commercially viable period for this type of farming begins at the start of the activity and includes the time taken to raise females to a breeding age, allowing for the gestation period of those animals to finish, and finishes when to progeny have reached saleable age. The commercially viable period for this type of farming is generally 3 to 4 years.

You commenced your farming activities in 2005 and, based on the commercially viable period, should have met one of the tests by the 2009-10 financial year. However, during this period, your farming activities were affected by drought resulting in loss of condition in your breeding stock and reduced conception rates. The need to purchase fodder for your stock during this period affected your farming budget meaning planned infrastructure had to be delayed and the time taken to hand feed meant that less time was available to progress your activities. The sale of stock was also impacted by the drought with less people willing to purchase stock until conditions on their own properties improved.

Drought is considered to be 'special circumstances' within the meaning of paragraph 35-55(1)(a) of the ITAA 1997. The drought conditions your farming activities experienced meant that there was no longer an objective expectation that these activities would satisfy a test by the 2009-10 financial year.

These drought conditions affected your activities during the 2008-09, 2009-10 and 2010-11 financial years and you now do not expect to satisfy one of the four non-commercial loss tests until the 2012-13 financial year.

The inability of your business activity to satisfy one of the four non-commercial loss tests was due to special circumstances, as set out in paragraph 35-55(1)(a) of the ITAA 1997, and lead time, as set out in paragraph 35-55(1)(b) of the ITAA 1997.

Therefore, the Commissioner will exercise the discretion in section 35-55 of the ITAA 1997 to allow you to offset the losses made from your farming business against your other assessable income for purposes of calculating your taxable income for the 2005-06 to 2011-12 financial years.

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).