Edited version of private ruling

Authorisation Number: 1011752651718

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Ruling

Subject: Non-Commercial Losses Special Circumstances

Question

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 a share of losses from your cattle breeding business in the calculation of your taxable income for the 2009-10, 2010-11 & 2011-12 income years?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2010

Year ending 30 June 2011

Year ending 30 June 2012

The scheme commenced on

1 July 2009.

Relevant facts

You operate cattle breeding activities from a few principal properties.

The farming area has been increased by 50%.

You manage and assist full time employees in developing the business.

You commenced business many years ago.

In the future you intend to spend more of your own time at the business to reduce labour costs.

Your strategy is to retain the better breeding heifers and build on breeding numbers which will increase by 50% in the coming years.

Your local area has received well below average rainfall for the last 12 or so years and according to a noted expert this has the longest run of below average rain since records began.

In the 2008-09 income year you purchased a XXX acre property which is located within 40kms of the other properties. The property enjoys higher rainfall than either of the other two properties. It also has an irrigation licence which was purchased with a view to providing the bulk of any hay requirements and pasture for finishing vealers. It was a run down farm which required fencing, fertilising and establishment of pasture, but your hay costs have been reduced as a result of the purchase.

You expect your budgeted expenses to decrease in the next 3 years.

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 subsection 35-10(2E) of the ITAA 1997 is met 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 contributions for that year;

(d) 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 35-10(2E) of the ITAA 1997, 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.

Application of section 35-55 of the ITAA 1997 (Commissioner's discretion) to this arrangement

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.

You believe special circumstances affected your business. The conditions under paragraph 35-55(1)(a) of the ITAA 1997 (special circumstances) will now be addressed.

As you did not pass the income requirement you not only need to demonstrate that special circumstances affected your business, but you also need to show that the special circumstances prevented you from making a taxable profit.

Special circumstances

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 in the 2009-10, 2010-11 and 2011-12 income years. The discretion is designed to allow for cases where unusual circumstances occurred to prevent businesses from meeting one of the four tests. You operate properties within 40kms of each other in an area which has been in a prolonged drought for many years.

Your local area has received well below average rainfall for the last 12 or so years and according to a noted expert this has been the longest run of below average rain since records began. To alleviate the effects of the drought you purchased a nearby property which has above average rain (compared to the other properties) where you intend to grow hay so you won't be forced to buy hay for the cattle.

It is considered that the circumstances you found yourself in were special circumstances according to TR 2007/6.

The Commissioner will therefore exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 as special circumstances have existed for many years and it will take approximately two and a half years to rebuild your herd to such an extent that you will make a taxable profit.

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