Edited version of private ruling

Authorisation Number: 1011831184736

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Ruling

Subject: Non commercial losses - Commissioner's discretion

Question

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 primary production activity in your calculation of taxable income for the 2009-10 to 2013-14 financial year?

Answer: No

This ruling applies for the following periods

Year ended 30 June 2010

Year ending 30 June 2011

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commenced on

1 July 2009

Relevant facts and circumstances

In the 1990s you commenced a primary production business.

The enterprise came close to profit before prices dropped for one of your crop varieties.

You removed that variety and replanted with a different variety. You incurred significant redevelopment expenditure.

The new crop will reach full production in the 2010-11 financial year.

You expect to make a tax profit in the 2013-14 financial year.

Your income for non commercial loss purposes is in excess of $250,000 for the 2009-10 financial and you expect this to be the case in the 2010-11 to 2013-14 financial years.

Relevant legislative provisions

Income Tax Assessment Act 1997 paragraph 35-55(1)(c)
Income Tax Assessment Act 1997 subsection 35-10(2)
Income Tax Assessment Act 1997 subsection 35-10(2E)

Reasons for decision

Summary

For your activity, 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 change in crop variety. The commercially viable period for your activity has passed; therefore the Commissioner will not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997.

Detailed reasoning

For the 2009-10 and later financial years, 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 the 2009-10 financial year and you expect this will be the case in the 2010-11 to 2012-14 financial years.

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 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:

· 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.

The phrase 'objective 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 objective 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.

You have not provided any information regarding what is the commercially viable period for your industry. However, you submit that you were earning income and were close to profit before being affected by negative market forces. As you were producing marketable produce and close to making a tax profit, it follows then that the commercially viable period for your enterprise would have passed. The uprooting of a particular variety and the replanting does not fall for consideration because your orchard was already established with a commercial crop.

To conclude, the replanting of a portion of your acreage does not alter the requirement that a commercially viable period from planting to maturity must be used for the purpose of the Commissioner's discretion. The Commissioner cannot exercise his discretion in your case because the objective commercially viable period has expired. Your inability to make a tax profit is not because of the nature of the business but because of your decision to amend your strategy.

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