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Ruling

Subject: Non-commercial losses - Commissioner's discretion

Question:

Will the Commissioner exercise the discretion in subsection 35-55(1) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your primary production business activity in your calculation of taxable income for the 2010-11 to 2014-15 financial year?

Answer:

Yes.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commenced on

1 July 2010

Relevant facts

You commenced your primary production business activity in the 2010-11 financial year, under a partnership structure.

The land was cleared and prepared for planting which was to take place in the 2011-12 financial year. However, due to extreme weather conditions in that year, planting was delayed until the 2012-13 financial year.

It is expected that the first harvest will take place in the 2015-16 financial year or three years after planting.

You have provided independent evidence from a government department, in the form of a fact sheet, which states that the first crop from this type of activity is not expected until year three and will increase to near full production by year seven.

Your profit and loss projections for the 2010-11 to 2018-19 financial years show that the assessable income in the first year of harvest (2015-16 financial year), your primary production activity will produce income in excess of $20,000 and will produce a net profit.

Your income for non-commercial loss purposes is or is expected to be more than $40,000 but less than $250,000 for the 2010-11 to 2014-15 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

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 from a business activity will not be taken into account unless: 

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

· you satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 and one of the four tests is met; or  

· if you do not satisfy the income requirement or if one of the tests is not met, the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

Your assessable income from sources not related to this activity has been, or is expected to be more than $40,000 for the 2010-11 to 2014-15 financial years. Therefore, the exception contained in subsection 35-10(2) of the ITAA 1997 does not apply.

Your income for non-commercial loss purposes is less than $250,000, therefore you satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997. However, 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 2015-16 financial year. 

The Commissioner's discretion - special circumstances 

Where the income requirement is satisfied, the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997, can be exercised where a business activity is affected by special circumstances, outside the control of the operators, such that it is unable to satisfy any of the tests.

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 

The Commissioner's discretion, under paragraph 35-55(1)(b) of the ITAA 1997, can be exercised where a 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 and there is an objective expectation that within a period that is commercially viable for the industry it will meet one of the tests or produce a tax profit.  

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 one of the tests. 

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.

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. (paragraphs 24 to 27).

Your situation 

You have provided independent evidence to show that the first crop from this type of activity is not expected until year three and will increase to near full production by year seven.

You commenced your activities in the 2010-11 financial year and, based on the independent evidence provided, no income would be produced, or one of the tests met, until the 2013-14 financial year. However, during the initial years, due to extreme weather conditions in that year, planting was delayed until the 2012-13 financial year.

Extreme weather conditions are considered to be 'special circumstances' within the meaning of paragraph 35-55(1)(a) of the ITAA 1997. The unavoidable delays in planting due to extreme weather conditions meant that there was no longer an objective expectation that you will produce any income or satisfy a test in the 2013-14 financial year.

With the planting postponed to the 2012-13 financial year, you now do not expect to produce any income or satisfy one of the four tests until the 2015-16 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 primary production business against your other assessable income for purposes of calculating your taxable income for the 2010-11 to 2014-15 financial years.

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