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Ruling

Subject: Non-commercial losses

Question

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 business activity in your calculation of taxable income?

Answer

No

Relevant facts

You satisfy the <$250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You carry on a business.

You have provided independent evidence as to the lead time for your industry and you intend to make $20,000 in assessable income outside this time due to your decision to stagger your planting.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 35-10(1)

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

Income Tax Assessment Act 1997 subsection 35-10(2E)

Income Tax Assessment Act 1997 paragraph 35-55(1)(b)

Reasons for decision

For the 2009-10 and later financial years, Division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless:

· you meet the income requirement and you pass one of the four tests;

· the exceptions apply; or

· the Commissioner exercises his discretion.

In your situation, none of the exceptions would apply and although you satisfy the income requirement, you do not meet any of the four tests in the years of income under consideration. Your losses are therefore subject to the deferral rule, unless the Commissioner exercises his discretion.

The relevant discretion may be exercised for the income year in question where:

· it is in the nature of the business activity that there will be a period of time before it can be expected to pass one of the four tests; and

· there is an objective expectation your business activity will produce a tax profit or meet one of the four tests within a commercially viable period for your industry.

The discretion that is relevant in your circumstances is provided by paragraph 35-

55(1)(c) of the ITAA 1997. In order to exercise this discretion, the Commissioner must be satisfied that there is an objective expectation, based on evidence from independent sources, that your business activity will produce a tax profit within a commercially viable period for the industry concerned.

For the Commissioner to exercise the discretion, you must also be able to show that the reason your business activity is producing a loss is inherent to the nature of the business and is not peculiar to your situation. That is, the reason why the business is making a loss must be due to the inherent features of the industry rather than the way the business is carried on.

Where an operator chooses to carry on the business activities in a manner that does not produce a tax profit within the period that is commercially viable for the industry concerned, paragraph 35-55(1)(c) of the ITAA 1997 may not be satisfied.

As an example, in the case of Scott v. Commissioner of Taxation [2006] AATA 542 (Scott's Case), the Administrative Appeals Tribunal (AAT) upheld the Commissioner's decision in not applying the discretion. Mr Scott initially planted olive trees in 1997 and 1998. He then planted further trees in July 2000. No income was produced in the subsequent four years. The Commissioner contended that the losses fell outside the commercially viable period for that industry, which was determined on an objective basis.

In relation to the commercially viable period, Mr Scott argued that there were other circumstances which should be taken into account when determining this time frame. On this issue, the AAT member expressed the following view:

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…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.

In your case you plan to stagger your plantings over a number of years. From the information you have provided, it appears that your activity could pass a test several years before this if you chose to plant at once or on a larger scale rather than adopting a staggered planting approach.

The reason that your business activity will not make a profit until the sixth year of operation is due to a decision you have made with regards to how you run your business rather than due to any inherent features of the industry. That is, another business in the same industry could make a tax profit in a substantially shorter time frame if it did not adopt a staggered planting approach.

Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997 in relation to your activity.

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