Edited version of your private ruling

Authorisation Number: 1012566419469

Ruling

Subject: non-commercial losses

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 share of the primary production business in your calculation of taxable income for the 2012-13 to 2017-18 financial years?

No

This ruling applies for the following periods

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

The scheme commenced on

1 July 2006

Relevant facts

You carry on a primary production business.

Relevant legislative provisions

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

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

Income Tax Assessment Act 1997 Subsection 35-55(1)(c)

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, you do not satisfy the income requirement (that is, your taxable income, reportable fringe benefits and reportable superannuation contributions but excluding your business losses, exceeds $250,000) and do not come under any of the exceptions. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

Special circumstances (first limb)

The Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the financial year where the business activity is affected by special circumstances outside the control of the operators of the business activity.

Special circumstances are those circumstances which are sufficiently different to distinguish them from the circumstances that occur in the normal course of conducting a business activity. For those individuals who do not satisfy the income requirement, special circumstances are generally those which have materially affected the business activity, causing it to make a loss.

Taxation Ruling TR 2007/6 sets out the Commissioner's interpretation of 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:

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 discretion can be exercised in income years after the one in which the special circumstances occurred if the effects of those special circumstances continue to prevent your business activity from satisfying any of the tests in those later income years. However, there may be situations where the special circumstances, because of their continued existence, become the ordinary or usual situation. It would not be appropriate to exercise the discretion once this occurs.

Nature of the activity (second limb)

The Commissioner's discretion in paragraph 35-55(1)(c) of the ITAA 1997 may be exercised for the financial year where there is an objective expectation, based on evidence from independent sources, that your business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period.

For the Commissioner to exercise the discretion you must 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.

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.

The note under paragraph 35-55(1)(c) states:

Paragraphs (b) and (c) are intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. For example, an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

The phrase 'objection expectation' was discussed in the Administrative Appeals Tribunal case of Scott v. Commissioner of Taxation [2006] AATA 542; VS2005/31-33, (Scott's case) 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 Scott's case, 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 objection 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.

Further, the Explanatory Memorandum provides the following relevant examples:

Tracey carries on a business of primary production from breeding and selling cattle. Their profit projections indicate that they do not expect to make a tax profit for six years.

Independent evidence provided by Tracey indicates the lead time period begins from the commencement of the activity and includes the time taken to raise the females to a breeding age, allowing for the gestation period of those animals to finish, and finishes when the progeny have reached a saleable age. On the evidence provided, the period for a typical business activity of breeding and selling cattle to become commercially viable is no greater than three years. Therefore, Tracey will not be able to produce a tax profit within a period that is commercially viable for the industry concerned and the Commissioner will not be able to exercise the discretion to allow the losses.

Joe earns in excess of $250,000 and has a substantial rural property which he and his wife visit most weekends. The property has a family residence and sheds and, apart from one area of the property where a few goats are kept, is otherwise developed with nut trees.

Joe planted a large number of nut trees on the land in 2007, and has been claiming his losses from this activity, having passed the real property test in prior years. As his income is higher than $250,000, Joe applies to the Commissioner seeking the exercise of the discretion in new paragraph 35-55(1)(c) to allow him to access his losses in 2009-10.

In support of his application, Joe provides a letter from the secretary of the Nut Tree Growers' Association that states that yields from that number and type of trees would ordinarily be sufficient to allow Joe to make a profit within about six years. This is the industry norm for growers of that type of nut tree. However, because the soil on the property is not very fertile and the site does not get a lot of sun, Joe accepts that the lead time for his particular nut-growing activity will be nine years not six years. Joe otherwise manages his nut tree orchards in accordance with industry management practices.

Having examined the case, the Commissioner concludes that, despite the large number of trees on the property and the fact that the business is being conducted in accordance with industry management practices, the discretion should not be exercised in Joe's favour. This is because the lead time for this activity to become profitable is greater than the industry norm: the failure to make a profit within a commercially viable period is due to factors that are peculiar to Joe's local environment. Despite the fact that these factors are out of Joe's control, and the fact that the activities are otherwise carried on in a commercially viable way, the excessive lead time before making a profit for Joe's activities are caused by the poor soil quality and lack of sunlight. The Commissioner does not exercise the discretion in Joe's favour because there is an excessive lead time before making a profit, when compared to other businesses in the industry.

Paragraphs 84 and 85 of Taxation Ruling TR 2007/6 state:

The Commissioner needs to be satisfied that there is an objective expectation that the business activity will satisfy a test or produce a tax profit in some future income year falling within a period that is commercially viable for the industry concerned. If the business activity is not expected to satisfy a test or produce a tax profit within this period then the discretion will not be exercised.

The objective expectation does not have to be held by, or attributed to, a particular person. The Commissioner need only be satisfied that, based on the available supporting material, an objective expectation exists.

After taking into account all the additional factors that you have submitted as impacts on the industry and your business, the Commissioner is not able to conclude that your business will make a profit within the commercially viable period for your industry.

Therefore, the Commissioner will not exercise the discretion under subsection 35-55(1)of the ITAA 1997 and the losses from your business will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997.

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