Edited version of your written advice

Authorisation Number: 1012665204253

Ruling

Subject: Non-commercial losses

Question 1

Was the partnership carrying on a business for the purpose of Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will you be subject to Division 35 of the ITAA 1997 for the relevant income years?

Answer

Yes

Question 3

Can the capital gain from the sale of the primary production property in the 20XX year be reduced by prior year tax losses which you have self-assessed as being deferred under the non-commercial (NCL) loss rules in accordance with subsection 35-10(2) of the ITAA 1997?

Answer

No

This ruling applies for the following period(s)

Income year ended 30 June 2010

Income year ended 30 June 2011

Income year ended 30 June 2012

Income year ended 30 June 2013

Income year ended 30 June 2014

The scheme commences on

1 July 200X

Relevant facts and circumstances

You own a property where you conduct primary production activities. On the property were a number of paddocks used in your primary production activities and two dwellings.

One of the dwellings was rented out from time to time. While the second was lived in by an employee that worked weekend shifts on the property free of charge. You have never lived in either of the dwellings.

You acquired the property in 20xx. You had a business plan when you acquired the property. The purpose of acquiring the property was to carry on primary production activities; the property has continued to be used for that purpose and no other while you have owned it.

You were involved in overseeing the day to day running of the property which took about 2 hours a day.

You employed X staff members on a permanent basis to undertake activities on the property on a daily basis.

One of the staff members worked 5 days a week and was paid on a weekly basis while the other worked 2 to 4 days a week and was paid by the hour.

You had income from other sources during the period of 1 July 20xx to 30 June 20xx which exceeded the income test.

In most years, the primary production activity expenses exceeded the primary production activity income, resulting in a loss. However in the 20xx, 20xx and 20xx income year the primary production activities were profitable.

From 1 July 20xx to 30 June 20xx, you have self-assessed that the NCL rules have applied to prevent the tax losses from the primary production activity being used against other income.

The property was sold in the 20xx financial year to a party not interested in continuing the business and accordingly was sold as vacant possession with no amount allocated for goodwill. All primary production activity had ceased on the property when it was sold.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 section 955-1

Reasons for decision

Carrying on a Business

The question of whether a business is being carried on is a question of fact and degree to be determined on a case by case basis. The courts have developed a series of indicators to determine the matter, which are summarised in Taxation Ruling TR 97/11. Although TR 97/11 specifically refers to primary production, the same principles apply to all businesses. Some indicators of carrying on a business which the courts have considered to be relevant include:

• whether the activity has a significant commercial purposes or character

• whether the taxpayer has more than just an intention to engage in business

• whether there is regularity and repetition of the activity

• whether the activity is of the same kind, and carried on in a similar manner, to that of ordinary trade in that line of business

• whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

• the size, scale and permanency of the activity, and

• whether the activity is better described as a hobby, a form of recreation or sporting activity.

TR 97/11 states the indicators must be considered in combination and as a whole and whether a business is being carried on depends on the 'large or general impression gained' from looking at all the indicators and whether these factors provide the operations with a 'commercial flavour. However, the weighting to be given to each indicator may vary from case to case, and no one indicator will be decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922).

You have provided the following relevant facts in relation to whether a business activity has been commenced:

• you had a business plan when you acquired the property

• you acquired the property with the intention of carrying on primary production activities

• you have x paddocks available for primary production activities each varying between x and x square meters

• in addition to paddocks there are a number of facilities on the property

• you employ two staff to maintain the property and provide services to your clients

• in addition to the primary production activity you provide services

• you have previously made a profit from the primary production activity.

In viewing the above it is considered that the primary production activities you carry on go beyond the passive earning of rent and will amount to the carrying on of a business. The activity appears to have been carried out in a businesslike manner, on a commercial scale for a period of xx years. Even though it has not recently made a profit, there is a prospect of profits as evidenced by the 20xx, 20xx and 20xx financial years.

Non-Commercial Losses (NCL) Provisions

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 in certain circumstances. Section 35-10(1) of ITAA 1997 provides:

The rule in subsection (2) applies for an income year to each business activity you carried on in that year if you are an individual, either alone or in partnership (whether or not some other entity is a member of the partnership), unless:

(a) you satisfy subsection (2E) for that year, and one of the tests set out in any of the following provision is satisfied for the business activity for that year:

(i) section 35-30 (assessable income test);

(ii) section 35-35 (profits test);

(iii) section 35-40 (real property test);

(iv) section 35-45 (other assets test); or

(b) the Commissioner has exercised the discretion set out in section 35-55 for the business activity for that year.

Further section 35-10 (2) of the ITAA 1997 provides:

If the amounts attributable to the *business activity for that income year that you could otherwise deduct under this Act for that year exceed your assessable income (if any) from the business activity for that year, or your share of it, this Act applies to you as if the excess:

(a) were not incurred in that income year; and

(b) were an amount attributable to the activity that you can deduct from assessable income from the activity for the next income year in which the activity is carried on.

The effect of the above two subsections is that the loss you make from a business you carry on as an individual or a partnership will be quarantined to that particular business activity unless:

• you satisfy 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 you do not come under any of the exceptions. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

Assessable income from your business activity

As discussed above the NCL provisions will have the effect of deferring the losses your primary production business has made in the relevant income years. You have provided that you have made a capital gain on the sale of the property used to carry on the business. The question then arises as to whether this capital gain is assessable income from the same business activity as to which the previous losses were deferred.

Taxation Ruling TR 2001/14 provides the Commissioner's view on the application of Division 35 of the ITAA 1997. At paragraph [61] it clarifies what is assessable income for the purpose of Division 35 of the ITAA 1997:

Assessable income is defined in section 995-1 of the ITAA 1997 to include statutory income as well as ordinary income (see generally, division 6 of the ITAA 1997). This definition governs what income will be counted towards the Assessable income test in section 35-30, provided that such income is 'from' the relevant *business activit

While it's clear that any capital gain made on the sale of the property under section 104-5 of the ITAA 1997 will give rise to statutory income which will in turn be assessable income. The question then remains whether that assessable income is assessable income from the relevant business activity.

Paragraph [92A], [92B] and [92C] of TR 2001/14 provides the Commissioner's view on the meaning of the word 'from' in subsection 35-10(2) of the ITAA 1997:

92A. Watson v. Deputy Commissioner of Taxation [2010] FCAFC 17; (2010) 182 FCR 104; 2010 ATC 20-167; (2010) 75 ATR 224 (Watson) concerned whether income protection policy payments were assessable income from the business activity, being the taxpayer's financial planning business. The Full Federal Court held at paragraph 29 that the word 'from' is intended to have its dictionary meaning. It indicates the starting point, source or origin of the assessable income. It was held at paragraph 31 that if the starting point or source of the assessable income must be the business activity, then the extent and nature of that business activity must be identified to determine whether or not particular income is 'from' it'.

92B. At paragraph 30 the Court held that the assessable income referred to in subsection 35-10(2) must be 'from' the business activity in the same year in which it is assessable income of the taxpayer.

92C. In Watson the question was whether the source or origin of the policy income was the business activity. At paragraph 32 the Court concluded that the policy income was not 'from' the business activity in question because it was derived from the taxpayer's incapacity to conduct business activity, not from the activity the taxpayer actually undertook.

It is considered that in applying above principles to your case we must first examine what is the relevant business activity, and then determine whether that business activity is the origin or source of the relevant assessable capital gain. In this instance the relevant business activity is the primary production activity including the provision of services relating to that primary production activity.

You have argued that the land was held for investment purposes quoting the principle from Pascoe v FCT (1956) 30 ALJR 403; (1956) 6 AITR 315; (1956) 11 ATD 108:

…but it is, nevertheless, I think, broadly true to say that, when a man invests money in the purchase of any kind of property, it will generally be either with a view to holding it and deriving income from it, or with a view to realising sooner or later an enhanced capital value..

However as discussed directly above and earlier in the ruling it would appear that objectively the land was purchased to carry on a business. Even though that business involved some passively earned income, the way in which the primary production activity was carried on clearly went beyond the derivation of passive rental income. Therefore on the sale of the property each partner has merely realised their share of the property used in the primary production business.

The relevant assessable income being the capital gain on the sale of the property cannot be said to be sourced from any incident of the primary production business activity, as this activity will have necessarily ceased on the disposal of the property. This is distinguishable from large scale business activities that hold multiple capital assets used to derive rental income, as in those situations the sale of any single asset will not result in the end of the business. Accordingly the previously deferred losses under Division 35 of the ITAA 1997 will not be available to reduce the assessable capital gain.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).