Edited version of your written advice

Authorisation Number: 1012975579896

Date of advice: 24 February 2016

Ruling

Subject: Non-commercial losses - Commissioner's discretion - lead time

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 business in your calculation of taxable income for the relevant financial years?

Answer

No

This ruling applies for the following period

Year ended 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

The scheme commenced on

1 July 20XX

Relevant facts

Your other income for NCL purposes is over $250,000 in the relevant financial year. You do not satisfy the income requirement contained in subsection 35-10(2E) of the ITAA 1997.

You commenced a primary production business activity in the 20XX-XX financial year.

You have provided a copy of your business plan showing details of the property, how the activity will be conducted and improved.

You have forecast a profit for the 2018-19 financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 35-1

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

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

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

Reasons for decision

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.

A taxpayer will satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 if their 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.

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. For example, the discretion will not be available where the failure to make a profit is for reasons other than the nature of the business such as: a consequence of starting out on a small scale, having a staggered start, continued high finance expenses.

Also, in order to exercise the lead time discretion, the Commissioner must be satisfied 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 (paragraph 35-55(1)(c) of the ITAA 1997).

The Commissioner's view on this issue is set out in TR 2007/6. The following is an extract from the ruling:

73A. Because the tests are not automatically relevant if the income requirement is not met, the first factor in paragraph 35-55(1)(c) considers whether it is 'because of its nature' that the activity has not produced, or will not produce, a tax profit.

74. 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 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.

75. Stone J in Eskandari confirmed this view when considering whether the Commissioner's discretion should be exercised in regard to losses incurred in a migration consultancy business. When looking at the type of activities referred to by the note and the EM, Stone J stated at FCA 31:

Such activities have an inherent characteristic that cannot be overcome by conducting the business activity in a different way but only by changing the nature of the business.

76. And further at FCA 32:

In my view, the phrase 'because of its nature' in s 35-55 indicates that the failure must be a result of some inherent feature that the taxpayer's business activity has in common with business activities of that type.

77. Therefore, the phrase 'because of its nature' refers to inherent characteristics of the business activity being conducted by the taxpayer, which are common to any business activity type. The inherent characteristics must be the reason why the activity is unable to satisfy any of the tests. The discretion is not intended to be available where the failure to satisfy one of the tests is for some other reason.

78. The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity and would not result in the requirements of subparagraphs 35-55(1)(b)(i) and (c)(i) being met. (refer to Example 9 at paragraph 139 of this Ruling.)

The inherent feature in a cattle breeding/selling business activity is that there is an initial period where you will not have any assessable income as it takes time to acquire breeding stock, breed offspring and then grow the offspring to sell them at the market. This initial period can be calculated by going through the process of calculating how long this would normally take in the particular industry. It may take one year to acquire stock, and dependant on their age at acquisition it will take another year or two to breed from them, the gestation period and a further year to grow the offspring ready for sale. This could be a period of approximately five years, depending on the circumstances.

Applying this to your case, you have started limited stock and you had sales of offspring in the relevant financial year. This is an initial period of approximately four and a half years, which is in line with what would normally be expected. It would be expected that you should objectively be able to make a profit in that or the following year to meet the requirements of their being something in the nature of the activity that prevents it from making a profit.

You have forecast that you will make a profit in the 2018/19 income year which is in the eighth year after commencement.

You have made a choice to slowly establish your numbers during this period. This has increased the period before your business activity can potentially make a tax profit. This is indicative that it is not because of something that is an inherent feature common to this industry that has stopped you from making a tax profit within what is a commercially viable period.

Case [2013] AATA 3, involved a taxpayer who was developing a vineyard and embarking on the venture with a view to a profit. It is a capital intensive business, with vines to be planted and the land had to be improved in various ways. The taxpayer proposed to stagger the planting over a number of years and the vineyard operation would not reach full production for approximately ten years. It was agreed that the vineyard could be completely planted and reach peak production within 5 years. In considering the issue of whether the failure to produce sufficient assessable income during a given year of income was "as a result of some inherent feature that the taxpayer's business activity has in common with business activities of that type", the following comments were made:

Vines can be planted and become productive within five years. The applicant has chosen to take a more gradual approach. No one quibbles with the wisdom of her decision, and I am told it is common practice in the industry. But she is unable to satisfy the first leg of the test in s 35-55(1)(c). In those circumstances, it would not be reasonable to exercise the discretion in her favour.

There was a similar outcome in Scott v. Commissioner of Taxation [2006] AATA 542 where there was a staggered planting of olive trees. The evidence did not support that the business activity would produce assessable income greater than the deductions attributable to it for a year within the standard commercially viable period.

One of your major expenses in the early stages is the cost of finance and this will prevent you from making a profit in the early years. These type of expenses are not, considered something that is an inherent characteristic that cannot be overcome by conducting the business activity in a different way. They are not something that is an inherent feature that would prevent you from making a profit in this initial period.

A recent decision by the Administrative Appeals Tribunal (AAT) considered a case where a delay in a taxpayer's cattle breeding business achieving profitability was attributable to financing costs. In this case the AAT held that high financing costs are not a factor that was inherent to the nature of the taxpayer's business and therefore not an appropriate circumstance for the Commissioner to exercise his discretion under section 35-55 of the ITAA 1997 (Hefner and Commissioner of Taxation [2013] AATA 407). There were similar outcomes in the cases Heany v FC of T [2013] AATA 331 and [2011] AATA 779.

We consider that the reason your business activity will take eight years (which is outside the normal commercially viable period of five years) to become commercially viable is peculiar to your situation, due, in part, to the fact that you purchased the property in a state of poor condition, you have undertaken a staggered approach to the building up of your numbers and level of borrowings needed to acquire the land and complete capital improvements, and is not solely due to the factors inherent to the nature of the business, as discussed above.

Therefore, the Commissioner will not exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(c) of the ITAA 1997 for the relevant financial years.

Further Information

It is noted that in your forecast figures only limited expenses have been claimed against this activity. You have indicated that certain expenses will be covered by other income or business activities. You cannot choose to claim the expenses that relate to this activity against other activities.

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