Edited version of your written advice

Authorisation Number: 1013009034661

Date of advice: 31 August 2016

Ruling

Subject: Non Commercial Losses - Commissioner's Discretion

Question 1:

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 livestock breeding enterprise in the calculation of your taxable income for the 20XX-XX income year?

Answer:

No

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 to allow you to include any losses from your livestock breeding enterprise in the calculation of your taxable income for the 20XX-XX income year?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

July 20XX

Relevant facts and circumstances

The arrangement that is the subject of this ruling is described below. The following documents have been relied upon to reach a decision:

• your application for private ruling dated on a specific date including:

• Business plan for 20XX and beyond

• Business plan for 20XX and beyond

• Profit projection 20XX to 20XX

• Letter from industry tax specialists, dated 20XX.

• Information from the Official Australian Industry Records.

The entity is a boutique livestock breeding business which is operated under a partnership between Partner A and Partner B.

The entity commenced livestock breeding activities in 20XX.

Original livestock

The business commenced with two livestock, Animal A and Animal B in 20XX.

The industry records show Animal A was bred in 19XX by Partner A and another party. Animal A was owned by Partner A until 20XX when it was purchased by the entity.

Animal A is currently still with the business.

Animal B was bred in 20XX and has been owned by the entity since 20XX.

Animal B was retired in 20XX and was given away for nil consideration.

Current livestock

The current breeding livestock are Animal A, Animal C, Animal D and Animal E.

Animal C was bred in 20XX by the entity out of Animal A and is currently still breeding.

Animal D was purchased in 20XX by the entity and is currently still breeding.

A share of Animal E is owned by the entity and is currently still breeding.

Other livestock

Animal F was born in 20XX out of Animal A and bred by Partner A. Animal F was sold in 20XX.

Animal G was born in 20XX out of Animal A and bred by the entity. Animal G was sold in 20XX.

Animal H is owned by the entity out of Animal A. Animal H is likely to be used as breeding livestock in the future.

Business information

The business currently operates animals that are temporarily situated at a stud farm.

It is intended to situate the business on X,XXX acres of land owned by an entity related to one of the partners.

The target market is purchasers from Australian and international markets, with an expected profit after a lead time of seven to ten years in approximately years 20XX/XX and 20XX/XX.

You have extensive experience in the thoroughbred industry and you also engage many professionals to assist with the ongoing management of the business.

An entity has provided independent advice stating that businesses entering the industry commonly experience a lag period of between 10-12 years, until they are consistently viable.

A letter from the director of industry tax specialists, dated on a specific date in 20XX, stated (at page 2):

"With respect to breeding stock, it is imperative that the breeder gives the stock enough time to reach it's optimum potential. In other words, it is important to assess the type and the quality of the progeny produced by a mare. This includes their appearance and athleticism. It would be prudent to assess this over a 3 or 4 year period. Again, breeders are required to take some time to assess and in some instances cull mares from the broodmare band at all times endeavouring to upgrade the quality of the stock. This process needs to happen in an orderly manner and a lag period of 10 years in our view is conservative"

The profit projection for the period 20XX to 20XX shows that the business will make operating profits in particular months which will result in the business generating an operating profit in the 20XX financial year.

Special circumstances that have prevented the entity from being profitable in the past include:

• Livestock death - An animal was destroyed in 20XX. While the animal was insured, this affected future breeding prospects.

• Livestock death - An animal died in 20XX/XX, which affected future breeding prospects.

• Industry wide disease in 20XX and 20XX which resulted in quarantine restrictions for breeding.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 35-1

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

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

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

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

Reasons for decision

Lead Time Paragraph 35-55(1)(c) of the ITAA 1997

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.

You satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 if your 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.

In order to exercise the 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).

You have provided evidence from an independent source that suggests the commercially viable period for your industry/business can be up to ten to twelve years.

The inherent nature of breeding will include the time that it takes to raise females to a breeding age, allowing for the gestation period of those animals to finish, and to determine the potential of the progeny.

A letter from the director of industry tax specialists, dated on a specific date in 20XX, stated (at page 2):

"With respect to breeding stock, it is imperative that the breeder gives the stock enough time to reach it's optimum potential. In other words, it is important to assess the type and the quality of the progeny produced by a mare. This includes their appearance and athleticism. It would be prudent to assess this over a 3 or 4 year period. Again, breeders are required to take some time to assess and in some instances cull mares from the broodmare band at all times endeavouring to upgrade the quality of the stock. This process needs to happen in an orderly manner and a lag period of 10 years in our view is conservative"

The Australian industry records show Animal A was bred in 19XX by Partner A and another person. Animal A was owned by Partner A until 20XX when it was purchased by the partnership, where Partner A is a partner. This shows that Partner A has owned the primary breeding livestock for the business since 19XX. Partner A would have been able to assess the type and quality of the progeny produced by this livestock.

The evidence from independent sources, shows that a commercially viable period for the industry is 10 to 12 years. Partner A has been breeding from Animal A prior to the entity commencing operation. The fact that they have changed entities, going from partnership to sole trader and back to a partnership, their ownership in the breeding stock has not changed.

As such, Partner A is aware of the capacity for Animal A to produce offspring and generate income for the business. The commercially viable period in this instance commenced when Partner A first started breeding operations with Animal A and not from the start of the entity.

Where an ongoing business activity is purchased or carried on by a new owner or entity, the 'period that is commercially viable for the industry concerned' is taken from the commencement of the activity, not when the new owner or entity took over the activity.

Based on the information in relation to the business, the period that is commercially viable for this industry would have expired prior to the 20XX/XX financial year.

Therefore, the Commissioner will not exercise the discretion available under paragraph 35-55(1)(c) of the ITAA 1997 and allow the losses from your business activity to be included in the calculation of your taxable income for the 20XX-XX financial year.

Special Circumstances - Paragraph 35-55(1)(a) of the ITAA 1997

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.

You satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 if your 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.

In order to exercise the discretion, the Commissioner must be satisfied that the business activity is affected by special circumstances outside the control of the operators of the business activity and the Commissioner considers that it would be unreasonable to require the loss to be deferred (paragraph 35-55(1)(a) of the ITAA 1997).

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.

The question of what constitutes 'special circumstances' has been judicially considered on many occasions. In the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation:

Those discretions are intended to be applied to a great variety of situations. In such a context, the core of the idea of 'special circumstances' is that there is something unusual or different to take the matter out of the ordinary course

Later, in the Federal Court Case of Employment, Education, Training Youth Affairs, Department of v. Barrett (1998) 82 FCR 524; (1998) 27 AAR 291; (1998) 52 ALD 499; (1998) 3SSR 38 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed that:

The word 'special' must be read in context. In normal parlance it signifies that the event or circumstances in question are out of the ordinary or normal course.

Tamberlin J then quoted the following passage with approval from the AAT case of Beadle Director-General of Social Security, Re (1984) 1 AAR 362; (1984) 6 ALD 1 at 3:

An expression such as 'special circumstances' is by its very nature incapable of precise or exhaustive definition. The qualifying adjective looks to circumstances that are unusual, uncommon or exceptional. Whether circumstances answer any of these descriptions must depend upon the context in which they occur. For it is the context which allows one to say that the circumstances in one case are markedly different from the usual run of cases. This is not to say that the circumstances must be unique but they must have a particular quality of unusualness that permits them to be described as special. 

In your case, your livestock breeding activities have made losses in previous years due, in part, to stock illnesses and deaths and diseases.

It is not accepted that the stock illnesses and deaths which affected the business in 20XX and 20XX constitute special circumstances. The sale, death or injury of stock can be seen as a normal occurrence in the industry and could reasonably be expected to occur in the normal course of business.

However, it is accept that the industry wide disease outbreak in 20XX-XX was outside your control and that it is considered to be 'special circumstances' for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. However, before the Commissioner can exercise the discretion you must be able to show that it was the special circumstances that caused your activities to make a loss in the 20XX-XX financial year.

In your case, there is no causal link to show that the quarantine imposed during the disease outbreak in 20XX-XX caused your activities to make a loss in the 20XX-XX financial year.

Consequently, the Commissioner's discretion in respect of special circumstances will not be exercised with respect to the 20XX-XX financial year.

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