Edited version of your written advice

Authorisation Number: 1013085890543

Date of advice: 7 September 2016

Ruling

Subject: Non-commercial losses

Question 1

Are you in business of primary production?

Answer

Yes.

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your primary production business activity in your calculation of taxable income for the relevant financial years?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts

In 20XX, you commenced activities in relation to the growing of plants for the purpose of sale.

Your intention is to market these plants to wholesale nurseries and landscapers as advanced trees for use as instant screening and landscape plants; therefore they are required to be of a particular size and maturity for this purpose.

You have provided independent evidence that it takes approximately four to five years for these plants to reach the required size and maturity for sale as advanced mature plants in your target market.

You have submitted a profit projection for the relevant financial years for your activity.

You currently have a substantial number of plants potted as year one stock.

You intend to pot additional plants each year, using cuttings from the previous year's plants at the time you re-pot these into larger grow-out pots.

You project you will be at the point of holding at least XXX plants by year four to five at the time you can commence selling the mature plants that were potted in year one.

You expect your activity to start producing income of approximately $XXX in the first year of sales in the 2018-19 financial year. This projection is based conservatively on the sale of only the largest of the plants potted in year one.

Once established, you expect to generate $XXX in sales per year, focussing on wholesale sales at lower rates that others in the market in order to achieve a higher turnover and larger market share, ensuring you minimise the risk of being left with previous year's stock when your current year plants are ready for sale.

You have conducted extensive market research and have determined there is a market for this product that displays a large demand that cannot be adequately supplied in the market at the moment.

You have received positive feedback and interest from various nurseries and landscape gardening businesses that are very keen to purchase your stock when at the advanced stage of growth.

You spend approximately one hour per day tending the plants at the moment, though you forecast this will increase each year so that by year four, you expect to be spending at least five to six hours per day on your activities.

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

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 995-1

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 satisfy the income requirement and you pass one of the four tests

• the exceptions apply

• the Commissioner exercises his discretion

However, for this division to apply, your activity must be carried on as a business.

Am I In business

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

The case of Evans v. Federal Commissioner of Taxation 89 ACT 4540; (1989) 20 ATR 922 stated that whether or not an activity amounts to carrying on business for taxation purposes is a question of fact. There is no exhaustive or determinative definition which can be applied to determine this matter. The facts of each case must be examined. In Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548, Webb J said:

The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.

When does a business activity commence?

The actual date of commencement of a business activity is a question of fact (Goodman Fielder Wattie Ltd v. FC of T 91 ATC 4438; (1991) 22 ATR 26) (Goodman Fielder Wattie).

For a business activity to have commenced a person must have:

• purpose, intention and decision to commence the business activity

• acquired a minimum level of business assets to allow that business activity to be carried on, and

• actually commenced business operations (Calkin v. CIR [1984] 1 NZLR 440)

We must examine the above indicators in light of the characterisation of your business activity.

In Goodman Fielder Wattie, Hill J stated at 4,447:

Critical to the resolution of the present controversy, is the characterisation of the business activity itself which is said to have commenced. It was conceded properly by the applicant that if the business claimed to be carried on by it was to be characterised as one of manufacturing and selling monoclonal antibody products, then that business did not commence until around November 1982...

For example, if your business activity is characterised as a primary production activity, involving the planting and cultivating of trees, then the planting of the trees could be seen as the commencement of that business. Alternatively, if your business activity is characterised as the provision of a service, the business would generally be considered to commence once you have commenced providing this service for remuneration.

Purpose, intention and decision

The intention and purpose of a taxpayer in engaging in an activity is relevant to when a business commences. However, an intention to commence a business will not determine that the business activity has actually commenced.

It is clear from the information you have provided that you have researched your proposed business activity, decided on the form of that business and had committed yourself to it. It follows that the Commissioner is satisfied you have met this requirement.

Acquisition of a minimum level of business assets to allow that business activity to be carried on

Most business activities have a structure that provides the framework of the business. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity.

In Calkin v. CIR [1984] 1 NZLR 440 Richardson J said at 446-447:

Clearly it is not sufficient that the taxpayer has made a commitment to engage in business: he must first establish a profit-making structure and begin ordinary business operations.

For a business activity to commence an appropriate business structure should be in place and ordinary business operations must begin.

As to what the business structure will consist of, and its size, will be a question of fact and degree, and will depend on the nature of the business activity.

In your case, your activities involve the planting and cultivating plants for the purpose of sale. You have demonstrated that you have purchased sufficient assets and have the infrastructure to allow you to carry on your business activities, therefore the Commissioner is satisfied you have met this requirement.

Commencement of business operations

As noted by Brennan J in Inglis v Federal Commissioner of Taxation (1979) 10 ATR 493; 80 ATC 4001, the level of activity is important in deciding whether a business is being carried on. Brennan J stated at ATC 4004-4005; ATR 496-497 that:

The carrying on of a business is not a matter merely of intention. It is a matter of activity. Yet the degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the supposed business is being conducted.

In Hadlow and FC of T [2002] AATA 1250; (2002) 2002 ATC 2294; (2002) 51 ATR 1197 the Small Taxation Claims Tribunal considered the amounts incurred by a taxpayer to research and develop a book. The question for decision was whether the activities were merely preparatory and preliminary or whether the activity had reached a stage where it was able to be characterised as a business.

In concluding that the activity was not carried on as a business in the relevant years, member Mowbray stated at paragraph 26:

Clearly Mr Hadlow has the subjective intention to carry on a business, but that is not sufficient. There must be business activity. There is a real question whether the activities to date are merely preparatory or preliminary (see Goodman Fielder Wattie at 4447), and whether the project has reached the stage where it is able to be characterised as a business. There has been much activity but….

The concept of business does not equate with being busy (Goodman Fielder Wattie at 4447; 386; 339)

Mr Hadlow has researched, undertaken travel, and visited museums, libraries and farms in pursuit of a particularly interesting topic. He has expended money but has made no sales, received no advances nor signed any contracts.

It is accepted that you have gone beyond merely having an intention to engage in business. It is important to evaluate this activity in regards to the characterisation of your business, which is the planting and cultivating of plants for the purpose of sale.

You have demonstrated that you have already planted a sufficient number of plants to enable you to be in a tax profit position in the first year your product is of a marketable size and level of maturity. Your activities have both a prospect and a purpose of profit and there is a demonstrated repetition and regularity to your activities. Therefore the Commissioner is satisfied you have also met this requirement.

Non-commercial losses

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

• 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

Having regard to your full circumstances, it is accepted that it is in the nature of the business activity that has prevented one of the four tests being passed. It is also accepted that you will pass one of the four tests or make a tax profit within the commercially viable period for your particular industry.

Consequently the Commissioner will exercise his discretion to allow you to include any losses from your primary production business activity in your calculation of taxable income for the relevant financial years.

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