Edited version of private advice

Authorisation Number: 1051670061821

Date of advice: 19 May 2020

Ruling

Subject: Commissioner's discretion for non-commercial losses

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) or paragraph 35-55(1)(c) of the Income Tax Assessment Act (ITAA 1997) to allow you to include any losses from your primary productionbusiness activity in your calculation of taxable income for the 2019 financial year?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

Your spouse's family has run a farm producing resources for 30 years.

The family members involved in the farm include yourself and your spouse, your sibling in-law and spouse and your spouse's parents.

Each of these members own farmland and assets used by the family farming enterprise.

The family farming enterprise also owns a large amount of farming plant and equipment.

The family group has commenced restructuring the family farm due to your sibling-in-law and their spouse choosing to farm in their own right. They are in the process of removing themselves from the family farming enterprise.

You and your spouse created a partnership in 2014.

During the 2018 and 2019 financial years you and your spouse were carrying on two farming activities simultaneously. These activities included the family farming enterprise and the partnership.

The family farming enterprise is operated through a discretionary trust of which you and your spouse are beneficiaries.

The partnership has not reported a profit since 2015 (first reporting year).

The income in the partnership initially stemmed from an arrangement with the main family farming enterprise whereby interest was paid on the partnership's loans which were secured against partnership farming assets and used by the family farming enterprise.

In 2018 the partnership sowed 100 acres of its farmland. This was harvested in December 2018 with proceeds received in June 2019. The Profit and Loss reflects sales of this crop.

In 2019 the partnership decided to increase the area sown to 1,000 acres of winter crops. The partnership contributed to fuel and fertiliser expenses and accessed other inputs from the family farming enterprise.

Expenditure for winter crops are usually incurred from Winter with harvest not occurring until Summer and depending on arrangements made with the grain buyer, the proceeds from grain sales may be received from January onwards.

It is common that the time between incurring of expenses to grow the winter crop and receiving the proceeds that may straddle two financial years. This period may be further extended if the resource is stored waiting for improvements in prices.

Due to drought conditions only approximately 350 acres of the 1,000 acres sown in 2019 was suitable for harvest in December 2019 with X tonnes delivered to the grain buyer.

This resulted in proceeds received in the March 2020 quarter.

Over 1,500 tonnes had been hoped to be harvested but nearly two-thirds of the crop was impacted by drought conditions and not recoverable.

In 2019, you and your spouse decided to refinance the existing loans connected to the partnership secured against land and water entitlements.

The cost for refinancing these loans totalled $XXXXX.

The partnership accounts reflect a large increase in interest paid as a result of the refinance in the 2019 income year.

The partnership accounts reflect a loss of $XXXXX in the 2019 income year.

During the 2019 financial year you sold a number of high security MGL (Megalitres) water entitlements. These entitlements have been replaced with the purchase of general MGL security water entitlements.

There is an expectation of profit in the 2020 financial year as a large proportion of the operational expenditure was incurred in the 2019 financial year and there is a long lead time between expenditure and the receipt of income that is predicted to straddle two financial years.

Your income for non-commercial loss purposes is predicted to be greater than $250,000 in the 2019 year.

Relevant legislative provisions

Division 35 of the Income Tax Assessment Act 1997

Reasons for decision

For the 2009-10 and later financial years, Division 35 of the Income Tax Assessment Act 1997 (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, 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.

The relevant discretion may be exercised for the financial year in question where your business activity is affected by special circumstances outside your control.

'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, including drought, flood, bushfire or some other natural disaster.

For individuals who do not satisfy the income requirement, the business activity must have been materially affected by the special circumstances, causing it to make a loss. In this context, the Commissioner may exercise this discretion for the income year in question where, but for the special circumstances:

·   your business activity would have made a tax profit; and

·   the activity passes at least one of the four tests or, but for the special circumstances, would have passed one of the four tests.

-   Assessable income test

-   Profits test

-   Real property test

-   Other assets test

Special Circumstances

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.

In application to your case you have requested that the Commissioner exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 in the 2019financial year.

In your case you planted 100 acres in the 2018 calendar year which was harvested and sold by the end of the 2019 financial year. The income from the sale of this crop appears in the company Profit and Loss reporting for the year ending 30 June 2019.

In the 2019 calendar year you planted 1,000 acres of crops. As you have identified in your ruling application, expenditure for winter crops are usually incurred from May/June with harvest not occurring until November/December. The Commissioner accepts that the time from harvest to sale is one year. It is therefore expected that the income from crops planted in the 2019 year would appear in the company Profit and Loss reporting for the year ending 30 June 2020. You have advised us that these crops were impacted by drought in 2019 and only 350 of the 1,000 acres were harvested for sale in December 2019.

You have provided us with data to support your claim that your farm has been subject to drought during this period.

It is accepted in your case that the droughtconstitutes special circumstances in relation to the crops planted in the 2019 calendar year which would affect income produced in the 2020 financial year. As you have requested a ruling for the year ending 30 June 2019, this 1,000 acre crop is not relevant to your ruling request regarding the application of the Commissioner's discretion under special circumstances.

In relation to the 100 acre crop you planted in the 2018 calendar year and harvested and sold by 30 June 2019, you have not indicated to us that these crops were affected by special circumstances. The Commission will not consider a deferral of your non-commercial loss under Division 35 of the ITAA 1997 on these grounds.

Applying the discretion regarding farming activities

The relevant discretion may be exercised for the financial year in question where:

·   it is in the nature of your business activity that there will be a period before a tax profit can be produced

·   there is an objective expectation your business activity will produce a tax profit within the commercially viable period for your industry.

TR 2007/6 states that the 'lead time' discretion provided for by paragraph 35-55(1)(c) of the ITAA 1997 is available for a business activity if there is an initial period from when the activity commenced where the nature of the activity prevents a tax profit from being made.

Although you registered your partnership in 2014, your partnership farming activities appear to have commenced with the first 100 acres of crops planted in the 2018 calendar year. Prior to this time, income received was in the form of interest paid off loans by the main family farming enterprise for the use of assets held in the partnership.

The 100 acres of crops planted in May/June 2018 yielded income for the year ending 30 June 2019. You also outlaid expenditure relating to fertiliser and chemical costs in this year. You have advised us of estimated costs of fertiliser and chemicals required per 250 acres.

The partnership purchased fertilisers and chemicals in bulk. It has been identified that your bulk purchase should cover an area of approximately 2,000 acres. You have advised us that approximately 50% worth of fertilisers and chemicals remains for future land care and preparation.

Given that there was a requirement to prepare the land for the planting of the 1,000 acre crop in May/June 2019, the Commissioner accepts that this outlay was a necessary expense for the year ending 30 June 2019. Expense consideration is also given to the fuel and oil costs required in crop preparation, planting and harvesting in this year.

As preparation for planting a crop occurs in the financial year prior to the year the harvest is sold, it is understandable that the partnership would have produced a loss for the year ending 30 June 2019 given these expenses.

In isolation, the Commissioner may consider the above grounds for the application of the discretion under Division 35 given that your farming activities in the partnership had commenced with the first 100 acre planting and a lead time for yielding profit is 12 months.

In your case, the loss reported in the 2019 year included the above expected expenses as well as an expense incurred as a result of the decision to refinance. You have also identified sales and purchases of water rights. In order to apply the discretion, the Commissioner must also consider the affect these decisions had on the loss generated.

Applying the discretion regarding business choices

TR 2007/6 does not support any view that the discretion should 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 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.

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.

It has been identified that you and your spouse have maintained a significant amount of debt secured against land and water entitlements which has been utilised by the family farming enterprise in its operations. With the recent drop in interest rates, the decision was made to refinance these loans. The change in loans provided a significant drop in the interest rates applied which will reduce future interest expenses for the partnership.

This decision to refinance also incurred a cost relating to the breaking of the loans. The result of this refinance is reflected in the partnership Profit and Loss with a significant increase identified in relation to interest charges when compared to the previous year's expense.

In addition to the refinance, a number of water entitlements were sold and purchased in the 2019 financial year. You have advised us that broad acre irrigation farmers, such as this family farming enterprise, utilise general security water entitlement allocations to grow their crops. These water entitlement allocations are at a lower cost per entitlement value compared to high security water entitlements.

A commercial decision was made during the 2019 financial year to dispose of some high security water entitlements held, due to the extraordinary high prices offered and demand in the market due to the ongoing drought.

In your original ruling application, you advised us that the decision to dispose of these high value entitlements was with the view of using the proceeds to reduce debt levels through the ongoing drought.

You have since advised us that the proceeds from the sale of these high security water entitlements have been used to acquire lower cost general security water entitlements.

During the 2019 financial year a number of high security water entitlements were sold. These were replaced with the purchase of general security water entitlements at a cost that exceeded the amount received from the sale of high security water entitlements.

The decision to refinance loans and purchase replacement water entitlements has clearly contributed to your partnership loss. These factors have a direct effect on both the amount of existing debt and the interest expenses relating to the 2019 financial year.

It is considered that these decisions were a 'business choice' which were not of a farming activity nature which contributed greatly to the partnership loss for the year ending 30 June 2019. On these grounds the Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the losses incurred in the year ending 30 June 2019.

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