Edited version of private advice

Authorisation Number: 1051765578068

Date of advice: 12 October 2020

Ruling

Subject: Commissioner's discretion for non-commercial business losses

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow the taxpayer to include losses from a business activity in the calculation of their taxable income for the year?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20xx

The scheme commences on:

xx xx xxxx

Relevant facts and circumstances

The taxpayer operates a primary production business activity across a number of different locations.

One of the areas where the taxpayer's primary production business is located experienced an exceptional period of low rainfall, frost conditions and heat during the relevant income year.

At a point in time during the relevant income year, the climatic event was of such extreme severity, that it reduced the yields of the primary production to almost zero.

The taxpayer has provided an expert report from an Agronomist, detailing the extreme weather circumstances within specified location.

The report confirmed that below average rainfall and severe frost and heat reduced the yield in the specified area significantly. It added that any of these occurrences alone can have a severe impact on yield and quality, however when combined, resulted in a devastating impact on yield, quality and profitability. To have all three factors combined in one season was described as a 1 in 50-year event.

Other primary production properties owned by the taxpayer were not affected by the same climatic event and no climatic reports have been commissioned in relation to them.

The taxpayer does not qualify for an exception from the non-commercial loss rules as the taxpayer's assessable income (excluding any net capital gain) from sources not related to the primary production activity is more than $XXX.

The taxpayer's income for non-commercial loss purposes is projected to be more than $XXX.

If the extreme climatic events had not affected the taxpayer's property, it was forecasted that there would have been profit from the taxpayer's primary production business in the relevant income year.

The taxpayer is expecting profits from primary production activities in the next income year.

The assessable income of the business activity in the relevant income year is projected to be over $XX.

The business activity resulted in a tax profit in x out of the past x years, including the current year.

The property that the taxpayer owns or leases with a value of at least $XXX is used in business activities.

The assets owned or leased by the taxpayer with a value of at least $XXX is used in business activities.

Otherwise allowable deductions attributable to this activity exceeded assessable income from the activity for the relevant income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 section 35-1

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

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

Income Tax Assessment Act 1997 section 35-55

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

Reasons for decision

Summary

The Commissioner will exercise the discretion under paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow the taxpayer to include losses from their business activity to offset other assessable income in the calculation of their taxable income for the relevant income year.

The Commissioner is satisfied that the primary production business activity was affected in the income year in question by special circumstances outside the control of the operator of the business activity and it would be unreasonable to apply the rule in section 35-10 of the ITAA 1997 in relation to the taxpayer's business activity.

Detailed reasoning

For the 20XX-XX and later income 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, or

·         the Commissioner exercises his discretion.

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 his 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 for the 20xx income year as your income for non-commercial loss purposes was above $250,000.

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(s) in question where, but for the special circumstances:

·         your business activity would have made a tax profit

·         the activity passes at least one of the four tests or,

·         but for the special circumstances, would have passed one of the four tests.

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. For those individuals who do not satisfy the income requirement, special circumstances are those which have materially affected the business activity, causing it to make a loss.

Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion(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:

47. In the context of Division 35, where the income requirement is satisfied, special circumstances are ordinarily those affecting the business activity such that it is unable to satisfy a test and it would be unreasonable for the loss deferral rule to apply.^8A Subject to paragraphs 48 and 53 of this Ruling, ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances. These fluctuations are expected to occur on a regular or recurrent basis when carrying on a business activity and affect all businesses within a particular industry. (Refer to Example 1 at paragraph 110 of this Ruling). However, substantial unexpected fluctuations of a scale not regularly encountered previously may qualify on a case by case basis.

48. Although not limited to natural disasters, paragraph 35-55(1)(a) refers to 'special circumstances' as including drought, flood, bushfire or some other natural disaster. These events are taken to be special circumstances outside the control of the operators of the business activity.

49. The special circumstances must have affected the business activity. Some indicators of the effects on the business activity that could lead to the exercise of the discretion in regard to the special circumstances limb are:

·         destruction of stock or equipment (refer to Example 2 at paragraph 112 of this Ruling);

·         delays in ploughing, planting, harvesting etc (refer to Example 3 at paragraph 115 of this Ruling);

·         delay in growth of crops (refer to Example 4 at paragraph 118 of this Ruling);

·         inability of operator to perform duties (refer to Example 5 at paragraph 122 of this Ruling); and

·         loss of business opportunities (refer to Example 6 at paragraph 125 of this Ruling).

50. In the situation where a business activity would have failed to satisfy a test even if the special circumstances had not occurred, it is unlikely that the Commissioner would consider it to be unreasonable for the loss deferral rules to apply and therefore the Commissioner would be unlikely to exercise the discretion. (Refer to Example 7 at paragraph 128 of this Ruling.)

50A. Where the business activity is carried on by an individual who does not satisfy the income requirement and this activity would have made a loss even if it had not been affected by special circumstances, it is also unlikely that it would be considered unreasonable for the loss deferral rules to apply and therefore the Commissioner is unlikely to exercise the discretion (Refer to Example 7A at paragraph 129A of this Ruling).

51. However, in some cases, the business activity may still be within the lead time for the industry and because of the nature of the activity would therefore have failed to satisfy a test or produce a tax profit even if the special circumstances had not occurred. In such cases the special circumstances may extend the time within which that particular business activity could objectively be expected to pass a test, and the Commissioner could exercise the discretion under paragraph 35-55(1)(a). (Refer to Example 11 at paragraph 154 of this Ruling.)

52. The discretion can be exercised in income years after the one in which the special circumstances have occurred if the effects of those special circumstances on a business activity continue such that it cannot satisfy any of the tests or produce a tax profit in those later years. However, there may be situations where the special circumstances in question, because of their continued existence, change, and become the ordinary or usual situation, in which case it would not be appropriate to exercise the discretion after that time. (Refer to Example 4 at paragraph 118 of this Ruling and Example 8 at paragraph 130 of this Ruling.)

Special circumstances not restricted to 'drought, flood, bushfire or some other natural disaster'

53. Paragraph 35-55(1)(a) refers to 'special circumstances outside the control of the operators 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.

Example 4 has been extracted from paragraphs 118 to 121 of TR 2007/6:

Example 4

118. Simon has a fruit growing business which satisfied the assessable income test in the 2004 income year and was expected to satisfy this test again in the 2005 and 2006 income years. In the 2005 income year however, Simon's farm was affected by a prolonged drought and his entire crop was lost. As a result of this he did not receive any assessable income from his farm in this year and a substantial loss was incurred.

119. In addition, the stress on the trees during the drought also affected the fruit set in the following year, causing substantially reduced crops. As a result Simon's business did not satisfy the assessable income test and produced a loss in the 2006 income year.

120. Simon's business did not satisfy any of the tests in Division 35 in the 2005 or 2006 income years and the exception for primary production business activities did not apply as he had received in excess of $40,000 of non farm income. As a result, if the Commissioner does not exercise the discretion in the 2005 and 2006 income years, the losses from the fruit growing business activity will be deferred.

121. In this case the Commissioner would exercise the discretion in paragraph 35-55(1)(a) for special circumstances in both years. The loss of the crops due to drought would be special circumstances which were outside Simon's control. The business activity was expected to have satisfied a test in both of these years if not for these special circumstances and consequently the Commissioner would be satisfied that it would be unreasonable for the loss deferral rule in section 35-10 to apply. As a result, Simon is able to offset his losses from the fruit growing business activity against his other assessable income in the 2005 and 2006 income years.

In this case, it is accepted that the drought conditions, frost conditions and heat significantly affected your business operations. As confirmed by the expert reports provided, the weather conditions significantly affected yield, quality and profitability of your primary production business activities at the property.

The Commissioner accepts that your business activity was affected by special circumstances that were outside your control. The Commissioner also accepts that, based on your forecasts, in the absence of those circumstances a taxable profit would have been made in the affected income year.

Your circumstances are similar to example 4 at paragraph 118 in TR 2007/6. You have also forecast that the business activity will be profitable in the next income year as the special circumstances will no longer be present and the drought is over.

Accordingly, the Commissioner will exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 to allow you to include any losses from your business to offset other assessable income in the calculation of your taxable income for the relevant income year.

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