Edited version of private advice

Authorisation Number: 1051882361078

Date of advice: 06 August 2021

Ruling

Subject:Commissioner's discretion for non-commercial losses

Question

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 in relation to your primary production activity in your calculation of taxable income for the 2020 financial year?

Answer

No

This ruling applies for the following period

Year ending 30 June 20xx

The scheme commences on:

1 July 2020

Relevant facts and circumstances

You commenced a primary production activity of breeding cattle in the 20xx financial year.

Your daily activities include:

•                 tending to cattle, including moving cattle between paddocks,

•                 wild dog prevention activities,

•                 feeding and watering cattle,

•                 animal husbandry,

•                 general property maintenance,

•                 slashing, weed control and fence maintenance.

You grew up on a cattle farm and hence have some experience.

At the start of the 20xx financial year you had $XX of stock. You did not purchase any stock but did have $X of natural increase. Similarly, in the 20xx financial year you have provided the same opening stock figure of $XX in the 20xx financial year with natural increase of $X.

Cattle account

Natural increase based on calving rate of 85%

Opening stock 1 July 20xx was one bull and X cows.

You have indicated that you predict you will meet the assessable income test (sales exceeding $20,000) in the 20xx financial year when you predict you will sell X beef cows/calves.

No assessable income has been received to date. You project that you will receive $XX in sales in the 20xx financial year and $XX in the 20xx financial year.

You met the income requirement in subsection 35-10(2E) of the ITAA 1997. However your income from sources other than primary production exceeded $40,000.

Relevant legislative provisions

Division 35 Income Tax Assessment Act 1997

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

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

Subsection 35-30 of the Income Tax Assessment Act 1997

Subsection 35-35 of the Income Tax Assessment Act 1997

Subsection 35-40 of the Income Tax Assessment Act 1997

Subsection 35-45 of the Income Tax Assessment Act 1997

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

Reasons for decision

The Commissioners discretion in relation to lead time is intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. Lead time normally applies to agricultural activities where for example, a fruit tree takes time between the planting of the tree and the production of any fruit, such that there will be no assessable income for a number of years.

In your case you have commenced a beef cattle business relying on natural increase to build your herd and produce assessable income. However, you have started at a small scale that the Commissioner believes was your choice and not an inherent factor in this industry that would make it not possible to meet any of the tests especially the assessable income test. Your request to have the Commissioner exercise his discretion to allow your non-commercial business losses against your other income has been denied.

The object of Division 35 of the Income Tax Assessment Act 1997 is to improve the integrity of the tax system by preventing losses from non-commercial activities that are carried on as businesses by individuals (alone or in partnership) being offset against other assessable income. The rule in subsection 35-10(2) of the ITAA 1997 defers losses from business activities unless they satisfy a test, are eligible for an exception or the Commissioner exercises the discretion in subsection 35-55(1).

Sub-section 35-10(4) of the ITAA 1997 contains an exception for primary production businesses that are carried on by certain individuals, where they have less than $40,00 of assessable income from sources not related to their primary production business. However, as your income not related to primary production exceeds this amount the exception does not apply to you.

Division 35 of the ITAA 1997 requires the deferral of losses unless you satisfy the income requirement and you pass one of the four tests in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) or 35-45 (other assets test) in the ITAA 1997.

As your income was below $250,000 in the income year, you meet the income test for the purposes of Division 35 of the ITAA 1997.

As your business activity failed to meet any of the 4 tests in the 20XX income year your business activity is treated as a non-commercial business activity and the losses from the business activity are deferred unless the Commissioner exercises the discretion. The discretion provided to the Commissioner should be interpreted in the light of this context.

Commissioner's discretion

The Commissioner may, on application, decide that the rule in subsection 35-10(2) does not apply to a business activity for one or more income years if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

•                 for an applicant who carries on the business activity who satisfies subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made- the business activity has started to be carried on and, for the excluded years;

                                     i.                    because of its nature, it has not satisfied, or will not satisfy, one of the tests set out in section 35-30, 35-35, 35-40 or 35-45 and

                                   ii.                    there is an objective expectation, based on evidence from independent sources (where available) that, within a period that is commercially viable for the industry concerned, the activity will either meet one of those tests or will produce assessable income for an income year greater than deductions attributable to it for that year.

You have requested the Commissioner exercise his discretion to allow your business losses on the grounds that because of the nature of your business activity there is a lead time of a number of years before your activity would be commercially viable and consequently able to pass any of the tests in Division 35. However, you have stated you started your business activity with 1 bull and X cows and are relying on natural increase to build your herd. Consequently, you do not envisage meeting any of the test until the 20xx income year where you predict you will be able to sell X cows for $X and then meet the assessable income test of earning assessable income over $20,000.

The meaning of 'because of its nature'

For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is producing a tax loss in a year, is because of something inherent to the nature of the business and not something 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, the hours worked or the need to build a client base.

Taxation Ruling TR 2007/6 Income tax: non-commercial businesses losses: Commissioner's discretion, deals with the exercise of the Commissioner's discretion and the meaning of 'because of its nature': At paragraph 78 it states;

The consequences of business choices made by an individual (for example...the size or scale of the activity...) 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.

Conclusion

You satisfy the income requirement contained in Division 35 of the ITAA 1997 as your income for non-commercial loss purposes in the income year prior to the income year of this application was less than $250,000.

You do not satisfy any of the four tests in Division 35 of the ITAA 1997 in the relevant financial year however you believe you will satisfy the assessable income test in the next financial year as you predict you will have sales of $25,000. You have requested the Commissioner apply the discretion to allow your losses on the grounds that because of the nature of your activity you will not be able to meet the assessable income test until a later income year.

The Commissioner will not be exercising the discretion in your case as it is believed the reason you have not met the assessable income test is because you have chosen to start your business activity in such a small scale that it would not be possible to meet any of the tests until your cattle numbers increase substantially. Had you started with more cows you would have had a greater chance of meeting the assessable income test when selling the offspring.

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