Edited version of private advice

Authorisation Number: 1051984128939

Date of advice: 29 June 2022

Ruling

Subject: Commissioner's discretion - non-commercial losses

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 business activity in the calculation of your taxable income for the 20XX income year?

Answer

Yes.

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include any losses from your business activity in the calculation of your taxable income for the 20XX to 20XX income years?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Your income for non-commercial loss purposes exceeds the $250,000 threshold as outlined in subsection 35-10(2E) of the ITAA 1997.

You are engaged in a primary production business which has commenced.

The primary production exception under subsection 35-10(4) of ITAA 1997 does not apply as your other assessable income exceeds $40,0000.

You commenced your business activity with a small number of livestock and are relying on natural increase to build your herd.

You intend for your herd to be purebred with high quality genetics.

You have provided financial projections that indicate the business will make a tax profit six years after commencing.

In the past you have leased your property on an agistment basis, these services ceased due to drought.

Due to the loss of agistment income, you obtained additional employment.

Your livestock was affected by disease in the relevant income year despite measures implemented by you.

The disease outbreak caused a reduction in livestock reproduction levels and bull sales in the relevant income years.

The risk of the disease can be eliminated through vaccination.

You implemented a long-term vaccination program for your livestock after the disease outbreak.

You purchased additional livestock in the income year after the disease outbreak to compensate the effects of the outbreak.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 section 35-10

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

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

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

Reasons for decision

Question 1: 2021 income year

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 meet 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.

Therefore, your business losses are subject to the deferral rule unless the Commissioner exercises discretion. The Commissioner will only grant discretion in certain circumstances where it would be unreasonable for the loss deferral rule to apply.

The Commissioner's approach to exercising the discretion under section 35-55 of ITAA 1997 is outlined in TR 2007/6 Income Tax: non-commercial losses: Commissioner's discretion.

As outlined in paragraph 16B of TR 2007/6, the discretion in paragraph 35-55(1)(c) of the ITAA 1997 may be exercised for a business activity that has started to be carried on, where for the income year(s) in question:

•         You do not satisfy the income requirement; and

•         'Because of its nature', the activity has not, or will not, produce a tax profit (that is assessable income that is greater than the attributable deductions); and

•         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 produce a tax profit.

Paragraph 77 of TR 2007/6 explains that the phrase 'because of its nature' refers to inherent characteristics of the type of business activity being conducted, which are common to any business activity of that type (refer to Federal Commissioner of Taxation v Eskandari (2004) 134 FCR 569). For the Commissioner to exercise discretion you must be able to demonstrate that the reason your business activity is unable to satisfy generating a tax profit is due to the inherent nature of the business and not peculiar to the way your business is carried on.

In your circumstances, you commenced a primary production. You have provided information to attest that it takes three years to breed your livestock to maturity, this includes the 9-month gestation and a period of two years for growth. Once maturity is reached, you intend to market the livestock for sale. It is accepted that this may impact your ability to produce income for an additional year.

Therefore, the Commissioner accepts that there is an applicable lead time of three to four years for your industry incorporating in natural constraints, and it would be unreasonable to apply the deferral rule outlined in section 35-10 of the ITAA 1997 to your business activity.

Question 2: 20XX to 20XX income years

Further to the details outlined above in question one, paragraph 78 of TR 2007/6 states that the consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, or the level of debt funding) are not inherent characteristics of a business activity and would not result in subparagraph 35-55(1)(c)(i) of the ITAA 1997 being met.

As per paragraph 75 of TR 2007/6, lead time discretion is intended to cover business activities which have an inherent characteristic that cannot be overcome by conducting the business activity in a different way, but only by changing the nature of the business. For example, a fruit tree has a lead time between the planting of the tree and the production of any fruit; this inherent characteristic impacts the business activity's ability to produce assessable income.

In Case 1/2013 2013 ATC 1-050; [2013] AATA 3, the Administrative Appeals Tribunal (AAT) determined that a taxpayer who staggered the planting of their vineyard over several years was not eligible for the discretion. The AAT accepted that while it may have been commercially prudent to adopt the staggered approach, it was not sufficient to meet the test outlined in paragraph 35-55(1)(c). The AAT determined that the staggered approach was the taxpayer's choice, and not the result of an inherent characteristic the business activity had in common with other businesses within the industry (in line with Federal Commissioner of Taxation v Eskandari 134 FCR 569).

In your circumstances, you have commenced a primary production business. You intend to rely on natural increase to build your breeding herd to a target size. You anticipate that once the herd reaches this size you will report a tax profit. You indicated in your application that you recognise there are a several pathways to having a fully operational stud herd.

It is considered that the length of time your business activity will take to make a tax profit is not because of an inherent characteristic or the nature of the business activity. Rather, it is your individual circumstances and your business choices to adopt a staggered approach to gradually build your herd size, breeding a herd with specialised genetics, and operating with high business expenses. This approach has significantly impacted the period in which your business activity will generate a tax profit. Whilst the staggered approach may be commercially prudent for your activity, it does not represent an inherent characteristic of your business activity.

In your application, you additionally advised that your business activity faced commercial challenges due to the impacts of drought and a disease outbreak within the breeding herd. The special circumstances discretion outlined in 35-55(1)(a) of the ITAA 1997 may be granted in conjunction with lead time discretion if the special circumstances have affected the business activity's ability to produce a tax profit during a time 'when because of its nature' it is not able to satisfy producing a tax profit.

It is accepted that you were impacted by special circumstances of drought and disease.

However, as per paragraph 26 of TR 2007/6, it is not accepted that the special circumstances have impacted the period that is commercially viable for the industry concerned to satisfy producing a tax profit. In your circumstances you advised that the special circumstances impacted your ability to continue providing agistment services which is not applicable to your livestock breeding activity. You further outlined that you also ceased agistment services due to the increasing numbers of livestock in your core herd.

Regarding the disease outbreak you encountered, as per paragraph 12 of TR 2007/6 the special circumstances must be outside of your control. Research indicates that the most effective method of eliminating the disease is through regular vaccinations, which you also indicated in your application. You advised that you did not vaccinate your herd until after the disease outbreak. Paragraph 56 of TR 2007/6 details that the concept of 'control' in relation to special circumstances are occurrences which the person concerned could not realistically prevent. It is considered that you could have prevented the disease outbreak by vaccinating your herd. Therefore, the Commissioner does not accept that the special circumstances of disease were outside of your control.

You provided financial projections which detail that you intend to make a tax profit in the 20XX income year. Therefore, it would be unreasonable for the Commissioner to consider discretion for the 20XX through to 20XX income years as discretion would not be required.

It is acknowledged that you have prudent explanations for the way your business activity is operating. However, the Commissioner does not consider that your business activities failure to produce a tax profit is due to inherent characteristics, but rather are consequences of business choices you have made. Therefore, in accordance with TR 2007/6, it would be inappropriate for the discretion to be exercised and the Commissioner will not grant discretion under paragraph 35-55(1)(c) of the ITAA 1997.

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