Edited version of private advice

Authorisation Number: 1052096965681

Date of advice: 4 April 2023

Ruling

Subject: Commissioner's discretion - non-commercial losses

Question

Will the Commissioner exercise the discretion in subsection 35-55(1) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include losses from your business activity in the calculation your taxable income for the 2021-22 financial year?

Answer

No

This ruling applies for the following period:

Financial year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You purchased a property used for a horticultural activity (the Property) in the name or your Company which settled in the final quarter of the financial year.

The produce harvest for the financial year was completed prior to the settlement of the Property with income of derived by the previous owner.

The horticultural activity on the Property was established several decades ago, in recent years, it has not been maintained well and has fallen into decline.

After settlement, plant health investigations revealed that approximately one quarter of the plants were infected by disease and needed to be replanted.

You began removing the infected plants within one month of settlement and will replant replacements after one full year of soil improvement and disease eradication. These plants are expected to yield produce from the 20XX-year harvest.

You expect the activity to be close to cash neutral in the current financial year and yield a small profit in the following financial year.

Your income for non-commercial loss purposes is above the $250,000 threshold in the 20XX-XX financial year.

Relevant legislative provisions

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

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

Income Tax Assessment Act 1997 subsection 35-55(1)

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

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

Reasons for decision

Summary

We have not exercised the discretion under either the lead time or special circumstances limbs of subsection 35-55(1). We consider that the appropriate lead time period for the horticultural activity was from its commencement in several decades ago and not when you purchased the Property. Although your activity was affected by a disease in one quarter of your plants, your losses for the year were attributable largely to the timing of the settlement of the Property, this is not considered to be special circumstances beyond your control.

Detailed reasoning

Under subsection 35-10(2), if the amounts attributable to the business activity for a year of income that otherwise could be deducted, apart from Division 35, exceed the assessable income (if any) from the business activity, the loss is treated as though it:

(a)          were not incurred in that income year; and

(b)          instead, were an amount attributable to the business activity that is deductible in the next income year in which that business activity is carried on.

The 'income requirement' is set out in subsection 35-10(2E). A person will satisfy the income requirement under subsection 35-10(2E) if their income for non-commercial loss purposes is less than $250,000. If the income requirement is not met, and your activity makes a loss, the Commissioner may exercise discretion to allow the inclusion of the losses.

In your case, you do not satisfy the income requirement as your income for non-commercial loss purposes is above $250,000.

Subsection 35-55(1) states that 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 (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

(a)          the business activity was or will be affected in the excluded years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster; or ...,

(c)           for an applicant who carries on the business activity who does not satisfy 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 produced, or will not produce, assessable income greater than the deductions attributable to it; 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 produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C)).

Lead time - Paragraph 35-55(1)(c)

The meaning of 'because of its nature' is discussed Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion (TR 2007/6).

17. states that for the failure to ..., produce a tax profit (subparagraph 35-55(1)(c)(i)) to be 'because of its nature', the failure must be because of some inherent characteristic that the taxpayer's business activity has in common with other business activities of that type (see Federal Commissioner of Taxation v. Eskandari (Eskandari).

77. Therefore, the phrase 'because of its nature' refers to inherent characteristics of the type of business activity being conducted by the taxpayer, which are common to any business activity of that type. These inherent characteristics must be the reason why the activity is unable to satisfy any of the tests. The discretion is not intended to be available where the failure to satisfy one of the tests is for other reasons.

Application to your circumstances

As per our view provided in TR 2007/6, the lead time discretion in 35-55(1)(c) is to provide a safeguard discretion that can be applied to activities that because of the nature require a number of years to become profitable. The inherent characteristics of the activities being common to any business activity of that type. The lead time discretion is therefore not intended to provide a safeguard against the specific business issues such as management decisions or the impacts of pest and diseases on a particular activity.

Where an ongoing business activity is purchased by a new owner as a going concern, the 'period that is commercially viable for the industry concerned' as per subparagraph 35-55(1)(c)(ii) is taken from commencement of the activity, not when the activity was purchased by the new owner.

In this case you have purchased a property with a horticultural activity that was originally established several decades ago. The lead time period that is common to a horticultural activity of the type you are undertaking has now lapsed. Therefore, the discretion under paragraph 35-55(1)(c) has not been exercised for your activity for the relevant income year.

Special Circumstances - Paragraph 35-55(1)(a)

In order to exercise the discretion, the Commissioner must be satisfied that the business activity is affected by special circumstances outside the control of the operators of the business activity and the Commissioner considers that it would be unreasonable to require the loss to be deferred (paragraph 35-55(1)(a)).

Paragraph 13 of TR 2007/6 provides that 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.

Paragraph 41D of TR 2007/6 considers the special circumstances for individuals who do not satisfy the income requirement as follows:

41D. For individuals who do not satisfy the income requirement, the factors that must be satisfied before deciding whether to exercise the special circumstances limb of the discretion for an income year are that:

•                    the business activity is affected by special circumstances such that it is unable to produce a tax profit; and

•                    the business activity either satisfies at least one of the tests or is affected by special circumstances such that it is unable to satisfy any of the tests; and

•                    the special circumstances affecting the business activity are outside the control of the operators of the business activity.

Application to your circumstances

Your horticultural activity has been affected by disease that required the removal and replacement of some or your production plants. Given you were not aware of the disease at the time of purchasing the Property, we accept that this could amount to special circumstances beyond your control.

However, given that that the settlement of the Property occurred after the harvest of the grapes for the financial year, the activity would not have made a profit in the income year in any case.

The main factor contributing to the loss was the timing of the settlement of the Property being after the annual harvest from the plants. We do not regard this to be special circumstances beyond your control, therefore, the discretion under paragraph 35-55(1)(a) has not been exercised for your activity for the relevant financial year.

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