Edited version of private advice

Date of advice: 12 May 2023

Ruling

Subject:Share farming

Question

Were you carrying on a business for the purposes of section 328-110 of the Income Tax Assessment Act 1997?

Answer

Yes, you are carrying on a business for the purposes of section 328-110 of the Income Tax Assessment Act 1997.

This ruling applies for the following periods:

Year ended 30 June 20AA

Year ended 30 June 20BB

Year ended 30 June 20CC

The scheme commenced on:

1 July 20WW

Relevant facts and circumstances

Property ownership and sales

You owned the following properties:

•         Property 1. Land size of the property totalled X hectares.

•         A one-third interest in Property 2. Land size of the property totalled X hectares.

•         A one-third interest in X megalitres of water.

•         Property 3. Land size of the property totalled X hectares.

In part, you subdivided Property 1 in 20AA, 20BB and 20CC years.

In 20BB, you transferred Property 1 to your child.

In 20CC, you transferred your one-third interest in X megalitres of water to your child.

Background to businesses you carried on

In 19MM, you commenced carrying on a primary production business in partnership with your children. The business activities were carried on Property 1, Property 2 and Property 3. The primary production business carried on was primarily X business with some livestock.

In 20NN, the partnership consisting of your children and you ceased due to the death of one child.

In 20NN, you continued the primary production business in partnership with your child.

In 20PP, you formally ceased the partnership with your child.

Share farming agreement

Subsequently, in 20PP you entered into a verbal share farming agreement with Partnership A to receive a fixed percentage of income from produce grown on the properties that you had an interest.

You receive your fixed percentage of income direct from the X. The payments are supported by RCTI's which are issued for GST and income tax purposes. You are registered with an ABN and GST. You prepare and lodge GST returns and remitted the GST collected from your share of sales. You prepare and lodge your income tax returns reporting the income derived from sales as business income.

It was considered that a fixed percentage of the income was an accurate reflection of your share of all business profits, as it reflects income upturns and downturns. Income from other sources is applied to the partnership for the purposes of meeting the expenses associated with the business.

The share farming arrangement has not been treated as a partnership for tax purposes. Based on this verbal agreement:

•         Partnership A was responsible for costs associated with the farming operations.

•         Partnership A are generally responsible for paying all Council Rates, which is reflected in the percentage of income that you received. However, during the 20ZZ to 20CC years, the farming conditions impacted the cash flow of the partnership, and therefore you paid your portion of the rates for these years.

•         You were responsible for other holding costs associated with ownership, together with other minor costs directly incurred by you.

Via the share farming agreement, you remained involved in the business operations of the primary production activities. Your involvement has not changed since the commencement of the primary production activities in 19MM and your continued ownership of the farming land involved in the business operations.

The business continued at Property 1 until approximately the 20YY year. The business continued on Property 2 and Property 3.

During the 20AA, 20BB and 20CC years:

•         You acted in an advisory role to the business operations. Note: a physical role was no longer possible.

•         You are engaged in all major decisions relating to the farming operations and approves all major transactions. Your involvement is a result of your interests in your properties being used as part of the overall security for funding and borrowings of the farm enterprise. Your involvement and considerations to decision making is paramount to allow this arrangement to be functional.

•         You spend approximately X hours per week engaged in business activities. This includes regular farm inspections and meetings.

•         You continued your involvement and obtained the same percentage of income, even after the Property 1 ceased being used in the business and your interest in Property 2 was transferred. Note: you still own Property 3.

During the farm inspections and meetings, the following were addressed:

•         Farm conditions, for example, crop and livestock conditions, weed issues

•         Decisions about input costs that is at what allocation price do they consider to the primary production activity.

•         Stock numbers and methods for increasing these.

You provided details of your taxable income from share farming operations for the 20PP to 20CC years, together with the forecasted income for the 20DD year. The following was observed:

•         The business was profitable in some specific years.

•         A large loss was incurred in the 20AA year due to an unknown liability.

•         The profit in recent years has been impacted by the drought conditions.

•         The increase in water availability has shown an increase in income for the 20CC and 20DD year (as forecasted). As such, the share of income from primary production will increase, as will your resultant profit.

You are only in receipt of the business income and small amounts of investment income. You rely on these sources of income to pay for your living expenses.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 328-110

Income Tax Assessment Act 1997 Section 960-100

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

The capital gains tax (CGT) provisions provide some small business relief in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997).

Basic conditions

To qualify for the small business CGT concessions, the basic conditions as contained in subdivision 152-A of the ITAA 1997 must be satisfied.

The basic conditions are:

•         A CGT event happens in relation to a CGT asset of yours in an income year,

•         The event would have resulted in a gain (apart from Division 152),

•         The CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997, and

•         At least one of the following applies;

˗   you are a small business entity for the income year,

˗   you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997,

˗   you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership, or

˗   you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you.

In this case, you are interested to know if you qualify as a small business entity to meet the above basic conditions in full. Specifically, if you were carrying on a business in the current year.

Small business entity

An entity is a CGT small business entity if:

(a) it carries on a business in the current year, and

(b) one or both of the following applies:

(i) it carried on a business in the income year (the previous year) before the current year and its aggregated turnover for the previous year was less than $2m, and

(ii) its aggregated turnover for the current year is likely to be less than $2m (subsections 152-10(1AA) and 328-110(1) of the ITAA 1997).

Aggregated turnover is your annual turnover plus the annual turnovers of any business entities that are your affiliates or that are connected with you.

Under subsection 328-120(1) of the ITAA 1997, an entity's annual turnover for an income year is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business.

In this case, we need to determine if the income from the share farming arrangements is ordinary income derived in the ordinary course of carrying on a business.

Taxation Determination TD 95/62 Income tax: will the owner (or lessor) of land who allows the land to be used in a sharefarming arrangement be considered to be engaged in a business of primary production as defined by the Income Tax Assessment Act 1936 ('the Act')? provides relevant guidelines.

Please note that TD 95/62 was written before the ITAA 1997. Where relevant the ITAA 1997 references will be used.

As highlighted in TD 95/62, there are many possible variations in the share farming agreements and each case has to be dealt with on its merits.

Under section 995-1 of the ITAA 1997, the definition of 'primary production business' includes:

•         cultivating or propagating plants, fungi or their products or parts (including seeds, spores, bulbs and similar things), in any physical environment or

•         maintaining animals for the purpose of selling them or their bodily produce (including natural increase).

In some circumstances, a share farming arrangement may amount to the carrying on of a business in partnership.

Factors which are considered by the Commissioner to be relevant to the existence or otherwise of a partnership generally, are set out in Taxation Ruling TR 94/8 Income tax: whether business is carried on in partnership (including 'husband and wife' partnerships).

As stated in TR 94/8, the question of whether a partnership exists is one of fact. The existence of a partnership is evidenced by the actual conduct of the parties towards one another and towards third parties during the course of carrying on business.

The following factors are relevant in deciding whether persons are carrying on business as partners in a given year of income:

• Intention, that is, the mutual assent and intention of the parties, and
• Conduct

(a) joint ownership of business assets

(b) registration of business name

(c) joint business account and the power to operate it

(d) extent to which parties are involved in the conduct of the business

(e) extent of capital contributions

(f) entitlements to a share of net profits

(g) business records

(h) trading in joint names and public recognition of the partnership

The above list of factors is not exhaustive and no single factor is decisive, although the entitlement to a share of net profits is essential.

Partnership is defined in section 995-1 of the ITAA 1997 to include an association of persons carrying on business as partners or in receipt of ordinary income or statutory income jointly.

If a partnership is in existence, then each partner will of course be considered to be carrying on that business.

As highlighted in TD 95/62, many arrangements do not amount to the carrying on of a business in partnership. The fact that the land is used in a business of primary production does not necessarily mean that the owner of the land is also carrying on that business. Paragraph 5 of TR 95/62 states to be carrying on a business, the taxpayer must be involved in the activities that make up that business. This would be evidenced by an element of control over, and/or an ongoing participation in, the business. The involvement should be direct or immediate, rather than passive. The payment of expenses relating to the ownership of the land would not, without more, be sufficient.

Where no involvement exists, the landowner would not be regarded as being engaged in the business of primary production. The receipt by the landowner of a payment from the farmer for the use of the land would be in the nature of income from property rather than from the carrying on of a business of primary production.

In this case, the relevant factors include:

•         You were the part or sole owner of Properties 2 & 3 that carried on primary production activities.

•         Since 20PP you entered into a verbal share farming agreement with Partnership A.

•         You are in receipt of a fixed percentage of income from the sale of X grown on the properties that you had an interest.

•         The shared farming arrangement requires:

˗   Partnership A pays for costs associated with the farming operations.

˗   Partnership A are generally responsible for paying all Council Rates, which is reflected in the percentage of the income that you received. However, due to farming conditions during the 20ZZ to 20CC years, you paid your portion of the rates for these years.

˗   you were responsible for other holding costs associated with ownership, together with other minor costs directly incurred by you.

•         You act in an advisory role to the business operations. A physical role was no longer possible.

•         You are engaged in all major decisions relating to the farming operations and approves all major transactions. Your involvement is a result of your interest in the properties being used as part of the overall security for funding and borrowings of the farm enterprise. Your involvement and considerations to decision making is paramount to allow this arrangement to be functional.

•         You spend approximately X hours per week engaged in business activities. This includes regular farm inspections and meetings.

•         During the farm inspections and meetings, the following were addressed:

˗   farm conditions, for example, crop and livestock conditions, weed conditions.

˗   decisions about input costs.

˗   stock numbers and methods for increasing these.

A balanced view of these factors, with no one factor being determinative in isolation, reasonably leads to a conclusion that the level of your involvement in the share farming arrangement goes beyond being passive.

You have primary production knowledge and experience for more than X years. Given your age, you apply your knowledge and experience in an advisory role. You are engaged in making and approving all major farm operational and transactional decisions. You carry out regular farm inspections and meetings. Your engagement demonstrates your ongoing participation in the business. Your engagement does not demonstrate your role as passive in a tenant/landlord situation.

Further, you can demonstrate control in this share farming arrangement as your share of various properties are used as security for loan borrowings of the farming activity. Your involvement and the decision making required shows a level control you exert in this arrangement.

Based on the facts of this situation, the income derived from the share farming arrangement is regarded as ordinary income derived in the ordinary course of carrying on a business. It follows that this income is included when calculating the annual turnover.

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