Edited version of private advice

Authorisation Number: 1052337747663

Date of advice: 20 February 2025

Ruling

Subject: Commissioner's discretion - special circumstances

Question 1

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your primary production business activity in your calculation of taxable income for the 20XX-XX financial year?

Answer 1

No.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You do not satisfy the less than $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

The primary production activity commenced several years ago, operated by a sole trader. The primary production business changed from a sole trader operation to a partnership at a later date, when you joined the partnership.

Evidence demonstrated that the property may have experienced a special circumstance. This circumstance existed at the time that the sole trader began the primary production activity, there was a short break, then existed again at the time that the partnership began. There was also a fall in the livestock market.

A loss occurred each year, including the relevant year, regardless of the circumstances for reasons other than any special circumstance. One year the loss was increased by the immediate write off of assets. The activity in the relevant year and the following one was being run at greater than capacity, which lead to an increase in costs.

Another different activity is undertaken by one of the partners at other locations.

You received a government grant.

The financial profit and loss statements were provided. These financial figures were not provided for each activity separately, even though at least one of the activities has made a loss. The two activities combined have made a loss since commencement.

The depreciation schedule was provided. There were assets purchased in the relevant year that were not related to a special circumstance. These amounts increased the loss that year.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 35-10(1)

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

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

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

Reasons for decision

Summary

Having regard to your full circumstances, the Commissioner is not satisfied that your business activity would have made a profit but for the special circumstances. Consequently, the Commissioner will not exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 for the 20XX-XX financial year.

Detailed reasoning

Division 35 of the ITAA 1997 prevents losses from a non-commercial business activity carried out by an individual taxpayer (alone or in partnership) from being offset against other assessable income in the year in which the loss is incurred, unless:

•                     the individual meets the income requirement and the business activity satisfies one of the 4 stipulated tests (paragraph 35-10(1)(a));

•                     an exception in subsection 35-10(4) applies; or

•                     the Commissioner exercises the discretion in subsection 35-55(1) for the business activity for one or more income years.

In your situation, you do not satisfy the income requirement and you do not come under any of the exceptions.

Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

You have requested the Commissioner to exercise their discretion under paragraph 35-55(1)(a) of the ITAA 1997 in the 2023-24 financial year, on the basis of special circumstances.

'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, including drought, flood, bushfire or some other natural disaster.

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 in question where, but for the special circumstances:

•                     your business activity would have made a tax profit; and

•                     the activity passes at least one of the four tests or, but for the special circumstances, would have passed one of the four tests.

Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion sets out when the Commissioner may exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997. The intention of the discretion was not where a 'business activity makes a loss because of factors which can apply to any business' (paragraph 10 of TR 2007/6). The discretion is for a commercial business activity that fails to satisfy any of the tests due to 'certain reasons outside the control of the operator' (paragraph 11 of TR 2007/6).

'Ordinary economic, weather or market fluctuations' that might usually be expected to affect the business activity would not be considered special circumstances. These would occur on a regular basis and would affect all businesses in that industry. 'Substantial unexpected fluctuations of a scale not regularly encountered previously may qualify on a case-by-case basis' (paragraph 47 of TR 2007/6). There may be circumstances where the continuing special circumstances become an ordinary or usual situation (paragraph 52 of TR 2007/6).

If your business activity would have made a loss even if it had not been affected by special circumstances, it is unlikely that it would be considered unreasonable for the loss deferral rules to apply and the Commissioner is unlikely to exercise the discretion (paragraph 50 of TR 2007/6). If you do not meet the income requirement and your activity would have made a loss even if it had not been for the special circumstances, it is unlikely that the Commissioner would exercise the discretion (paragraph 50A of TR 2007/6).

The example 7A18A that begins at paragraph 129A of TR 2007/6 demonstrates when the Commissioner may and may not exercise the discretion:

129A      Alister carries on a business of breeding cattle for sale and has done so for the past 20 years. In prior years this business activity has been very profitable. However, in the 2010 income year it was affected by drought, which caused Alister to spend much more than anticipated on fertilizer and seed to maintain the condition of his pastures. The drought also affected the average sale price per head Alister could obtain for his cattle. A large loss was made from the business for the 2020 income year.

129B      Alister did not meet the income requirement (subsection 35-10(2)(E)) for the 2010 income year. Therefore, the fact that his business activity satisfied both the assessable income and profits test for this year does not automatically mean that the loss deferral rule in subsection 35-10(2) does not apply. This is due to the change in paragraph 35-10(1)(a), and the introduction of subsection 35-10(2)(E) (the income requirement). He applies for the Commissioner to exercise the discretion under the special circumstances limb in paragraph 35-55(1)(a), and decide that the loss deferral not apply. ...

129D      The Commissioner notes the inherent profitability of the business, as borne out by its strong past performance in this respect. He concludes that, while the factors in paragraph 35-10(1)(a) are not directly to be applied, the fact that the business continues to satisfy the assessable income test and the profits test points towards it being 'commercial' in the sense indicated by the scheme of Division 35. The Commissioner concludes that it would be unreasonable in these circumstances for the loss to be deferred, and exercises the special circumstances limb of the discretion.

129E      If the facts were that the business had not made a profit in recent times, and moreover, was not reasonably expected to do so in the future, the mere fact that, for example, the business satisfied the real property test, or the other assets test, would not, in itself, indicate that it was unreasonable for losses from the business to be deferred. This would be so, even if the business activity was affected by special circumstances to some extent, but not to the extent that these circumstances caused what would otherwise be a profitable activity to be one which made a loss.

Taxation Ruling TR 2001/14 Income tax: Division 35 - non-commercial business losses considers the operation of Division 35 of the ITAA 1997.

Paragraph 63A of TR 2001/14 says:

As section 35-35 examines the results and not the ownership of the business activity, a change of ownership in a particular year will not prevent profits from a business activity, made under a previous owner, from being taken into account for the purpose of the Profits test. Consequently, profits from a business activity, made under a previous owner can be taken into account, provided the change in the ownership or the terms and conditions of a sale of the business do not result in a loss of continuity of identity of the business activity (see Example 6A at paragraphs 137A to 137D of this Ruling).

The non-commercial loss rules are all about business activities rather than the businesses. The primary production business activity commenced when stcok were purchased on a lower scale by the sole trader individual. The intention and decision to commence the business activity occurred at this time. The minimum level of business assets to allow that business activity to be carried on was acquired, and business operations commenced.

It is accepted in your case that a circumstance may constitute special circumstances. However, this in itself is not sufficient for the discretion to be exercised.

Would a profit have been made but for the special circumstances?

The following considerations lead us to believe that had the special circumstances not occurred the business activity would still have been in a loss situation:

Since commencement, while the assessable income test was satisfied each year, the expenses have always exceeded income and the primary production activity has never made a profit since commencement up to and including when the business entity changed from a sole trader to a partnership.

Although you advised there were expenses incurred that were related to special circumstances, there were high expenses incurred that are not related to the special circumstances. This loss situation has occurred every year. For example, you advised that the loss incurred in a certain financial year was mainly due to the immediate write off assets acquired that year.

As per your latest profit and loss statement there was a loss from the activity. Included in the expenses that contributed towards the loss were high amounts of expenses that were not related to a special circumstance.

Considering expenses, which are not directly related to special circumstances, which have increased the loss in the relevant financial year such that, had it not been for the special circumstances, you would still not have made a profit.

Multiple activities

Division 35 operates for a specific 'business activity' by calculating whether a non-commercial loss has been made from that activity, which would, but for Division 35, be able to be offset against other income (in the calculation of the individual's taxable income).

If you are carrying on more than one business activity and they are similar, you may group them together when considering the non-commercial loss rules. 'Business activities of a similar kind are those which inherently have the same nature or character' (paragraph 86 of TR 2001/14).

A taxpayer may carry on different business activities and the rules apply independently to each activity. In such cases, each business activity must (unless they can be grouped) separately satisfy the tests and will have separate consideration. This requires separate accounts and financial information for each different business activity. If a partnership carries on more than one business activity, the income and deductions must be accounted for separately for each unless they are similar activities or they have made a profit from both of them.

If an individual member earns assessable income from the business activity outside of the partnership, that assessable income can be taken into account by that member only.

There are factors that may be relevant to whether a business is made up of separate and distinct business activities for Division 35 purposes. Factors include location, assets used, goods/services produced (including market conditions), inter-dependency, and commercial links (paragraph 45 of TR 2001/14).

The factors and reasoning of paragraph 45 of TR 2001/14 were applied to your situation.

TR 2001/14 paragraphs 124 to 130 has an example of separate business activities not 'of a similar kind', where the taxpayer would have to attribute those otherwise allowable deductions, such as depreciation on equipment, between the two business activities to determine the profit or loss from each business activity.

There are significant differences between the activities as well - the different locations and market conditions, different other assets used, the significantly different way in which income is derived in each activity, and the different elements of 'risk' that apply to each. The two activities do constitute two separate and distinct business activities. They would not be regarded as being 'of a similar kind' for the purposes of Division 35 of the ITAA 1997.

It is necessary then to attribute income and those otherwise allowable deductions, such as depreciation, between the two business activities to determine the profit or loss from each business activity.

In this case the financial statements included the profit and loss from both activities combined. Even with the other revenue from the different activity, the financials of the combined activities resulted in a loss in the relevant year.

The projected income for a future financial year includes 'Other revenue', which is related to the different activity. Excluding the other revenue, the primary production activity will not make a profit in the respective financial year.

Ordinary Situation

Paragraph 47 of TR 2007/6 states in terms of where the income requirement is satisfied but applies even where the income requirement is not satisfied:

...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. However, substantial unexpected fluctuations of a scale not regularly encountered previously may qualify on a case by case basis.

TR 2007/6 paragraph 15 and paragraph 52 outlines the continued existence of special circumstances:

15.  The discretion can be exercised in income years after the one in which the special circumstances occurred if the effects of those special circumstances continue to prevent the business activity from satisfying any of the tests in those later income years. However, there may be situations where the special circumstances, because of their continued existence, become the ordinary or usual situation. It would not be appropriate to exercise the discretion once this occurs.

In certain primary production cases, for example where a drought existed before the taxpayer started their business, or the drought continued for many years, the special circumstances can be viewed as business as usual. The drought may then not be considered to be circumstances which are sufficiently different to distinguish them from the circumstances that occur in the normal course of conducting their business activity after such a long period of time. The drought would be considered to be the ordinary situation.

Changes in the average sale price in the primary production market is also an expected event in the industry.

In this case, the 'activity' commenced in a certain financial year. The activity was affected by circumstances applied for several years from when the primary production activity commenced and an intensifying situation occurred in another time period.

The fall in the market was an ordinary circumstance for this primary production activity. The activity commenced during certain weather conditions, that continued and was not unexpected. The partnership activity commenced during similar weather conditions, which the property had experienced in recent previous years.

The fall in the market, the weather conditions, and intensifying conditions were not unexpected events that would be viewed as special circumstances for this activity in the particular financial year.

Government Grant income

You received a government grant. If it were not for the government grant, the loss in that year would have been greater.

Conclusion

For the Commissioner to exercise the discretion under special circumstances, the Commissioner needs to be satisfied that the special circumstances have materially affected the business activity, causing it to make a loss. Your financial data provided does not indicate that the loss was mainly caused by the weather conditions, rather it was caused mainly by other expenses that were not related.

Based on the information provided and your statements, you have made business decisions to operate the activity at greater than carrying capacity. The business decisions in how to carry on the business activity have directly affected your inability to derive more income compared to periods when the region is not experiencing certain weather conditions and you would expect better conditions.

The activity has been making a loss from when it began and it has not been shown that you will make a profit from the activity.

The Commissioner is not satisfied that your activity would have made a profit but for the special circumstances. Accordingly, the Commissioner cannot exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the particular financial year for the loss for the primary production activity. Any 'loss' for that activity cannot be taken into account in calculating your taxable income for the financial year requested.

As a result, you cannot claim losses from your activities in the primary production business against your other income in the financial year requested. The losses from your business will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997. That is, the losses from in the stated income year will be carried forward to be offset in later years when there is a profit from your primary production activity or if you meet the requirements in Division 35 of the ITAA 1997 to be able to claim the deferred losses in a later year.

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