Edited version of private ruling

Authorisation Number: 1011472594890

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Ruling

Subject: Were you carrying on a business of primary production in the 2008-09 income year?

Question

Were you carrying on a business of primary production in the 2008-09 income year?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2009

The scheme commenced on

July 1997

Relevant facts

The activity is one of farming on a property a number of kilometres from your home.

Advice was sought and a local consultant conducted a review of the property.

It was recommended you grow a particular crop.

The farm has been brought to a condition where it is ready and able to produce a substantial crop. The only significant impediment was a decision by the State Government to impose a moratorium on access to existing water supplies. All applications for water entitlement that had been made were kept on hold.

During repeated telephone enquiries of the water authorities, you were assured that the moratorium on taking water would be short lived and you would hear soon about when it would be lifted. In anticipation of the lifting of the moratorium on water access, a sprinkler system was installed and successfully tested. No formal irrigation was done because of the moratorium.

The water reform review process was finalised during the 2009-10 income year and all applications for water entitlement have now been refused.

The process of water reform has had a devastating effect on the ability of this property to make the crop a financial success. Without water at the appropriate time the crop is unmarketable.

On average about X hours per week are spent working on the property.

You purchased a variety of necessary equipment.

The necessary pest and weed control has been carried out on the property.

You have provided Profit and Loss Statements for the periods 200X to 200Y income years. The average expenses per year are $X. You have also provided future profit projections based on different yields. These indicate a maximum profit of $Y on higher yields and a profit of $Z on a low yield.

You have provided a copy of a valuation report from a registered rural and urban valuer.

Reasons for decision

Summary

After applying all the indicators of a business to your circumstances, it is concluded that you were carrying on a business for tax purposes in the 2008-09 income year.

We consider that the income you receive is income according to ordinary concepts, assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) and that expenses necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income will be deductible under section 8-1 of the ITAA 1997.

You have provided evidence from a registered valuer that you can pass the non-commercial losses real property test under section 35-40 of the ITAA 1997, in the 2008-09 income year. This will allow you to claim the losses incurred in this year from this activity and also the deferred losses from the prior years against your other income.

Detailed reasoning

Carrying on a business

The question of whether a taxpayer is carrying on a business is a question of fact and degree. There are no rigid rules for determining whether the activity amounts to the carrying on of a business. The facts of each case must be examined. In Martin v FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551, Webb J said:

The test is both subjective and objective; it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and, as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.

However, the courts have developed a series of indicators that can be applied to the taxpayer's circumstances to determine whether the taxpayer is carrying on a business.

Taxation Ruling TR 97/11 'Income tax: am I carrying on a business of primary production?', summarises these indicators. The relevant indicators of whether a taxpayer is carrying on a business are:

- whether the activity has a significant commercial purpose or character

- whether the taxpayer has more than just an intention to engage in business

- whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

- whether the activity is of the same kind, and carried on in a similar manner, to that of ordinary trade in that line of business

- the size, scale and permanency of the activity, and

- whether the activity is better described as a hobby, a form of recreation or sporting activity.

No one indicator is decisive. The indicators must be considered in combination and as a whole.

Application to your circumstances

You have established a substantial crop, with the intention of making a profit from the activity. This was done after selecting a suitable property, experimenting with products and seeking expert advice from the consultants. Your research shows that the activity is of a scale that it can produce a profit, if reasonable yields are achieved.

The crops were planted and you have conducted the necessary work in the form of pruning, fertilising, weed and pest control and general management of the crop over this period to potentially allow crops to be harvested. You have harvested minor crops and been through all the necessary steps of physical harvesting, packing and marketing through agents.

The activity has been carried on in a similar manner to that of a commercial crop. You have purchased the necessary equipment to conduct the activity.

At the time of planting the restriction on water licences was not applicable and in these early stages the crop could be watered with the use of a tanker. The moratorium on the issue of new licences did not occur until several years after planting and the continuation of this was dependant on the outcome of the water reform process. This was not finalised until the 2009-10 income year, a period which was much longer than you expected.

After the finalisation of the water reform process, the applications for water entitlement that had been on hold were refused. However, during the income year in question (2008-09) the plan had yet to be finalised so there was a possibility that the outcome of the review was that the moratorium would be lifted. You continued to carry on your activity (that is, tend the crops etc) on the basis that the activity would become profitable once you gained access to additional water. You had previously installed a pump and sprinkler system in anticipation that the moratorium would be lifted and you would be granted a licence within a reasonable time.

After applying the indicators of a business to your circumstances during the 2008-09 income year, it is considered that you were carrying on a business during that year.

Future income years

Please note that whether or not a person is carrying on a business can change over time as their circumstances change. With the release of the water resource plan during the 2009-10 income year, the water review process in your area was finalised and applications for a water entitlement were refused. However, you believe that it may be possible to purchase an allocation or acquire a temporary trade of water in the foreseeable future.

Although this is your belief, for you to be able to demonstrate that your activity still has a prospect for profit, that belief must be shown to be realistic. Firstly, the water resource plan must permit the purchase or trade of water allocations. Secondly, there must be a system in place to facilitate such transactions or if such a system does not yet exist, you must be able to show that one will be set up in a timeframe that will allow your activity to still be considered commercially viable. As you stated, the official processes are very slow so if a purchase/trade system is not yet in place, it may be the view of an objective observer that your activity no longer has a reasonable prospect for profit as the time period before additional water could be obtained would be considerable. The additional cost of purchasing or trading for a water allocation would also need to be considered in determining the ongoing viability of the activity as a business.

Non-commercial losses

For the losses from this activity to be offset against your other income in the 2008-09 income year you must be able to pass one of the four non-commercial losses tests, meet the exception or obtain the Commissioner's discretion in Division 35 of the ITAA 1997.

You have provided evidence in the form of a valuer's report to show that the land value of the property used in this activity exceeds $500,000. This means you pass the real property test under section 35-40 of the ITAA 1997. This will allow you to offset the losses (including deferred losses) from this activity against your other income in the 2008-09 income year.

It should be noted that these non-commercial losses rules have changed for the 2009-10 income year onwards and the four tests are not available where a taxpayer cannot meet the income requirements ($250,000) under subsection 35-10(2E).