Edited version of private ruling

Authorisation Number: 1011498277721

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Subject: non commercial business activities

Question

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 activity in your calculation of taxable income for the 2008-09 and 2009-10 income years?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2009

Year ended 30 June 2010

Relevant facts

You purchased a property several years ago. You have planted several thousand trees. You also have livestock.

You commenced your business several years ago.

You do not have irrigation.

You are using a system to help bring the water table back into existence by way of planting appropriate vegetation and careful management of fertilizers.

You rely on the rain for your trees.

Initially you predicted that the trees would be producing a profitable yield by 20XX, however, due to weather conditions, this has not eventuated.

Your area has suffered extreme weather conditions recently.

This has made it extremely difficult to maintain and grow the trees to a viable level.

You predict that you will be profitable in 20ZZ and have assessable business income of over $20,000.

Had it not been for the weather conditions, you expected your business to pass the assessable income test based on industry predictions in 20YY.

Your income from other sources exceeds $40,000 but is not over $250,000.

You have provided projected income and expenditure for the following four years.

Your business activity has not satisfied any of the tests set out in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) or 35-45 (other assets test) of the ITAA 1997 for the 2008-09 and 2009-10 income years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 35-10(2).

Income Tax Assessment Act 1997 Subsection 35-10(4).

Income Tax Assessment Act 1997 Section 35-30.

Income Tax Assessment Act 1997 Section 35-35.

Income Tax Assessment Act 1997 Section 35-40.

Income Tax Assessment Act 1997 Section 35-45.

Income Tax Assessment Act 1997 Section 35-55.

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

Reasons for decision

Summary

Based on the information you have provided, it is accepted that your failure to achieve a profit or to pass a test was due to the special circumstances envisaged under paragraph 35-55(1)(a) of the ITAA 1997. Therefore the Commissioner will exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997 and the losses from your crop growing activity for the 2008-09 and 2009-10 income years are allowed and not deferred under section 35-10 of the ITAA 1997.

Detailed reasoning

Division 35 of the ITAA 1997 applies to losses from certain business activities for the 2000-01 income year and subsequent years. Under the rule in subsection 35-10(2) of the ITAA 1997, a 'loss' made by an individual (including an individual in a general law partnership) from a business activity will not be taken into account in an income year unless:

- the exception in subsection 35-10(4) of the ITAA 1997 applies,

- you satisfy subsection 35-10(2E) of the ITAA 1997 and one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 are met, or

- if one of the tests is not satisfied, the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

Generally, a 'loss' in this context is, for the income year in question, the excess of allowable deductions attributable to the business activity over the assessable income from the business activity.

Losses that cannot be taken into account in a particular year of income, because of subsection 35-10(2) of the ITAA 1997, can be applied to the extent of future profits from the business activity, or are deferred until one of the tests is passed, the discretion is exercised, or the exception applies.

For the purposes of applying Division 35 of the ITAA 1997, subsection 35-10(3) of the ITAA 1997 allows you to group business activities 'of a similar kind'.

Business activity

Your activity will only be potentially subject to Division 35 of the ITAA 1997 if it is carried on as a business. If your activity is not carried on as a business, and cannot reasonably be expected to produce assessable income, for example it is carried on as a hobby, then you cannot claim general deductions in relation to it, regardless of the operation of Division 35.

Whether a business is being carried on depends on the 'large or general impression gained' (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all the indicators of carrying on a business, and no one indicator will be decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). These indicators are described in Taxation Ruling TR 97/11.

In your case, you advise that your primary production activity is carried on as a business.

Exception

Under subsection 35-10(4) of the ITAA 1997, there is an 'Exception' to the general rule in subsection 35-10(2) of the ITAA 1997 where the loss is from a primary production business activity or a professional arts business activity and the individual taxpayer has other assessable income for the income year from sources not related to that activity, of less than $40,000 (excluding any net capital gain).

In your case, the exception in subsection 35-10(4) of the ITAA 1997 has no application.

Subsection 2E and the tests

The income requirement in subsection 35-10(2E) of the ITAA 1997 applies from 1 July 2009 and will be met where the sum of the following amounts for an income year is less than $250,000.

Taxable income (ignoring losses subject to the non commercial loss rules)

Reportable fringe benefits

Reportable superannuation contributions

Net investment losses

You satisfy subsection 35-10(2E) of the ITAA 1997 for the 2009-10 income year.

In broad terms, the tests require:

(a) at least $20,000 of assessable income in that year from the business activity (section 35-30 of the ITAA 1997)

(b) the business activity results in a taxation profit in three of the past five income years (including the current year) (section 35-35 of the ITAA 1997)

(c) at least $500,000 of real property, or an interest in real property, (excluding any private dwelling) is used on a continuing basis in carrying on the business activity in that year (section 35-40 of the ITAA 1997), or

(d) at least $100,000 of certain other assets (excluding cars, motor cycles and similar vehicles) are used on a continuing basis in carrying on the business activity in that year (section 35-45 of the ITAA 1997).

You do not meet any of the four tests for the 2008-09 and 2009-10 income years.

Losses from activities that do not meet any of the four tests under Division 35 of the ITAA 1997, or the exception in subsection 35-10(4) of the ITAA 1997, will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997, unless the Commissioner exercises a discretion under section 35-55 of the ITAA 1997 that it would be unreasonable to defer the loss.

Paragraph 35-55(1)(a) of the ITAA 1997

Paragraph 35-55(1)(a) of the ITAA 1997 provides that the Commissioner can exercise the first arm of this discretion where certain special circumstances apply. Special circumstances in this context are those outside the control of the business operator, including those such as drought, flood, bushfire or some other natural disaster, that have materially affected that activity.

Under paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner may decide that the rule in section 35-10 of the ITAA 1997 does not apply to a business activity if the Commissioner is satisfied that it would be unreasonable to apply that rule.

It is intended that the Commissioner only exercise this first arm of the discretion if one of the tests would have been satisfied but for the special circumstances.

In your case it is accepted that the conditions significantly affected your business operations. The delay in producing business income is directly related to the severe conditions as it has meant that your crop growth and expected production levels have slowed down considerably, compared to your expected forecasts.

The Commissioner accepts that your business activity was affected by special circumstances that were unusual and outside your control, namely drought and flood conditions. The Commissioner also accepts that, based on your forecasts, in the absence of those circumstances the assessable income test would have been passed for the income years in question.

Therefore, the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997 has been granted for the 2008-09 and 2009-10 income years. The Commissioner is therefore satisfied that it would be unreasonable to apply the rule in section 35-10 of the ITAA 1997 in relation to your business activity for these years. This means that any 'loss' for that activity can be taken into account in calculating your taxable income for that year.

Other information

A discretion is only required where the activity makes a loss or does not meet one of the tests. The figures contained in the revised forecast that you provided with your private ruling application, show that you expect to make a profit and to meet the $20,000 assessable income test in the 2010-11 income year. Therefore, it is not necessary for the Commissioner to exercise a discretion for the 2010-11 income year.

It is noted that your crop growing activity is affected by a lack of irrigation. It is arguable whether its affect is so severe that your activity would not make a profit or meet a test even without the conditions you have suffered. In this private ruling and your previous private ruling we accepted the forecasts that you provided because they are in line with the industry accepted timeframes for 'lead time' for your crop. Based on these forecasts we have given you the benefit of the doubt and accepted your statement that you would have met a test were it not for the conditions.

In the revised forecast you provided for the current private ruling, you state that you expect your a crop of X kgs for the 2010-11 income year and Y kgs for each subsequent year. As these figures are from a forecast that you revised to take into account the conditions, if in future years these totals do not eventuate, there would be a presumption that this was due to your lack of irrigation rather than the conditions.

Therefore, if in the future you request a further private ruling requesting the Commissioner exercise his discretion in section 35-55 of the ITAA 1997, evidence other than further revised forecasts would be required to satisfy the Commissioner that the discretion should be exercised. An example of the type of evidence that would be required would be a report from an independent expert in the industry that states that even though your property lacks irrigation, it was only the conditions which prevented you from making a profit or meeting a test. That is, the report would have to conclude that your plantation is able to produce a commercially viable crop even without irrigation.