Edited version of private ruling

Authorisation Number: 1011621087157

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Ruling

Subject: Non-Commercial Losses - Commissioner's discretion - lead time

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

No.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

We previously made a ruling but you have informed us of a change in your circumstances and asked for a replacement ruling.

You are conducting a primary production enterprise on two adjoining properties.

The first property was purchased in Year 1. The second property was purchased in Year 2.

You state that there are two separate businesses, one on each property, and that there is no intention to join the properties and sell as one entity. The intention is to have each property able to be sold as a going concern in its own right.

The staggered purchase of the properties has assisted you with the cash flow requirements. The sale of trading stock has also assisted the purchase of additional stock for the new enterprise.

At the time of purchasing the second property you have envisaged that you would purchase trading stock soon after purchasing the property. However, due to unavoidable circumstances you were not able to purchase trading stock until Years 2 and 3.

You had a set plan to continue your primary production activity and produce a profit in Year 7.

You have provided independent evidence from a government department with regards to the commercially viable period for your industry. As per the evidence the commercially viable period for the industry is 30 months.

You have provided the income and expense statements and other information with regards to your activity.

You have stated that you satisfied the assessable income test in section 35-30 of the ITAA 1997 and the real property test in section 35-40 of the ITAA 1997 and that the business is expected to be commercially viable within 30 months.

As you have not satisfied the income requirement in subsection 35-10(2E) of the ITAA 1997, you have requested the Commissioner to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Section 35-55

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

The Commissioner will exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for an applicant who does not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 if certain requirements are satisfied for the year concerned.

For the discretion to be exercised, the business activity must have started to be carried on and, for the excluded years:

· because of its nature, it has not produced, or will not produce, assessable income greater than the deductions attributable to it, and

· 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) of the ITAA 1997).

The note to subsection 35-55(1) of the ITAA 1997 states that paragraphs 35-55(1)(b) and 35-55(1)(c) of the ITAA 1997 are intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income.

In some cases, the question might arise whether an individual taxpayer is carrying on the one business, or whether they are carrying on separate and distinct business activities for non-commercial loss purposes. Taxation Ruling TR 2001/14, which discusses non-commercial business losses, provides guidelines at paragraphs 40 to 54 and 83 to 88 to assist in determining this question.

Are you carrying on separate business activities?

You purchased the first property in Year 1 and you purchased the adjoining property in Year 2. You state that the primary production activity consists of two separate businesses, being one business on each property.

The table in paragraph 45 of TR 2001/14 summarises some of the factors that may be relevant to whether a business is made up of separate and distinct business activities for non-commercial loss purposes. The factors summarised are location, assets used, goods/services produced (including market conditions), interdependency and commercial links. The list is not meant to be exhaustive.

Applying these guidelines to your circumstances, we do not consider that you are carrying on separate primary production business activities for the purposes of the non-commercial loss provisions for the following reasons:

· both activities are of the same type and are carried out on adjoining properties

· the same types of assets would be used in both activities

· the same type of goods are being produced, and would be marketed in a similar manner, and

· there would be a significant level of interdependency between the activities in terms, for example, of working capital support, customer base, and the manner in which the activities are carried out.

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997?

In order to determine whether the Commissioner will exercise this discretion, we will need to determine if the abovementioned requirements have been satisfied.

Business activity started to be carried on

The first requirement to be satisfied is that the business activity must have started to be carried on.

We have determined above that you are carrying on one business activity in relation to your primary production activity. This business activity has commenced.

This requirement is satisfied.

Nature of the business activity

The second requirement to be satisfied is that, for the excluded years, the business activity has not produced, or will not produce assessable income greater than the deductions attributable to it because of its nature.

Paragraphs 77 and 78 of Taxation Ruling TR 2007/6, which discusses non-commercial business losses and the Commissioner's discretion, state:

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.

The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity…

The profit and loss statement provided by you shows that the business activity will not produce assessable income greater than the deductions attributable to it in this income year.

It was determined in your previous private ruling that the time required to complete the activities which determine the commercially viable period for the activity can not be more than two to three years.

You have provided independent evidence from a government department with regards to the commercially viable period for your industry. As per the evidence the commercially viable period for the industry is 30 months.

Your business activity commenced in Year 1. Your profit and loss statement indicates that you have received substantial income from your activity in Year 3 and you expect to receive a similar amount of income in this income year (Year 4). This would indicate that there are no inherent characteristics of the activity still preventing you from making a profit in this income year.

Factors such as staggering the purchase of the properties and subsequent pasture development, adverse climate conditions and cattle prices are not inherent characteristics of this type of activity. You also have a substantial rent expense, and finance costs contributing to the loss, which are also not inherent characteristics.

Paragraph 80 of TR 2007/6 states:

80. The identification of this 'initial period' may often involve some practical difficulty, particularly where causes other than an inherent characteristic appear to be another reason why the business activity is unable to satisfy a test for a particular income year. Where both an inherent characteristic and some other factor are identified, this in itself will not mean that the requirement in subparagraph 35-55(1)(b)(i) is no longer met. It is only where it is clear that the reason the activity is unable to satisfy a test is not because of any inherent characteristic, but because of some other factor, that this requirement will not be met.

In your case, inherent characteristics do not appear to be a factor in your not making a profit from the business activity for this income year. This would mean that under paragraph 80 of TR 2007/6, the requirement in relation to the nature of the business activity would not be satisfied, as the failure to satisfy this requirement is solely because of some other factor, such as the factors mentioned above.

This requirement is therefore not satisfied.

Objective expectation about future performance

The third requirement to be satisfied is that the Commissioner must be satisfied that an objective expectation exists that the business activity will in some future income year falling within a period that is commercially viable for the industry concerned, produce assessable income for an income year greater than the deductions attributable to it for that year. The objective expectation must be based on independent information, where such information is available.

As discussed above, the commercially viable period for your activity would be no more than three years from the commencement of the business activity. You have not provided any independent evidence which would indicate a longer commercially viable period for your activity.

The profit and loss statement provided by you shows that you do not expect to show a profit from the activity until Year 7, which is well outside the expected commercially viable period for this type of activity.

You have therefore not shown that the relevant objective expectation about future performance exists in this case, and this requirement is not satisfied.

Lead time

Your activity would typically have a lead time and is therefore of a kind contemplated by the note to subsection 35-55(1) of the ITAA 1997.

Conclusion

Although your business activity is of a kind contemplated by the note to subsection 35-55(1) of the ITAA 1997, the activity does not satisfy all of the relevant requirements in paragraph 35-55(1)(c) of the ITAA 1997. The requirements in relation to the nature of the business activity and objective expectation about future performance have not been satisfied in this case.

The Commissioner will therefore not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include the loss from your primary production activity in your calculation of taxable income for the income year.

Note

In your case, the loss from your business activity that can not be taken into account in a particular year of income under the non-commercial loss provisions are quarantined, and can only be applied against assessable income from this business activity in future income years.