Edited version of private ruling

Authorisation Number: 1011625858154

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Ruling

Subject: Non-commercial losses lead time

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (lead time) to allow you to include any losses from your business activities in your calculation of taxable income for the income years in question?

Answer

No

This ruling applies for the following period

Year ended 30 June 2010

Year ending 30 June 2011

Year ending 30 June 2012

Year ending 30 June 2013

The scheme commenced on

1 July 2009

Relevant facts

You operate a farm on which you operate sheep, cattle and crops.

The farm employs various contractors

Over the coming years you plan to change the focus of the farm to breeding sheep and cattle.

You believe the new breeding activity will be profitable in year 5 (2013-14).

Your income for non-commercial losses income requirement purposes in 2008-09 was greater than $250,000.

Relevant legislative provisions

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

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 35-45.

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997) prevents losses from non-commercial business activities (being conducted by an individual or a partner in a partnership) being offset against other assessable income in the year the loss is incurred. The loss is deferred unless:

You satisfy the income requirement under section 35-10(2E) of the ITAA 1997 and pass one of the following four tests:

· at least $20,000 of assessable income in that year from the business activity (assessable income test)

· the business activity results in a taxation profit in three of the past five income years (profits test)

· 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 (real property test), or

· 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 (other assets test) or

· the Commissioner exercises his discretion (special circumstances or lead time) or

· you meet the exception test (can only be met if the activity is a primary production or a professional arts business and your assessable income from that year from other sources that do not relate to that activity is less than $40,000).

The income requirement under section 35-10(2E) of the ITAA 1997 is met if the sum of the following is less than $250,000:

· your taxable income for that year;

· your reportable fringe benefits total for that year;

· your reportable superannuation contributions for that year;

· your total net investment losses for that year.

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 (including the income test under subsection 35-10(2E) of the ITAA 1997, a discretion is exercised, or the exception applies.

Are you carrying on a business?

Your activities will only be subject to Division 35 of the ITAA 1997 if it is carried on as a business. You stated in your private ruling application that your activity is carried on as a business. This ruling is made on the basis of accepting this claim.

Commissioner's discretion

As your activities have commenced, and are carried on as a business, they are subject to the provisions in Division 35 of the ITAA 1997.

As you have failed the income requirement under section 35-10(2E) of the ITAA 1997 you cannot rely on passing one of the four tests outlined above.

The exception does not apply as you earned more than $40,000 from non-primary production activities.

You only have access to section 35-55 of the ITAA 1997 (under either special circumstances or lead time)

The first arm of the discretion in paragraph 35-55(1)(a) of the ITAA 1997 relates to special circumstances applicable to the business activity. This arm has no relevance for the purposes of this private ruling.

The second arm of the discretion in paragraph 35-55(1)(b) of the ITAA 1997 may be exercised for one or more income years where:

You have satisfied the income requirement under section 35-10(2E) of the ITAA, and

· the business activity has started to be carried on; and for those years:

· because of its nature it has not satisfied, or will not satisfy, one of the tests set out in Division 35 of the ITAA 1997, and

· there is an objective expectation that the business activity of an individual taxpayer will either satisfy one of the tests or produce a taxation profit within a period that is commercially viable for the industry concerned.

Your income for Non-Commercial loss income requirement purposes was over $250,000 in 2008-09 therefore it is assumed you will also fail the income requirement in 2009-10, 2010-11, 2011-12 and 2012-13, therefore paragraph (b) above is not applicable it is assumed that you will not meet the income requirement.

The third arm of the discretion in paragraph 35-55(1)(c) of the ITAA 1997 may be exercised for one or more income years where:

· you have failed the income requirement, and

· 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 greater than the deductions attributable to it for that year.

The note to paragraphs b & c states:

Note: Paragraphs b & c 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. For example, an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

The type of feature contemplated by the phrase 'because of its nature', in the context in which it appears, is that referred to in the note quoted above. That is, that there is an inherent or innate feature of the activity resulting in an inability to produce income in the year of commencement and (in most cases) a number of years thereafter. This is borne out further by paragraph 1.51 of the Explanatory Memorandum for the New Business Tax System (Integrity Measures) Act 2000, which states:

This arm [paragraph 35-55(1)(b)] of the safeguard discretion will ensure that the loss deferral rule in section 35-10 does not adversely impact on taxpayers who have commenced to carry on activities which by their nature require a number of years to produce assessable income. Examples of activities which would fall into this category are forestry, viticulture and certain horticultural activities.

The note and the passage cited above do not support any view that the discretion should be exercised for any start-up activity that is yet, for example, to satisfy the assessable income test in section 35-30 of the ITAA 1997, simply because of the small scale on which it was started, or because a client base is being built up. Those sorts of constraints on being able to satisfy that test are far removed from the specific one referred to in the note and the Explanatory Memorandum.

In order to meet the conditions under paragraph 35-55(1)(c) of the ITAA 1997 you have to have not produced assessable income greater than the deductions attributable to it because of the nature of your breeding activities. You also have to have produced assessable income for an income year greater than the deductions attributable to it within a period that is commercially viable for the industry concerned (based on evidence from independent sources (where available)).

The generally accepted commercially viable period for cattle breeding is 2-3 years and for sheep breeding it is 1-3 years.

In application to your case, you have estimated that it will take 5 years (until 2013-14) until your assessable income will be greater than the deductions attributable to it. It is accepted that your breeding activities will not produce assessable income greater than the deductions attributable to it because of its nature however, you will not produce assessable income greater than the deductions attributable to it within a period that is commercially viable for the industry concerned (as it should take between 1 to 3 years and you estimate your activities will take 5 years).

The Commissioner has decided that it would not be unreasonable to apply the rule under subsection 35-10(2) of the ITAA 1997 and will therefore not exercise his discretion for the 2009-10, 2010-11, 2011-12 & 2012-13 income years.