Edited version of private ruling

Authorisation Number: 1011649594215

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Ruling

Subject: Non-commercial losses - Commissioner's discretion

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your horticultural activity in your calculation of taxable income for the 2009-10 income year?

No.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You and your spouse purchased a property. You began residing on the property.

The business will involve the staged planting of A trees, with approximately B trees intended to be planted in the 2010-11 income year and between C and D trees in each of the following four years.

You and your spouse will operate the business in partnership, with seasonal staff employed at peak times.

You intend to sell some of the trees and sell the produce of others.

You have provided a copy of your business plan dated September 2010, showing projected income and expenses. Year 1 in your business plan corresponds to the 2010-11 income year and it is in this year that you will plant the trees.

Your business plan shows your first harvest in Year 4 (2013-14).

You contend that the business commenced on 1 January 2010. Activities undertaken between 1 January 2010 and 30 June 2010 consisted of property acquisition, capital equipment purchases, ordering orchard material, establishing contracts for agistment of cattle, ground preparation prior to planting, licensing applications and general property maintenance.

Ground preparation consists of mowing, marking, deep ripping and augering.

Actual tree planting could not be undertaken prior to July 2010 due to the seasonal nature of the activity (July - August). The property has a large dam that will supply water for irrigation.

Income for the period 1 January 2010 to 30 June 2010 consists of interest and agistment income.

You have incurred expenditure in the period 1 January 2010 o 30 June 2010 predominantly related to the acquisition of the property, interest paid on borrowings and depreciation.

You intend to market the trees in the following ways:

· in a publication

· via word of mouth

· through a Growers Association

· via farm gate sales

· via a website that you intend to establish

· via advertising with a co-operative, and

· markets and agricultural shows.

You have obtained some advice from independent qualified sources, but you have not provided evidence of a commercially viable period of time for the industry concerned to produce a tax profit.

The following documents form part of the scheme under consideration:

· your Private Ruling application

· your business plan

· income and expenditure projections for your business activity.

Your income for non-commercial loss purposes for the 2009-10 income year was less than $250,000.

You expect to meet the 'other assets' test in the 2010-11 income year and the assessable income test in the 2011-12 income year. You expect your business activity to make a tax profit in the 2016-17 income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 8-1.

Income Tax Assessment Act 1997 - Section 35-1.

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

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

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

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

Income Tax Assessment Act 1997 - Section 40-880.

Reasons for decision

Summary

The Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 to allow you to apply your business losses against your assessable income in the 2009-10 income year. This is because Division 35 of the ITAA 1997 only applies to a business activity which has started to be carried on and we do not consider that your business had commenced in the 2009-10 income year.

Detailed explanation

Business 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.

In order for Division 35 to apply, a taxpayer must have commenced business.

Paragraphs 69A and 97 to 105 of Taxation Ruling TR 2001/14 consider when a business activity has started to be carried on.

In determining when a business commences, there are three indicators that must be present before it can be said that a business has commenced. These are:

· purpose, intention and decision

· acquisition of a business structure, and

· commencement of business operations.

Purpose, intention and decision

The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity. This is developed by researching the proposed business and, in some instances, by experiment. This process culminates in a final decision on whether to commence business. However, not all businesses commence in such an orderly manner.

It is apparent from the information you have provided that you have researched your proposed business activity, decided the form of that business and you have shown some commitment to it by investing in capital equipment and the acquisition of a major capital asset, being the property. You have also prepared a business plan for your activities.

Acquisition of a business structure

Most business activities have a structure that provides the framework of the business. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity.

In Calkin v. CIR [1984] 1 NZLR 440 (Calkin's case), Richardson J said at 446-447:

Clearly it is not sufficient that the taxpayer has made a commitment to engage in business: he must first establish a profit-making structure and begin ordinary business operations.

For a business activity to commence, an appropriate business structure should be in place. As to what this structure will consist of, and its size, this will be a question of fact and degree, and depend on the nature of the business activity.

You have planned the requirements you will need for your proposed activity. However, we do not consider you will have acquired the minimum amount of business assets needed to commence your business activity until you have prepared the land on the property to a condition sufficient to support the tree planting.

Commencement of Business Operations

The degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the relevant business is being conducted: see Inglis v. FC of T 80 ATC 4001; (1979) 10 ATR 493.

Based on the decision in Calkin's case, both the acquisition of the minimum level of business assets and the commencement of 'business operations' are necessary to be able to conclude that a business has commenced.

It is accepted that, during the 2009-10 income year, you had gone beyond merely having an intention to engage in business and there had been some activity. For example, you have purchased some of the items necessary for the conduct of your business and you had researched the activity.

However, it is important in evaluating these activities to have a proper regard to the characterisation of your business. In Goodman Fielder Wattie Ltd v. Federal Commissioner of Taxation (1991) 29 FCR 376; 91 ATC 4438; (1991) 22 ATR 26, Hill J stated:

Critical to the resolution of the present controversy, is the characterisation of the business activity itself which is said to have commenced. It was conceded properly by the applicant that if the business claimed to be carried on by it was to be characterised as one of manufacturing and selling monoclonal antibody products, then that business did not commence until around November 1982...

For a primary production activity involving the planting and cultivating of trees, the planting of the trees would normally be seen as the commencement of that business. Alternatively, if your business activity was characterised as a trading activity, involving conducting services in return for a fee, the business would generally be considered to have commenced once you began conducting the services for a fee.

The business you proposed to commence in the 2009-10 income year was growing trees for resale or for the sale of their produce.

Therefore, until you have the assets ready to commence business, (including a prepared site) and you have planted your trees, you will not have commenced business.

We consider that, up to this point, your activities were preliminary to the carrying on of your intended business and you were still in the course of establishing a business. The costs associated with the establishment of a trading entity are capital in nature as they relate to the structure of the business rather than the daily activities from which the business gains its assessable income (see FC of T v. Maddalena 71 ATC 4161; (1971) 2 ATR 541).

Our impression is that there were circumstances, including site preparation activities and seasonal factors, which delayed the commencement of your intended business.

Furthermore, we hold the view that income from agistment alone does not constitute a business of primary production for tax purposes (Taxation Ruling IT 225).

The reason for this is that agistment income will rarely equate to the running costs of the property, therefore the activity of agistment lacks a commercial character. We consider that, in most cases, the agistment of the property occurs as a prelude to the use of the property for some other purpose, for example a business of primary production or private use. It is usual to apportion these cases to allow expenses to the extent of income received.

This view is supported by the decision in Case 38/97 97 ATC 397; Case 12,163 (1997) 36 ATR 1154, which specifically dealt with the treatment of interest expenses incurred in relation to agistment income. Agistment income is assessable (section 6-5 of the ITAA 1997), however as the leasing out of land for agistment does not constitute the carrying on of a business, expenses are only deductible to the extent of the income derived.

Based on the information you have supplied, we have formed the opinion that you had not commenced carrying on a business in the 2009-10 income year, as you had not planted any trees in 2009-10.

Where the business activity has not yet commenced, the Commissioner is not able to exercise the discretion. Therefore the Commissioner will not exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(b) of the ITAA 1997.