Edited version of private ruling

Authorisation Number: 1011670144047

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Ruling

Subject: Non-commercial losses - Commissioner's discretion - Lead time.

1. Are you carrying on a business?

No.

2. 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 losses from your fruit growing activity in your calculation of taxable income for the 2009-10 income year?

No.

3. Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to include losses from your fruit growing activity in your calculation of taxable income for the 2010-11 to 2014-15 income years?

Unable to rule.

This ruling applies for the following period

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on

1 July 2009

Relevant facts

You state that you commenced carrying on a primary production activity of fruit growing on your property in the 2009-10 income year, with a plan to plant X trees initially and additional Y trees per annum over the next three years.

The farm has suitable soil and climatic conditions and is located in a fruit growing region.

You expect to operate the farm by yourself with the employment of casual staff on a seasonal basis.

You intend to sell your product to the fresh fruit market and the juice market.

Your plans are for an initial planting of two to three year old trees that will not fully crop for three years after planting or reach maturity for six years.

Activities carried out in the 2009-10 income year include site preparation, including organic soil amendment and the purchase and laying of second hand irrigation equipment.

The purchase of trees was originally planned for mid 2010. However, this did not occur partly due to financial constraints. The three-year-old trees need to be planted in August-September in order for the whips to establish root systems prior to summer, thus further reducing the mortality rate.

It is now envisaged that tree planting will commence once soil condition is confirmed as satisfactory.

You now plan to purchase X trees in June 2011 and have them delivered in August 2011 for planting.

You expect to pass the assessable income test and make a profit from your activity in the 2015-16 income year.

Your fruit growing activity will not satisfy 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 2009-10 to 2013-14 income years.

The following documents form part of the scheme under consideration:

· your Private Ruling application which we received on 6 October 2010

· 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 your activity will become commercially viable in the 2015-16 income year.

Relevant legislative provisions

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)(b)

Reasons for decision

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.

Your proposed business activity is fruit growing. You have planned the requirements you will need for this 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 and you have purchased the trees.

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 fruit trees 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, seasonal and financial factors, which delayed the commencement of your intended business.

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 fruit 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 for the 2009-10 income year.

2010-11 to 2014-15 income years

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 has commenced. Therefore, the Commissioner is unable, at this stage, to exercise a discretion under Division 35 of the ITAA 1997.

We are also unable to rule where the facts are not known with reasonable certainty. Once your facts are more certain and you actually purchase and plant the trees, you should request a new ruling at that time.