Edited version of private ruling

Authorisation Number: 1011674070466

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Non Commercial Losses

Will the Commissioner exercise the discretion under paragraph 35-55(1)(b)(lead time) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include a share of losses from the mixed farming activity in the calculation of your taxable income for the 2009-10, 2010-2011, 2011-12 income years?

No.

This ruling applies for the following periods

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commenced on

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The following description of the scheme is based on information provided by you. The following documents form part of the scheme under consideration:

· Your private ruling application.

· Your business plan.

You bought a property nine years ago. The property came with an irrigators licence. You have purchased in excess of eight kilometres of irrigation pipe and fittings and petrol powered pumps in recent years.

When you purchased your property it had fruit trees on it, about X of the trees were in poor condition and could not be saved. You now have Y fruit trees.

You provided a plan of your property which shows that you have irrigated sections of your land where you currently grow fruit trees and the flowers. You planted the flowers (they are in their third year of growth) for distillation to be sold to local and export markets. You will take cuttings and increase the number of plants to 10,000 over the next two years. You have stated in your business plan that the bushes will produce in the first year, but reach full production in the third year.

You were selling the fruit to jam companies in the early years, but the companies were also importing fruit which eventually made it uneconomical for you to supply your fruit to them.

You started looking at other uses for the fruit. In the future, you intend to focus on the fermentation and distillation of the fruit to produce alcohol.

You are also looking at extracting essential oils from various parts of the fruit trees which can be used for homeopathic uses, cleaning products and to use in the food industry.

Currently you and your spouse spend 15 to 20 hours per week on farming activities, depending on the time of year. You expect that your hours at the farm will increase and your current employment will decrease in the future, you cannot confirm a time frame for this occurring. It is dependant on your finances and timing of the crops.

You have only produced small quantities of oils and brandy for testing quality and small market testing. You have not sold any product. You have stated that the equipment that you currently have is not good enough to use to make sufficient amounts of product for sale.

To enable you to extract essential oils from the fruit and flowers you require better stills for extraction.

The bushes will produce in the first year, but reach full production in the third year. You expect to be able to harvest 10 tonnes of petals from 2,000 - 2,500 bushes at their current rate of production - that is without adding fertilizer.

Your marketing strategy has been that you have approached various companies in relation to selling your essential oils. You also intend to establish a website for the marketing of both the orange and rose products.

You have claimed interest expenses in prior years. The interest claimed was for 50% of the interest charged on the loan for the property.

You have also irrigated a section of your land where you intend to grow another type of fruit. Another section has been marked as a possible location for a four variety of trees.

The business plan that you have supplied states that your activity will become commercially viable in the 2012-13 income year. You have not provided any reports from industry experts in relation to the viability of producing essential oils or the quantities that you need to grow to become viable.

You have attended various workshops in distilling.

You intend in the future to explore the possible production of product for medicinal purposes and/or for food production. The registration for medicinal use requires a vast amount of testing and trailing, therefore you will look at this avenue in the distant future.

You stated that you have approached authorities regarding licences that you may require. A food licence is not required at this time. However you are working your way towards becoming an organic producer. It will take five years to become an organic producer.

You earn over $40,000 a year from other sources.

You believe your property, including your double story house and shed, would be valued at less than M$1. It is difficult to determine whether the land you are using is worth over $500,000.

You state that your other assets excluding cars, motorcycles and similar vehicles would come close to $A.

Your income does not exceed $B.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 35-10

Income Tax Assessment Act 1997 Subsection 35-35

Income Tax Assessment Act 1997 Subsection 35-55

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

The lead time is one to three years for the production of assessable income from the flowers. As the lead time has passed, the Commissioner is not able to exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997. Therefore, you must defer any losses to a future year, where you have met one of the four tests, met an exception or the Commissioner has exercised the discretion in your favour.

Reasons for decision

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:

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

· the 'Exception' in subsection 35-10(4) of the ITAA 1997 applies, or

· 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 a taxpayer's allowable deductions attributable to the business activity over that taxpayer's 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 on the tests is passed (and subsection (2E) is met), the discretion is exercised, or the exception applies.

Tests

In broad terms, the tests require:

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

· 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)

· 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

· at least $ X,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).

In addition to the above tests an income requirement must be met (subsection (2E)) for the 2009 -10 year. You will satisfy that test for an income year 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.

For the purpose of paragraph (a), when working out your taxable income, disregard any excess mentioned in subsection (2) for any business activity for that year that you could otherwise deduct under this Act for that year.

In your case, you do not meet any of the four tests above, you did not earn at least $20,000 of assessable income from the business activity, you did not make a profit in any of the past five years, your real property is not valued at least $500,000 and you do not have at least $100,000 of other assets used in the business. Your income meets the less than $250,000 test.

The discretion for lead time may be exercised.

Lead time

The discretion in paragraph 35-55(1)(b) of the ITAA 1997 may be exercised where:

· the business activity has started to be carried on and for that or those income 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 expectation that the business activity of an individual taxpayer will either pass one of the tests or produce a taxation profit within a period that is commercially viable for the industry concerned.

The 'Note' to paragraph 35-55(1)(b) of the ITAA 1997 states:

Note: This paragraph is 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 hard wood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

Taxation Ruling TR 2007/6 provides guidance on how the discretion may be exercised and states that paragraph 35-55(1)(b) of the ITAA 1997 typically applies in situations where a lead time exists between the commencement of the activity and the production of assessable income from that activity.

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.

You purchased the farm with established fruit trees on it nine years ago. There are Y trees left. Lead time is not available for the fruit trees which were an established crop when you purchased the farm. The fact that you have changed the use of the produce from the trees does not allow further lead time to become available.

You planted flower bushes three years ago. You have stated in your business plan that the flowers come into production in the first year and reach full production within three years. You state that you are establishing a new industry. You are establishing a farm which will produce essential oils. Your income will be derived from extracting oils from your bushes and trees. You have also considered adding other fruit trees to your farm. You state that the delay in deriving income is the time it has taken to establish a new industry.

The wording of paragraph 35-55(1)(b) of the ITAA 1997 and the 'Note' 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 you are taking extra time to establish your business, or you have not yet purchased the equipment required to produce a marketable product.

The lead time is one to three years for the production of assessable income from the flowers.

As the lead time has now passed, the Commissioner is not able to exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997. Therefore, you must defer any losses to a future year, where you have met one of the four tests, met an exception or the Commissioner has exercised the discretion in your favour.