Edited version of private ruling

Authorisation Number: 1011703125685

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Ruling

Subject: Commissioner's discretion for non-commercial business losses

Question 1

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 business activity in your calculation of taxable income for the years ending 30 June 2006 to 30 June 2029.

Answer

No.

This ruling applies for the following period(s):

Income years ending 30 June 2006 to 30 June 2029 inclusive

The scheme commences:

After 1 July 2005

Relevant facts and circumstances

In your application for a private ruling you have requested the Commissioner to exercise his discretion in section 35-55 of the ITAA 1997 in relation to your business activity for the years ending 30 June 2006 to 30 June 2029.

The facts that you provided about your business are summarised below.

The application included two business plans.

The purpose of the activity is to farm native trees and Eucalypts for high value timber for furniture manufacturing.

Over a number of years you planted approximately 4,000 trees of a dozen varieties on about four hectares of the property.

The second business plan estimated that the entire cost of ripping, mounding, purchase of seedlings, planting, fertilising, weed control, pruning, thinning, harvest, site clean-up and milling, for the 25 year life of the project, would be $12,171.

Thinning of the trees is intended to produce logs for fencing or firewood, to be used either on the farm or for sale. The remaining trees are planned to be logged at approximately 20 to 25 years of age, and milled on the farm using a portable mill, and then air dried at the farm.

You have also carried out, or plan to carry out, the following activities on the farm:

§ negotiated to receive $100 per hectare per year for carbon credits;

§ native regenerative planting, including a corridor linking the river to the plantation;

§ cut hay in the 2008 calendar year for use on the farm; and

§ in respect of tourism, overseas visitors have come to the farm to help and enjoy the environment, and the farm may generate income from ecotourism in the future.

The property has an average rainfall of approximately 700mm.

The business has or will involve the following activities:

1. Establishing plantations for sawlog production

2. Establishing plantations for ecotourism

3. Establishing plantations for carbon storage

4. Establishing plantations for native bird and wildlife refuge and corridors

5. Form and stem pruning trees for sawlog production

6. Fertilizing, tree health monitoring and inventory

7. Thinning of trees for sawlog production

8. Weed control

9. Fencing

10. Hay production

11. Grazing

12. Firebreak maintenance and fuel reduction management

13. Establishing plantations for farm forestry education and sustainability *

14. Restoration of remnant river vegetation and wetland establishment *

15. Harvesting and marketing the forest products *

16. Horsemanship *

(* the last four activities have some private purpose)

You plan to conduct the first thinning yourself. The timber from the first thinning will be used on farm for fencing.

You will conduct the second thinning and final harvest yourself, with the aid of a contractor.

Income will be generated by selling timber as firewood, sawlog, veneer log, furniture grade air dried boards, though some trees may be sold as standing timber.

You consider that the business will become commercially viable in 8-10 years when the second thinning are sold for fencing or firewood.

The ecotourism and forestry education part of her business is envisaged for 4 years time after toilet, catering, and accommodation facilities are constructed.

The hay production part of the business will take a few seasons of testing to establish.

The grazing part of the business will require fencing of paddocks, and is not expected until 2013.

No income has been received in relation to the registration of the property for carbon credits.

After thinning, you expect that final harvest will be about 615 trees, which will yield 1,080 cubic metres of wood, which is expected to sell for between $86,400 ($80 per cubic metre) and $324,000 ($300 per cubic metre).

An insurance policy gave the agreed value of your trees for the period 30 November 2009 to 30 November 2010 as $32, 982.

You also provided: details of your qualifications and memberships; various public and private reports concerning forestry; a management report for your property dated April 2008; Profit and loss statements; and a report concerning your property dated September 2010:

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1(1)

Income Tax Assessment Act 1997 section 35-55

Income Tax Assessment Act 1997 subsection 35-10(2)

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

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 35-40

Income Tax Assessment Act 1997 section 35-55

Income Tax Assessment Act 1997 section 35-55(1)(b)

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

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Summary

Whilst you have carried out a number of activities on your property, the activities to date do not match your business plans, and your sales forecasts are not realistic. The Commissioner will not exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 for the income years ending 30 June 2006 to 30 June 2029 because: you have not demonstrated that these activities amount to carrying on a business; and even if you had been able to show that you were carrying on a business, you did not show that your activities on the property would produce a profit within a commercially viable period.

Detailed reasoning

The discretion at paragraphs 35-55(1)(b) and 35-55(1)(c) of the ITAA 1997 only apply where you are carrying on a business.

You indicated at item six of your 'Application for a private ruling on the Commissioner's discretion for non-commercial business losses' (the Application) that you would like the Commissioner to consider whether your activity is a business activity.

Brief summary of your activities

The relevant facts above contain the details. You maintain that you started your business two months after acquiring the property, and that you commenced planting trees a year after acquiring the property, and that you have since planted over 4,000 trees covering more than four hectares, with just under 7 hectares yet to be developed.

You consider that the business encompasses a number of activities including forestry, but that some of these activities have not yet started and some will have a part-private purpose.

You have provided some information regarding how you might derive income from selling hay and timber from your property. You have not provided information regarding how you intend to derive income from carbon trading, tourism, wetland regeneration, native planting, or visits from organic farming groups.

Carrying on a business

Subsection 995-1(1) of the ITAA 1997 defines the term of 'business' as including 'any profession, trade, employment, vocation or calling, but not to include occupation as an employee', and 'primary production business' as including the planting or tending of trees that are intended to be felled.

Taxation Ruling TR 97/11 'Income tax: am I carrying on a business of primary production?' provides a guide to the indicators to whether a person is carrying on a business of primary production.

Paragraphs 8 and 9 of TR 97/11 explain with reference to subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) the definition of primary production, and it is evident that tourism does not meet the definition or primary production. Nonetheless, the factors discussed in TR 97/11 can be of equal assistance in determining whether a non-primary production business is carried out.

Paragraphs 12 and 13 of TR 97/11 explain that whether you are carrying on a business requires the weighing of indicators which have been considered relevant by the 'courts', and said indicators are considered below.

Significant commercial purpose

A business plan is considered relevant for determining whether a significant commercial purpose is present. TR 97/11 at paragraphs 104 through115 provides an example of the form that a business plan can take.

Two plans were provided with the application: the first refers to activities carried out to spring 2009; and the second dated March 2010.These plans provide a general description of the proposed forestry activities from age -1, with costs, growth rates, and mill door prices. But the two plans are not detailed business plans, and some particular deficiencies with the second plan are:

§ it would be expected that the plan would include actual or real data from your property;

§ the growth details in the plan are from a completely different region to where your property is located, and refer to a type of tree that comprises less than 4% of your plantings. It would be expected that your plan would include expected growth rates for your region for all your tree plantings; and

§ the mill door prices are for species which you did not plant.

Thus, the documents specifically labelled as plans do not show that the purported business has or will be carried on for commercial reasons and in a commercially viable manner.

The material that you provided with the ruling application also includes various items about likely timber pricing, but not in a way that is specific to your proposed business, you have not provided any yield estimates for your trees, and therefore this information appears to be speculative rather than a business plan.

Another report you provided aimed to demonstrate the expected cash flow from your enterprise, but it had a number of deficiencies, such as:

§ it ignores the majority of the varieties of trees that you planted;

§ the costs in the report do not match the other information you have provided in your profit and loss statement; and

§ the report predicts net present value over 30 years as a negative return.

Another indicator of a significant commercial purpose would be to obtain technical literature on the activity in question. Certainly you have provided evidence of some literature with your application, but you have not provided comprehensive information for all the species/varieties of trees planted, nor have you explained why they in particular were selected and why they were planted in the numbers that you did.

With regard to the suitability of the trees for your location, from the literature regarding trees that you provided, only one type of tree planted meets the minimal rainfall conditions that exist for your property. And whilst you have advised that you have 'stock and domestic' water rights with regard to the adjacent river, and a dam and a water tank, you have not explained how these are adequate for the number of trees you have planted or what irrigation infrastructure is in place to offset the rainfall deficiency for all the trees you have planted.

Another factor for considering significant commercial purpose is whether there is a market for the product. Whilst clearly there is a general market in Australia for hay and wood products, you have not shown that there is a specific market for what your purported business will produce. Your attempts to generate income from carbon and hay have not yielded any income. A report you provided notes that the hybrid trees you planted have yet to be harvested for sawlogs of around 30 years, and that there are no sawmills in the region cutting plantation eucalypt sawlogs (hence you are planning to saw, dry and market the timber yourself).

The plans that you have provided are not sufficiently detailed and the report on your property does not appear to be a realistic review of your actual operations. Therefore, you have not provided sufficient information to support that you have a significant commercial purpose for your purported business.

More than just an intention to engage in business

Apart from tree farming, your second plan includes references to receiving payments for carbon credits, the movement of native birds into the plantation trees, wetland regeneration, creation of a native vegetation corridor linking the river with the plantation, growing hay in the river paddock, and visits from organic farm volunteers. Clearly your intentions for the farm are wider than harvesting trees for sale of timber, and that ecotourism, for example is a long term aim that requires infrastructure.

If carbon trading is separate and distinct from your tree farming activities, insufficient information has been provided on how this will be carried out, and it can only be concluded that this is also only an intention at this stage.

With regard to your tree farming activities, clearly the level of activity and planting places it in a different category to the activities referred to in the two preceding paragraphs. However, experimental, pilot or preparatory activities can be considered as occurring before the commencement of a business. You have a number of intentions for your property, and the number and type of trees planted do not readily fit within your tree farming business plan, so it may be that some or all of your tree planting activities are not necessarily for logging and sale.

Whether the taxpayer has a purpose of profit

As previously noted, your plans and forecasts do not demonstrate that your activities have the prospect of a profit. But as noted at paragraph 50 of TR 97/11, this indicator alone is not determinative of whether a business is being carried on.

Whether there is repetition and regularity

The number of trees planted is an indication of repetition and regularity, and that a business is being carried on.

Paragraph 56 of TR 97/11 also refers to maintaining the quality of product, and you provided the a management report for your property which reported on the progress of some of the trees then planted.

Whether the activity is of the same kind and carried out in a similar manner to that of the ordinary trade

It would not be expected that in the ordinary tree farming trade that such a disparate number of trees would be planted in small area, and you have not explained why you did this.

Whether the activity is planned, organised and carried on in a businesslike manner

The ruling application does not demonstrate that all parts of the activities were carried out in a businesslike manner. Information missing from the plans and the ruling application include: Why the different types of trees were selected; the suitability for the property of the trees, how or why that volume of land was planted; the current markets for the wood from the trees planted; and realistic cash flow/profit and loss forecasts.

The size, scale and permanency of the activity

The size and scale to date is definitely small compared to a typical commercial forestry operation, but this factor is not determinative.

Whether the activity is better described as a hobby

Because of the large number of activities carried out or intended to be carried out on the property, and the diverse types of trees planted on the property which are not supported by a commercial business plan, it is possible that your tree farming activities are indeed a hobby or recreation or otherwise private. It is equally possible that some smaller portion of your tree farming activities are a business, but for the purposes of this ruling application, you have not chosen to segregate them.

Application of all the indicators

No written business plan provided from the time before the property was purchased or before planting started. The descriptions of the business provided with the ruling application cover a range of activities which cover business and private purposes. The reason for the selection of different trees and the numbers of each type planted has not been provided. There has clearly been activity by way of planting of the trees, with maintenance and monitoring of the trees since planning.

No assessable income had yet been derived. The material provided with the ruling application does not predict any future income for the native and wetland vegetation or tourism parts of the purported business, the income from carbon trading would appear at this stage to be pure speculation, and there is no evidence to support the forecast income from hay. Income from the felling of trees is to be expected in the future, but the forecasts provided are confused, and as a result do no not demonstrate a strong profit-making motive for the tree planting.

Overall therefore, the material provided with the ruling application does not demonstrate that you are carrying on a business.

Subsection 8-1(1) and Division 35 of ITAA 1997

Subsection 8-1(1) of the ITAA 1997 allows a taxpayer to deduct from their assessable income any loss or outgoing incurred in gaining or producing their assessable income or in carrying on their business of gaining or producing assessable income.

Division 35 only applies to limit deductions otherwise allowed under subsection 8-1(1) where you are carrying on a business. The material supplied with your ruling application does not demonstrate that you were carrying on a business for the 2005-06 through 2009-10 income years. However, if our analysis of your application is incorrect, we have considered Division 35 hypothetically below.

Division 35

For the 2000-01 and later income years, however, Division 35 of ITAA 1997, applies to losses from non-commercial business activities. Under the rule in subsection 35-10(2) of the ITAA 1997, a deduction for a non-commercial loss incurred by an individual from certain business activities in an income year will not be allowable in that income year unless:

§ you satisfy subsection 35-10(2E) (2009-10 and later income years only) and one of tests in section 35-30, 35-35, 35-40 or 35-45; or

§ the Commissioner exercises the discretion in section 35-55; or

§ the exception in subsection 35-10(4) applies.

Subsection 35-10(2E) only applies for the 2009-10 and later income years, and is satisfied if for any income year the sum of the following is less that $250,000: your taxable income, your reportable fringe benefits, reportable superannuation contributions and your net investment losses. You have not provided the relevant information for the 2009-10 or later income years, and it cannot be determined that this subsection applies to you.

The four tests are:

§ Section 35-30 assessable income test - the amount of assessable income from the business activity is at least $20,000;

§ Section 35-35 profits test - the assessable income for the business exceeds the sum of deductions for each of at least 3 out of the past 5 income years;

§ Section 35-40 real property test - the value of the real property used in the business activity is at least $500,000; or

§ Section 35-45 other assets test - the value of the other assets used in the business activity total at least $100,000.

There is no evidence that any assessable income has been derived from the activity, details of the value of the property on which the activity is carried out has not been provided, and the only information provided on the value of 'other assets' was that the plant, machinery and improvements at written down value were significantly less than $100,000.

You have therefore not provided any evidence nor made any claim that your business activity meets any of the four tests in Division 35.

The exception in subsection 35-10(4) applies where (a) the activity is a primary production business and (b) the assessable income of the taxpayer that does not relate to that activity is less than $40,000. The exception to subsection 35-10(2) does not apply.

As you are not evidently excepted from Division 35 under subsection 35-10(4), and similarly you have not demonstrated that that you have passed any of the tests in subsection 35-30, 35-35, 35-40 or 35-40, then it follows that subsection 35-10(2) will operate to preclude you claiming a deduction for your non-commercial business losses unless the Commissioner exercises a discretion under subsection 35-55.

You indicated in your application for the private ruling that your basis for the application for the Commissioner's discretion was 'The nature of your activity'. This indicates that you have applied for the discretion under subsection 35-55(1)(b) or subsection 35-55(1)(c).

For the 2005-06, 2006-07, 2007-08, and 2008-09 income years, the relevant discretion is subsection 35-55(1)(b), being:

The Commissioner may decide that the rule in section 35-10(2) does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply the rule because...

(b) for an applicant who carries on the business activity who satisfies

subsection 35-10(2E) (income requirement) for the most recent income year ending

before the application is made - the business activity has started to be carried on

and, for the excluded years:

(i) because of its nature, it has not satisfied, or will not satisfy, one of the tests set out in section 35-30, 35-35, 35-40 or 35-45; and

(ii) 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 either meet one of those tests or will produce assessable income for an income year greater than the deductions attributable to it for that year…

For the 2009-10 and later income years, as you have not satisfied the subsection 35-10(2E) income requirement for the most recent income year ending before the Application was made, the relevant discretion is contained in subsection 35-55(1)(c), being:

c) for an applicant who carries on the business activity who does not satisfy

subsection 35-10(2E) (income requirement) for the most recent income year ending

before the application is made - the business activity has started to be carried on

and, for the excluded years:

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

(ii) 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)).

For both subsection 35-55(1)(b) and subsection 35-55(1)(c) of ITAA 1997, the prime issue (presuming for the time-being that you are carrying on a business) is whether your activity will produce a profit within a commercially viable period.

The only information that you provided that could meet these requirements is a report from an independent source that predicts net profits in years 8, 10, 15, 25, 29, and 30. However, as noted in the 'Significant commercial purpose' part of this ruling, the report has the following serious errors or incorrect assumptions:

§ the report does not accurately record the hectares planted;

§ the report does not analyse all the types of trees you planted;

§ the report includes income form sale of hay when no such income is evident from the other information you provided;

§ the report shows income from carbon trading which is not elsewhere supported by your application; and

§ the estimated costs in the report are significantly less than your actual expenses certain income years.

Accordingly, you have not demonstrated an objective expectation based on evidence from independent sources that your activity/activities will produce a profit within a commercially viable period.

In conclusion therefore, the Commissioner will not exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 from the years ending 30 June 2006 to 30 June 2029.