Edited version of private ruling

Authorisation Number: 1011725663706

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Ruling

Subject: Non-commercial losses

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include your share of any losses from the new primary production activity in your calculation of taxable income for the income year?

Answer: No.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

Background

You are conducting primary production activities on several properties. The new activity is carried on in partnership on one property, while the original activity is carried on by you as a sole trader on your other properties. The property on which the new activity is carried on is some distance away from the other properties.

Both activities are similar in nature.

Original primary production activity

You commenced this activity a number of years ago.

This activity has not made a profit for quite a few years.

New primary production activity

You have recently started a similar type of activity on another property. This property was purchased recently for the sole purpose of establishing this activity.

You joined a local association for this type of activity.

In the current year you have spent a considerable amount of money on fixing the run down property and this includes the purchase of assets to help set up the activity. You have also undertaken considerable repairs and maintenance to fences, buildings and equipment.

You have stated that you are unable to provide the income and expense statements and stock trading accounts for the future years as you do not know how external factors will affect the sales.

You have incorporated the income and expenses of both activities in the income tax returns you have previously lodged.

You did not keep separate accounts for the two activities, however the accounts are currently being separated, and separate accounts will be kept in the future.

The new activity will show a loss for the current income year.

The activities use different assets, have different commercial risks and there are differences in the type of goods produced.

You have forwarded a letter from an expert in the new activity. This expert states that for anyone undertaking to set up this type of activity, it is going to be about a program over a number of years.

The new activity has a substantial interest expense.

Your tax agent is working with you to make this venture profitable within the lead time, and is meeting with you regularly and helping you with controlling costs etc. so that you can start making a profit.

As you have not satisfied the income requirement in subsection 35-10(2E) of the ITAA 1997, you have requested the Commissioner to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the income year for the new primary production activity.

Relevant legislative provisions

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

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

Income Tax Assessment Act 1997 Section 995-1

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

The Commissioner will exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for an applicant who does not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 if certain requirements are satisfied for the year concerned.

For the discretion to be exercised, the business activity must have 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) of the ITAA 1997).

The note to subsection 35-55(1) of the ITAA 1997 states that paragraphs 35-55(1)(b) and 35-55(1)(c) of the ITAA 1997 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.

In some cases, the question might arise whether an individual taxpayer is carrying on the one business, or whether they are carrying on separate and distinct business activities for non-commercial loss purposes. Taxation Ruling TR 2001/14, which discusses non-commercial business losses, provides guidelines at paragraphs 40 to 54 and 83 to 88 to assist in determining this question.

Are you carrying on separate business activities?

Division 35 of the ITAA 1997 applies to activities that are carried on as a business and while the meaning of the term business is defined in section 995-1 of the ITAA 1997, the meaning of the composite term 'business activity' is not. The inclusion of the extended definition of business in the composite term does not, however, alter the ordinary meaning of the composite term in any significant way. That ordinary meaning is an activity forming part or all of the taxpayer's activities 'engaged in for the purpose of profit on a continuous and repetitive basis' (Hope v. The Council of the City of Bathurst 80 ATC 4386 at 4382; (1980) 12 ATR 231 at 236), or an activity that is one of the activities that makes up the 'course of conduct' (FC of T v. Murry 98 ATC 4585 at 4596; (1998) 39 ATR 129 at 145) that is the taxpayer's business.

However, a business can consist of one or more business activities. In Allied Mills Industries Pty Ltd v. FC of T 88 ATC 4852 at 4864; (1988) 19 ATR 1724 at 1737, Gummow J acknowledged that a taxpayer might carry on 'several distinct businesses'. Gummow J stated:

Viewed in the light of the conduct of *business of the taxpayer as a whole, one cannot sensibly say that the taxpayer went out of *business or that the taxpayer parted with a substantial part of its *business undertaking, or that its profit-making apparatus was materially crippled.

It may be that activities of a taxpayer are so disparate in character and so discrete in the manner they are conducted, that one properly asks questions of the type posed by the facts of this case by reference to some but not the whole of those activities; examples of several distinct *businesses conducted by one taxpayer may be provided by the Board of Review decisions Case H100 (1956) 8 T.B.R.D. 457 (retail jeweller and real estate letting agent) and Case N38 (1962) 13 T.B.R.D. 161 (printer and seller of goods on commission)…

Paragraph 43 of TR 2001/14 states that to be identified as a separate business activity for Division 35 of the ITAA 1997, the activity (or set of activities) will need to exhibit the following:

· it produces a loss, in the sense that looked at as a separate activity there is clearly assessable income produced, or intended to be produced, from it, and otherwise allowable deductions attributable to carrying it on in excess of that income

· its conduct is not motivated by factors connected with supporting in any commercial way the carrying on of the individual's other business activities and

· it shows signs in its own right that it is unlikely to ever be profitable.

All of these requirements need to be satisfied, though the greatest weight would typically be given to the last two.

The table in paragraph 45 of TR 2001/14 summarises some of the factors that may be relevant to whether a business is made up of separate and distinct business activities for non-commercial loss purposes. The factors summarised are location, assets used, goods/services produced (including market conditions), interdependency and commercial links. The list is not meant to be exhaustive.

Applying these guidelines to your circumstances, the following factors would indicate that the two activities are separate and distinct business activities:

· Use of different assets

· Different commercial risks

· Differences in the type of goods produced

· In view of the distances between the original and new activity, there is no interdependency.

· The activities are carried out from different locations.

· Financial separation of the activities - one is conducted as a sole trader and the other in partnership and separate accounts for each activity are currently being prepared.

In view of the activities being separate in nature, the lead time for the new activity would be looked at as a single activity.

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 in relation to the new primary production activity?

In order to determine whether the Commissioner will exercise this discretion, we will need to determine if the abovementioned requirements have been satisfied.

Business activity started to be carried on

The first requirement to be satisfied is that the business activity must have started to be carried on.

The new activity has started to be carried on and this requirement is satisfied.

Nature of the business activity

The second requirement to be satisfied is that, for the excluded years, the business activity has not produced, or will not produce assessable income greater than the deductions attributable to it because of its nature.

Paragraphs 77 and 78 of Taxation Ruling TR 2007/6, which discusses non-commercial business losses and the Commissioner's discretion, state:

77. Therefore, 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.

78. The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity…

You have forwarded a letter from an expert who has been involved with this type of activity. This expert states that for anyone undertaking to set up this type of activity, it is going to be a program over a number of years.

As you only recently commenced the new activity, it is accepted that your current loss from the activity is as a result of the nature of the activity.

This requirement is therefore satisfied.

Objective expectation about future performance

The third requirement to be satisfied is that the Commissioner must be satisfied that an objective expectation exists that the business activity will in some future income year falling within a period that is commercially viable for the industry concerned, produce assessable income for an income year greater than the deductions attributable to it for that year. The objective expectation must be based on independent information, where such information is available.

You have not shown that the new activity will show a profit within the commercially viable period for your particular industry. No business plan or financial forecasts have been presented by you to show when you expect your activity to be profitable. These documents can be prepared despite the fact that unforeseen external factors might affect the forecasts at a later time.

You have therefore not shown that the relevant objective expectation about future performance exists in this case, and this requirement is not satisfied.

Lead time

This type of activity would typically have a lead time from commencement up to the initial sales. Your business activity is therefore of a kind contemplated by the note to subsection 35-55(1) of the ITAA 1997.

Conclusion

Although your business activity is of a kind contemplated by the note to subsection 35-55(1) of the ITAA 1997, the activity does not satisfy all of the relevant requirements in paragraph 35-55(1)(c) of the ITAA 1997. The requirement in relation to the objective expectation about future performance has not been satisfied in this case.

The Commissioner will therefore not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include the loss from your new primary production activity in your calculation of taxable income for the income year.

Note

In your case, the loss from your business activity that can not be taken into account in a particular year of income under the non-commercial loss provisions is quarantined, and can only be applied against assessable income from this business activity in future income years.