Edited version of private ruling

Authorisation Number: 1011760048412

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Ruling

Subject: Non-Commercial Losses - Special Circumstances

Question

Will the Commissioner exercise the discretion under paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include the loss from your primary production business in the calculation of your taxable income for the 2009-10 financial year?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 1998

Relevant facts

You conduct a primary production business.

You incurred a loss from your business in the 2009-10 financial year due to produce failing as a result of a drought.

According to data provided by a government department the area where your farm was located was in drought for a substantial period.

Your business is very water dependent with crop yields directly related to the availability of water from irrigation and rainfall.

You have provided figures which showed your business would have made a tax profit for the 2009-10 financial year but for the drought.

Your tax returns for the two financial years prior to the drought show the business made tax profits in those years.

You do not meet the <$250,000 income requirement under Division 35 of the ITAA 1997 for the 2009-10 financial year due to a large capital gain you received in that year.

Relevant legislative provisions

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

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

Reasons for decision

Summary

Based on the evidence provided, the Commissioner accepts that but for special circumstances (being the drought), your primary production business would have made a tax profit in the 2009-10 financial year. Therefore, the Commissioner will exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 to allow you to allow you to include the loss from your primary production business in the calculation of your taxable income for the 2009-10 financial year.

Detailed reasoning

Division 35 of the ITAA 1997 prevents losses from non-commercial business activities (being conducted by an individual or a partner in a partnership) being offset against other assessable income in the year the loss is incurred. The loss is deferred unless:

You satisfy the income requirement under section 35-10(2E) of the ITAA 1997 and pass one of the following four tests:

(a) at least $20,000 of assessable income in that year from the business activity (assessable income test)

(b) the business activity results in a taxation profit in three of the past five income years (profits test)

(c) 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 (real property test), or

(d) at least $100,000 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 (other assets test) or

(e) the Commissioner exercises his discretion (special circumstances or lead time) or

(f) you meet the exception test (can only be met if the activity is a primary production or a professional arts business and your assessable income from that year from other sources that do not relate to that activity is less than $40,000).

The income requirement under section 35-10(2E) of the ITAA 1997 is met 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.

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 of the tests is passed (including the income test under subsection 2E), the discretion is exercised, or the exception applies.

Are you carrying on a business?

Your activities will only be subject to these provisions if it is carried on as a business. You stated in your private ruling application that your activity was carried on as a business. This ruling is made on the basis of accepting this claim.

Application of section 35-55 of the ITAA 1997 (Commissioner's discretion) to this arrangement

As your activity has commenced, and is carried on as a business, it is subject to the provisions in Division 35 of the ITAA 1997.

It appears from your application that you believe special circumstances affected your business. The conditions under paragraph 35-55(1)(a) of the ITAA 1997 (special circumstances) will now be addressed.

As you did not pass the income requirement you not only need to demonstrate special circumstances affected your business, but you also need to show that the special circumstances prevented you from making a tax profit.

Special Circumstances

Paragraph 35-55(1)(a) of the ITAA 1997 sets out the first arm of the Commissioner's discretion as follows:

The Commissioner may, on application, decide that the rule in subsection 35-10(2) does not apply to a business activity for one or more income years… if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

(a) the business activity was or will be affected in that or those income years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster;
Note: This paragraph is intended to provide for a case where a business activity would have satisfied one of the tests if it were not for the special circumstances.

Paragraph 35-55(1)(a) of the ITAA 1997 refers to 'special circumstances' outside of the control of the operators of the business activity. No exhaustive definition is given of 'special circumstances' but the paragraph does include drought, bushfire and other natural disasters.

The question of what constitutes 'special circumstances' has been judicially considered on many occasions. In the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation:

Those discretions are intended to be applied to a great variety of situations. In such a context, the core of the idea of 'special circumstances' is that there is something unusual or different to take the matter out of the ordinary course…

Later, in the Federal Court Case of Secretary, Department of Employment, Education, Training & Youth Affairs v. Barrett and Another (1998) 82 FCR 524 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed that:

The word 'special' must be read in context. In normal parlance it signifies that the event or circumstances in question are out of the ordinary or normal course.

Tamberlin J then quoted the following passage with approval from the AAT case of Re Beadle and Director-General of Social Security (1984) 1 AAR 362; (1984) 6 ALD 1:

An expression such as 'special circumstances' is by its very nature incapable of precise or exhaustive definition. The qualifying adjective looks to circumstances that are unusual, uncommon or exceptional. Whether circumstances answer any of these descriptions must depend upon the context in which they occur. For it is the context which allows one to say that the circumstances in one case are markedly different from the usual run of cases. This is not to say that the circumstances must be unique but they must have a particular quality of unusualness that permits them to be described as special.

It can be seen that to determine what are 'special circumstances', we need to look at the context in which the phrase is used. Also, it is clear that 'special circumstances' will be something out of the ordinary or unusual. 'Special circumstances' in paragraph 35-55(1)(a) of the ITAA 1997 is used in the context of a situation occurring such that it would be unreasonable for the Commissioner to apply the loss deferral rule for a particular year or years.

For this to be the case for a taxpayer who does not meet the <$250,000 income requirement, it will not only be necessary that an event or situation has occurred which is of itself unusual, but that it has resulted in the business activity failing to make a tax profit. Clearly, if the business activity would not have made a tax profit even if the event or situation had not arisen, we cannot say that the business activity was affected by 'special circumstances' in the sense in which this term is used in paragraph 35-55(1)(a).

In Taxation Ruling TR 2007/6, the Commissioner provides guidance to taxpayers in what he considers to be special circumstances for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. Apart from drought, flood and bushfire which are specifically mentioned in the legislation, it may also include:

· earthquakes

· hailstorms

· an oil spill

· a chemical spray drift

· a gas plant explosion

· a power plant shutdown

· a water authority malfunction

· government authority restriction imposed on land use, or

· other events (for example, illness of the operator or employee(s)) which have significantly affected the ability of the operator to carry on the business activity.

In application to your case you have requested that the Commissioner exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 in the 2009-10 income year. The discretion is designed to allow for cases where unusual circumstances occurred.

Your properties were in drought for a significant period. Your business is very water dependent with crop yields directly related to the availability of water from irrigation and rainfall. Consequently your income from cropping in the 2009-10 income year was well below what was expected. As a result of the low income and increased expenses you made a loss in that year.

The Commissioner will exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 as we accept that the drought constitutes special circumstances and but for these special circumstances your business activity would have made a tax profit in the 2009-10 financial year. Therefore, you are not required to defer the losses your business made in the 2009-10 financial year.