Edited version of private ruling

Authorisation Number: 1011766893519

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Ruling

Subject: Non-commercial losses - Commissioner's Discretion

Issue 1

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 activities in the calculation of your taxable income for 2007-08 income year?

Answer

Yes.

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 to allow you to include any losses from your business activities in the calculation of your taxable income for 2008-09 income year?

Answer

Yes.

This ruling applies for the following years:

Income year ending 30 June 2008

Income year ending 30 June 2009

The scheme commences on:

1 July 2007

Relevant facts and circumstances

You purchased a property a few years ago with the intention of commencing an agricultural business.

It was established in our original private ruling that the lead-time expected in your agricultural industry. This is based on information you provided from a state government department.

In our private ruling we decided that you did not qualify for Commissioner's discretion in relation to lead time for the 2007-08 income year or because of special circumstances for the 2008-09 income year.

You objected to this decision.

You have provided new facts that materially alter those considered in your original ruling. Therefore we cannot consider your case as an objection. We will consider your application as a new private ruling request based on the new circumstances provided for your arrangement.

You provided written confirmation of the withdrawal of your objection and a request to consider your submission as a new private ruling application.

In the 2007-08 income year you were applying for Commissioner's discretion on the basis of lead time in your specific industry which you claim affected your ability to meet the assessable income test under section 35-30 of the ITAA 1997.

For the 2008-09 income year you applied for Commissioner's discretion on the basis of special circumstances (drought) that affected your ability to meet the assessable income test.

The previous owners of the property had established a similar business. They had received the required aquaculture and primary producer licenses.

These licenses were transferred to you as part of the property purchase.

The previous owners had ceased their business operations prior to your purchase; therefore, you did not purchase the property as a going concern. However, stock was included in the property purchase.

You stopped all production later.

You have stated that for the first 12 months, you spent three days a week at the farm and later, you began living on the farm.

You also employed others to work on the farm for periods of between three and six months.

Initially, you provided the following information:

· your business plan

· profit and loss statements for the 2007-08 and 2008-09 income years.

· independent evidence from a state government department on your industry which suggests the growout time for this type was supplied

· monthly rainfall figures for the region, taken from the Bureau of Meteorology website, for the period.

· additional information requested.

You have responded to a number of statements that appear in your original private ruling request.

In your objection you highlight the text from our reasons for decision from your original private ruling:

In response to this ruling, you state that you did not purchase an operational or viable business because the previous owner had not operated the business for a number of years, and there existed no significant commercial purpose, business plan, business intention and no purpose of profit.

You also state that when the property was purchased there was still approximately X of stock, but many of these were unsuitable for breeding or sale due to the previous owner not paying attention to their condition for a period of years. This initial stock was not commercially viable or up to commercial standards.

Thirdly, you state that in order to make the venture viable and sustainable, you had to use the existing suitable mature stock as brood stock and then build them up. You state that this would allow the business - after X months - to commence sales of new and fresh stock at a commercial standard, which you state is consistent with your business plan.

You state that this was not a decision you were able to make as the water was provided by adjacent dams via pumps. You state that the pumps were not switched on because there was insufficient water in the dams to pump. While you could have decided to run the pumps, the lack of water in the dams would have resulted in no change to the water level and it is likely that this would have also damaged the pumps.

You state that ultimately the lack of water in the dams was a direct result of lack of rainfall during the 2007-08 and 2008-09 income years.

You state that while this unfortunate event is true, it must be put into perspective. Some of the stock perished in this event.

You have provided the following new information with your request for a private ruling:

Rainfall charts for the surrounding stations near your property located.

Background

The area where your property is located is reported as being a locality within the XXXX Shire.

According to external online sources, the region where your property is located has significant history as viable agricultural land, with crops and cattle grazing being prominent agricultural industries in the area.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Division 35

Income Tax Assessment Act 1997 - section 35-10

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 35-45

Income Tax Assessment Act 1997 - section 35-55

Reasons for Decision

Non-commercial loss

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:

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

· one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 is met, or

· if one of the tests is not satisfied, the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

The object of Division 35 of the ITAA 1997 is to prevent losses from non-commercial activities that are carried on as businesses by individuals (alone or in partnership) from being offset against other assessable income in the income year that the loss was incurred.

The rule in subsection 35-10(2) of the ITAA 1997 defers losses from business activities unless the activity satisfies one of the business tests or is eligible for an exception or the Commissioner exercises the discretion under paragraphs 35-55(1)(a) or 35-55(1)(b) of the ITAA 1997.

The first arm of the discretion in paragraph 35-55(1)(a) of the ITAA 1997 relates to 'special circumstances' applicable to the business activity, and has no relevance for the purposes of this private ruling.

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

(i) the business activity has started to be carried on

(ii) because of its nature it has not met one of the tests set out in Division 35 of the ITAA 1997, and

(iii) 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.

Taxation Ruling TR 2007/6 provides detailed guidance on the application of the Commissioner's discretion provided in subsection 30-55(1) of the ITAA 1997. The ruling provides guidance on the circumstances where Commissioner's discretion may be warranted where an individual taxpayer's business activity does not satisfy any of the Non-commercial losses business tests due to special circumstances or industry specific lead-time.

Special Circumstances

Paragraph 12 of TR 2007/6 states that the Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the financial year(s) in question where the business activity is affected by special circumstances outside the control of the operator of the business activity.

Special circumstances are those circumstances which are sufficiently different to distinguish them from the circumstances that occur in the normal course of conducting a business activity. Ordinarily, special circumstances are those which have materially affected the business activity, causing it to not satisfy any of the four tests in Division 35 of the ITAA 1997. Special circumstances must be outside the control of the operators of the business activity, which may include drought, flood, bushfire or some other natural disaster (refer to paragraphs 13 and 14 of TR 2007/6).

Paragraph 15 of the TR 2007/6 states that a discretion can be exercised in income years after the one in which the special circumstances occurred if the effects of those special circumstances continue to prevent the business activity from satisfying any of the tests in those later income years. However, there may be situations where the special circumstances, because of their continued existence, become the ordinary or usual situation. It would not be appropriate to exercise the discretion once this occurs.

However, substantial unexpected fluctuations of a scale not regularly encountered previously may qualify on a case by case basis (refer to paragraph 47 of TR 2007/6).

Lead Time

The Commissioner may exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 for a business activity that has started to be carried on, where for the income year(s) in question:

· because of its nature, it has not satisfied, or will not satisfy any of the tests; and,

· there is an objective expectation, based on evidence from independent sources (if available) that, within the period that is commercially viable for the industry concerned, the activity will satisfy one of the tests or produce a 'tax profit'.

Paragraph 17 of TR 2007/6 states that for the failure to satisfy one of the four tests to be 'because of its nature', the failure must be because of some inherent characteristic that the taxpayer's business activity has in common with other business activities of that type (see Federal Commissioner of Taxation v. Eskandari (2004) 134 FCR 244; 2003 ATC 4782: (2003) 53 ATR 614).

Paragraph 18 of TR 2007/6 further states that where the activity's failure to satisfy a test is because of such an inherent characteristic, the requirement in subparagraph 35-55(1)(b)(i) of the ITAA 1997 will be met for any income year within the period from the time the business activity starts to the end of the last income year in which that characteristic still affects the activity's ability to satisfy a test (the 'initial period').

Paragraph 19 of TR 2007/6 states that where this initial period has passed, any continuing failure to satisfy a test will be for reasons outside of subparagraph 35-55(1)(b)(i) of the ITAA 1997, and the discretion will not be exercised (unless the special circumstances limb is satisfied).

Application of law to your circumstances

2007/08 income year - Lead Time

You purchased a property with the intention of commencing an agricultural business.

It was established in our original private ruling that the lead-time expected in your agricultural industry. This is based on information you provided from a state government department.

In our original private ruling we decided that you did not qualify for Commissioner's discretion in relation to lead time for the 2007-08 financial year.

In response to this ruling, you state that you did not purchase an operational or viable business because the previous owner had not operated the business for a number of years, and there existed no significant commercial purpose, business plan, business intention and no purpose of profit.

You state that when the property was purchased there was still approximately X of stock, but many of these were unsuitable for breeding or sale due to the previous owner not paying attention to their condition for a period of years. This initial stock was not commercially viable or up to commercial standards.

You also state that in order to make the venture viable and sustainable, you had to use the existing suitable stock as brood stock and then build them up. You state that this would allow the business - after X months - to commence sales of new and fresh stock at a commercial standard, which you state is consistent with your business plan.

While you did buy a property where an agricultural business venture had once taken place, a period of years had elapsed between the time that the property had been used in an agricultural business by the previous owner and the time that you acquired the property.

In that time you contend that no effort had been made by the previous owner to maintain the viability of the property or to maintain the stock that was left when the previous owner ceased their business venture. Therefore, while a similar activity had once taken place at the property, you acquired the property in a state where you contend you virtually had to start the activity again from the beginning.

The normal lead time expected in your industry is about X months. In this case you are contending that the lead time that applied is approximately Y months which seems reasonable given the initial - but poorly maintained - stock on acquisition of the land.

Therefore, with consideration of the facts of your arrangement for the 2007-08 financial year we accept that there was lead-time that was within the normal lead time expected in your industry that prevented you from meeting one of the non-commercial losses business tests in this income year.

Therefore, we accept that there are sufficient grounds in your case to warrant Commissioner's discretion in the 2007-08 financial year.

This decision overrules that provided in the previous private ruling issued to you which was considered based on incomplete information.

2008-09 income year - Special Circumstances

In the original private ruling issued to you we advised that we did not believe there were sufficient special circumstances in the 2008-09 financial year to warrant Commissioner's discretion under subsection 35-55(1) of the ITAA 1997.

You have provided evidence that demonstrates that you purchased the property on which you were going to commence the business at a time when drought had already been declared for the shire within which the property was located. Drought was declared in your area and you state that you purchased the property after this date.

This may indicate that you were aware before commencement of the business that drought or low-rainfall conditions prevailed in the region and that these conditions may affect the viability of your business venture.

It is unclear from your submission whether you considered these declared drought conditions an extraordinary event for the region, or part of the normal prevailing weather conditions of the region.

You state that this was not a decision you were able to make as the water was provided by adjacent dams via pumps. You state that the pumps were not switched on because there was insufficient water in the dams to pump. While you could have decided to run the pumps, the lack of water in the dams would have resulted in no change to the water level and it is likely that this would have also damaged the pumps.

You state that ultimately the lack of water in the dams was a direct result of lack of rainfall during the 2007-08 and 2008-09 financial years.

You contend that you did not satisfy the assessable income test in the 2008-09 income year because of the special circumstances of drought, or alternatively a severe and extended dry-weather event thereby satisfying the criteria for the Commissioner's discretion under subsection 35-55(1) of the ITAA 1997.

You have also provided rainfall charts for surrounding locations that demonstrate unusually low rainfall for the whole of the 2008 financial year.

You have also provided evidence that the shire within which your property is located was drought declared.

Based on these facts, it is considered that there was unusually low rainfall in your area. There was no significant rainfall to break the conditions which were as of specific date declared as a drought by the state government.

Given that the region in question normally receives sufficient rainfall to yield successful crops, we accept that a significant and unusual low-rainfall weather event and at some times during this period this low-rainfall weather event was declared a drought by the state government.

Therefore, we accept that there were special circumstances that existed in the 2008-09 financial year that prevented your business activity from successfully satisfying any of the non-commercial losses business tests in this financial year.

This decision overrules that made in your previous private ruling which was based in incomplete information.