Edited version of private ruling

Authorisation Number: 1011772345046

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Ruling

Subject: Non-commercial losses

Question 1

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

Answer

No.

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include any loss from your 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

You commenced a primary production activity a number of years ago.

The activity has not been profitable for some time due primarily to the impact of drought and low prices. Management took the view that you needed to preserve the blood lines. In addition, where possible you have leased or acquired additional land proximate to the home paddocks, resown grass paddocks, cleaned out dams, repaired fences, purchased farm equipment and repaired stock yards and sheds.

In addition, the property has been subject to extensive clearing over the years to the extent that there was very little natural bushland remaining. You have sought to employ sustainable development approaches to the land usage including reafforestation of erosion areas in conjunction with local land care groups. In short term this sterilises part of the land as it is required to be fenced off while the reseeded areas advance. These are part of the long term decisions where investment is required to bring the property to a sustainable commercial operation. The potential for carbon credits for reafforestation is also a future profitable activity available to the property.

All of this work was undertaken to make the property commercial. It is now one of the largest primary production properties in the region.

The recent good rains in your region have filled your dams and the season has been good, putting you in a good position to rebuild.

The gross sales have consistently been greater than $250,000 each income year.

The activity showed a loss for the income year.

The following has been implemented as part of your business plan to have a sustainable business activity due to the drought conditions:

· the dams have been repaired, widened and deepened, solar pumps installed, and major works on the dam were necessary after the bushfires

· an application for a bore was made

· paddocks have been subdivided for more efficient feed utilisation

· increase in the regions for open hay production in order to decrease reliance on bought hay

· the bloodlines have been maintained

· additional adjoining land was purchased in order to increase the operations of the business

· the decision has been made to diversify

· stockyards have been repaired and extended to allow for the increase in numbers.

In addition, certain expenditures were incurred in the income year as follows:

· clearing out dams to assist with the drought proofing

· dry shifting soils caused considerable problems with the outbuildings, some of which had to be replaced or repaired

· purchase of solar pumps and associated piping and

· application for a bore licence.

Bushfires occurred in many areas in the state including the area where this property is located. Many properties were affected.

Some years had higher and lower average rainfalls. A recent year was the warmest year on record with a higher than average temperature and below average rainfall.

The special circumstances relating primarily to the drought conditions have necessitated careful long term planning and accordingly certain expenditures were required and these include but are not limited to the following:

· the purchase of more land

· diversification to take advantage of the stronger economic market

· invested in cleaning out dams to increase resistance to drought

· invested in vegetation initiatives to reintroduce regional trees to assist in the prevention of soil erosion and provide shelter for live stock

· repaired fencing as long term investment in farm maintenance

· encouraged by investment incentives purchased more machinery to enhance productivity

· tested variation in payable products

· continued to maintain flock and bloodlines during the drought and

· invested in machinery to assist in livestock feeding efficiency.

You consider that for the future, although in this type of business a certain amount of uncertainty must exist, the following points are relevant:

· forecast of rising demand and a shrinking global herd will boost prices for the foreseeable future

· rising prices forecast particularly in the category produced

· outlook for rainfall is strong for the foreseeable future allowing greater numbers to be retained whilst stocks are rebuilt for the higher carrying capacity and

· inflation predicted to remain low.

Excluding depreciation, the activity broke even or made a profit in some of the recent years.

The activity is not expected to show a profit for several more years.

The value of the property and other assets used on the property exceed $500,000 and $100,000 respectively, and both the real property test and the other assets test are satisfied.

You have not satisfied the income requirement in subsection 35-10(2E) of the ITAA 1997 for the income year.

Relevant legislative provisions

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

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

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

Question 1

For those individuals who do not satisfy the income requirement special circumstances are those which have materially affected the business activity, causing it to make a loss. As per paragraph 13A of TR 2007/6, for these individuals the Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the income year(s) in question where:

· but for the special circumstances, the business activity would have made a tax profit and

· the activity passes at least one of the four tests or, but for the special circumstances, would have passed one of the four tests.

Special circumstances

Taxation Ruling TR 2007/6, which provides guidelines in relation to non-commercial business losses, discusses 'special circumstances' at paragraphs 40 to 66.

This ruling states that ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances. These fluctuations are expected to occur on a regular or recurrent basis when carrying on a business activity and affect all businesses within a particular industry. However, substantial unexpected fluctuations of a scale not regularly encountered previously may qualify on a case by case basis.

Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to 'special circumstances' as including drought, flood, bushfire or some other natural disaster. These events are taken to be special circumstances outside the control of the operators of the business activity.

The special circumstances must have affected the business activity.

In your case, you carry on a primary production activity. You state that your activity was affected by the drought during the income year. The drought conditions have existed for a number of years. This is a factor outside of your control, and it is accepted that this is a special circumstance as discussed in TR 2007/6 above.

Tax profit for the income year

In this case, if depreciation had been excluded, your activity would have broken even or made a profit in only some of the recent years. The activity has generated losses for a number of years and your projected income and expenditure shows that you do not expect the activity to show a profit for several more years. The activity showed a substantial loss for this income year.

Your activity has not made a tax profit for a number of years, and you have not shown that, but for the special circumstances, your activity would have made a tax profit in this income year.

This requirement is not satisfied.

The four tests

The four tests in question are contained in sections 35-30, 35-35, 35-40 and 35-45 of the ITAA 1997.

The assessable income test in section 35-30 of the ITAA 1997 requires that the amount of assessable income from the business activity for the year is at least $20,000. You have advised that your assessable income from the activity for the 2009-10 income year was in excess of this amount, which means that the assessable income test would have been satisfied.

Your application also indicates that the activity passes the real property test in section 35-40 of the ITAA 1997, and the other assets test in section 35-45 of the ITAA 1997.

It is therefore accepted that your activity either passes at least one of the four tests, or would have passed one of the four tests but for the special circumstance discussed above.

Conclusion

As you have not shown that, but for the special circumstances, your activity would have made a tax profit in the income year, the Commissioner will not exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997 for this income year.

Question 2

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 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.

You have stated that your business activity commenced a number of years ago 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.

The profit and loss statement provided by you shows that the business activity will not produce assessable income greater than the deductions attributable to it in the income year.

Paragraphs 77 and 78 of Taxation Ruling TR 2007/6 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…

Your business activity commenced a number of years ago. Your profit and loss statement indicates that you have received substantial income from your activity in every recent income year, including the current income year. This would indicate that there are no inherent characteristics of the activity still preventing you from making a profit in the current income year.

Factors such as leasing and acquiring additional land, resowing paddocks and repairs are not inherent characteristics of the activity.

Paragraph 80 of TR 2007/6 states:

80. The identification of this 'initial period' may often involve some practical difficulty particularly where causes other than an inherent characteristic appear to be another reason why the business activity is unable to satisfy a test or produce a tax profit for a particular income year. Where both an inherent characteristic and some other factor are identified, this in itself will not mean that the requirement in subparagraph 35-55(1)(b)(i) and (c)(i) is no longer met. It is only where it is clear that the reason the activity is unable to satisfy a test is not because of any inherent characteristic, but because of some other factor, that this requirement will not be met.

In your case, inherent characteristics do not appear to be a factor in your not making a profit from the business activity for the income year. This would mean that under paragraph 80 of TR 2007/6, the requirement in relation to the nature of the business activity would not be satisfied, as the failure to satisfy this requirement is solely because of other factors.

This requirement is therefore not 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 provided any independent evidence for the period that is commercially viable for the industry. As your primary production activity commenced a number of years ago, it is considered that the lead time for your activity has passed and it no longer has any relevance to your activity. Additionally, the projected income and expenditure statement provided by you shows that you do not expect to show a profit from the activity for several more years, which would be well outside the expected commercially viable period for this type of activity.

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

Your activity would typically have a lead time and 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 requirements in relation to the nature of the business activity and objective expectation about future performance have 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 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 are quarantined.

Such losses will be able to be offset in later income years when either a profit is made, or you satisfy one of the tests along with the income requirement.