Edited version of private ruling

Authorisation Number: 1011787459822

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Ruling

Subject: non-commercial losses

Question

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 losses from your primary production activity in your calculation of taxable income for the 2009-10 to 2014-15 financial years?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on

1 July 2009

Relevant facts

The arrangement that is the subject of the Ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· your Private Ruling application,

· your business plan,

· income and expenditure details and forecasts for the relevant years, and

· Your state Department of Primary Industries articles on rejuvenating perennial pastures and sustainable carrying capacity.

You operate a primary production business.

The property has a total carrying capacity of X head and will produce X heads per year once fully operational.

You and your spouse operate the farm on a part time basis, with casual labour used for clearing and weed spraying as well as burning operations and bush fire control.

You employ up to X casual labourers in season. You rely on a retained professional for some skilled tasks and to oversee the operation on a general basis.

You carry out the general maintenance and repairs to roads, tracks and fences. You also do part of the clearing activities and routine operations.

Buying, selling and cartage of products are contracted.

The business has been operating on a permanent basis since its purchase from previous operators a few years ago.

The property was used at the time of purchase for farming, however the pastures have degenerated to bushland to varying degrees. A sufficient area of quality pasture is still present on the flats to establish a running business from year one.

Because of previous use, most of the infrastructure exists to support immediate operations and in sufficiently good working order to operate for a number of years before significant repair or replacement is required. Fences, yards, sheds and dams are in working order.

Capital outlay has been limited to minor capital items such as small farming instruments.

Some parts of the property may be agisted to other farmers, based on demand.

In the 2010-11 financial year, X breeders have been maintained successfully and produced a number of offspring. The practice will be extended to more breeders when another good quality paddock has been established.

With less than X% of the property currently cleared, a production of X heads has been achieved in the 2010-11 financial year.

Many dams are present on the property, providing sufficient water reserves in each paddock. In addition, creeks cross the property and compliment the dams. At the time of purchase, although a low rainfall year, none of the dams were empty. During the following dry year of 2009, sufficient drinking water for the animals was always available.

A number of tanks fed by rainfall from the shed will provide working water in more than sufficient quantity for spraying and watering in the yards.

The dry year in 2009-10 resulted in no heads being sold in that year due to adverse rainfall conditions preventing sufficient stock growth. In your business model you have factored in regular occurrences of these 'dry' years where the rainfall would support stock but without sufficient growth to allow normal turnover in that year. The rainfall statistics for your area indicate that one such 'dry' year has been observed every X years.

The heavy rains caused one creek to overflow in 2010-11. However this event did not affect your business greatly.

Regenerating pastures will be a priority to make the business profitable. Although break even point will be obtained quickly, the full regeneration of the available pastures is a priority and will be continued for the first X years of operations.

The pastures are currently essentially native grasses, although some improvement has been made to three paddocks and this pasture improvement is still visible despite weed invasion.

Millable timber is present on the property. Young timber is available for future milling.

The acquisition of the business was financed by selling other assets and by debt.

The debt repayment, as well as the initial negative cash flow will be funded from permanent employment income.

The negative cash flow in early years comes essentially from clearing activity and can be varied or slowed as required.

In the 2010-11 financial year you meet both the real property test and assessable income test.

You predict the business will be profitable in the 20XX-XX financial year at the end of clearing operations.

You do not satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Subsection 35-10(4).

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.

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

Reasons for decision

Summary

It is considered your clearing costs and failure to achieve a profit was not due to special circumstances referred to in paragraph 35-55(1)(a) of the ITAA 1997. Therefore the Commissioner will not exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997 and the losses from your business will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997.

Detailed reasoning

Division 35 of the ITAA 1997 applies to losses from certain business activities. 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,

· you satisfy subsection 35-10(2E) of the ITAA 1997 and one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 are met, or

· the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

Business activity

Your activity will only be potentially subject to Division 35 of the ITAA 1997 if it is carried on as a business. In your case, you advise that your primary production activity is carried on as a business.

Exception

Under subsection 35-10(4) of the ITAA 1997, there is an exception to the general rule in subsection 35-10(2) of the ITAA 1997 where the loss is from a primary production business activity or a professional arts business activity and the individual taxpayer has other assessable income for the income year from sources not related to that activity, of less than $40,000 (excluding any net capital gain).

In your case, the exception in subsection 35-10(4) of the ITAA 1997 has no application.

Subsection 35-10(2E) of the ITAA 1997

The income requirement in subsection 35-10(2E) of the ITAA 1997 applies from 1 July 2009 and will be met where the sum of the following amounts for an income year is less than $250,000:

· taxable income (ignoring losses subject to the non commercial loss rules)

· reportable fringe benefits

· reportable superannuation contributions

· net investment losses

You have advised that you will not satisfy subsection 35-10(2E) of the ITAA 1997 for the relevant years.

Therefore as you do not satisfy the income test and the exception does not apply, the losses from your activities will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997, unless the Commissioner exercises a discretion under section 35-55 of the ITAA 1997 that it would be unreasonable to defer the loss.

Paragraph 35-55(1)(a) of the ITAA 1997

Paragraph 35-55(1)(a) of the ITAA 1997 provides that the Commissioner may exercise a discretion where certain special circumstances apply.

Taxation Ruling TR 2007/6 sets out the Commissioner's interpretation of the exercise of the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997. It states:

For those individuals who do not satisfy the income requirement in subsection 35-10(2E) special circumstances are those which have materially affected the business activity, causing it to make a loss. For these individuals the Commissioner's discretion in paragraph 35-55(1)(a) 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 at least one of the four tests.

The special circumstances must be outside the control of the operators of the business activity. Such circumstances are specifically defined to include drought, flood, bushfire or some other natural disaster.

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 is clear that 'special circumstances' will be something out of the ordinary or unusual. 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) of the ITAA 1997.

The operators of the business activity must show that the special circumstances were outside their control. The concept of control was discussed in Secretary, Department of Employment, Education and Youth Affairs v. Ferguson (1997) 76 FCR 426; (1997) 48 ALD 593; (1997) 147 ALR 295 for the purposes of subsection 45(6) of the Employment Services Act 1994 . At 76 FCR 438; 48 ALD 603; 147 ALR 306, Mansfield J said:

The expression in s45(6)(a) requires that the main reason for the failure was something that the person had within that person's control. The concept of "control" in that context is one of fact, but I think it is intended to mean something which the person could have done something about….

It recognises the focus of the expression upon occurrences which the person concerned could not realistically prevent.

You advise that your area had a dry year in 2009-10 and no sales occurred in that year due to adverse rainfall conditions preventing sufficient growth. However, even if X sales occurred in that year and obtained $X income from sales, the business would still result in an overall loss for that year.

The heavy rains caused one creek to overflow in 2010-11. However this event did not affect your business greatly.

You have stated that the clearing costs of your land and regenerating pastures are the main circumstances that are stopping your business from being profitable.

It is acknowledged that the condition of the property may be unsuitable to reach the full carrying capacity for several years. However, the ongoing clearing costs were predicted to affect your farming activities for the initial X years.

In your case, the need for the clearing costs would be seen as a normal part of operating the business after the purchase of the property. That is, the 10 year regeneration plan is seen as part of the management process of your business activity.

The fact that the property is less than X% cleared is not considered to be special circumstances. It is not something that is sufficiently uncommon, unusual or out of the ordinary. The larger clearing costs are not considered to be special circumstances for the purposes of the non-commercial losses legislation. Your circumstances are not similar to increased expenses and/or decreased income caused by floods or bushfires.

Therefore the Commissioner does not consider your circumstances as being special circumstances that were unusual and outside your control. That is, as a farmer, your failure to make a profit was not due to special circumstances outside of your control, such as a natural disaster. The fact that much of your property has degenerated to bushland in varying degrees is not the kind of circumstance for which paragraph 35-55(1)(a) of the ITAA 1977 was enacted.

It follows that the Commissioner will not exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 to allow you to offset the losses made from your farming activities against your other assessable income for purposes of calculating your taxable income for the 2009-10 to 2014-15 financial years. The loss deferral rule will therefore apply to losses made from your business activity in those years.