Edited version of private ruling

Authorisation Number: 1011795317028

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Ruling

Subject: non-commercial losses

Question 1:

Was your partnership operating a business in the 2007-08 financial year?

Answer: No

Question 2:

Was your partnership operating a business from July 200X to April 200Y?

Answer: No

Question 3:

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow a partner who does not satisfy the income requirement to include any losses from their business in the calculation of their taxable income for the period from May 200Y to 30 June 200Y?

Answer: Yes.

Question 4:

Will the Commissioner exercise the discretion in paragraph 35-55(1)c) of the ITAA 1997 to allow a partner who does not satisfy the income requirement to include any losses from their business in the calculation of their taxable income for the 2009-10 financial year?

Answer: Yes.

Question 5

Is there any requirement for the Commissioner to exercise a discretion for the period May 200Y to 30 June in the subsequent year for a partner who meets both the income requirement and passes one or more of the tests set out in sections 35-30, 35-35, 35-40 and 35-45 of the ITAA 1997?

Answer: No

This ruling applies for the following periods

Year ended 30 June 2008

Year ended 30 June 2009

Year ended 30 June 2010

The scheme commenced on

1 July 2007

Relevant facts and circumstances

200X Financial year

You purchased a XX hectare property, a considerable portion is arable land. There is a house on the property. The approximate value of the house and surrounds was $X00,000 based on the assessment of a local agent.

You and your spouse are the registered title holders as joint tenants.

A loan was taken out in joint names for the purchase of the property.

A lease arrangement was entered into to lease out YY hectares to a third party at the rate of $X,000 per annum, plus maintenance of property and fences. The house and surrounds were not included in the lease.

It was your intention to farm fruit crops and run livestock.

You sought advice from various agricultural sources in relation to the trees that you intend to plant.

You have prepared a business plan and revised this plan based on research conducted.

Your intention was to leave your current jobs and sell your primary residence to repay all debts to enable the commencement of the business. The sale of the home would provide sufficient capital for rehabilitation and establishment of new crops.

You began research on what is required to rehabilitate existing trees and the planting of other crops.

200Y Financial year

Your Business Plan outlined what needed to be worked on to complete the plan and what further investment was required pending the sale of the home.

Activities 200Y

· · Soil tests were completed to determine suitability for fruit trees.  

· · The soil was treated. This was required before planting could be done in early spring.  

· · Fencing to keep livestock out of planting area was to be completed

· · Fertiliser costs were budgeted for and on back order for delivery prior to planting.  

You planted trees from October 200Y to December the subsequent year:

In the subsequent year:

One partner resigned from employment to operate the farm, undertaking all fencing, planting and general farm business.

You signed a lease agreement to lease out some of the farm for a certain period to the recent year.

The existing trees have been fenced off, irrigated and await renovation pruning in the winter of the recent year.

You completed a dam on the property in the recent year.

You ordered further trees .

Wind screening plantings are to be carried out.

You have also planted a "mini orchard" with various fruit trees that research shows should adapt well to local conditions none of these trees are included in tax accounts, until you are convinced of commercial viability, until then, you considered this orchard to be a hobby.

Reasons for Decision

Summary

You are not considered to be in business until the trees were ordered for planting, prior to that time there was only a plan and an intention. We consider that you business commenced in May 200Y.

Having regard to your full circumstances, from May 200Y, it is accepted that it is in the nature of your business activity to require a lead time and that there is an objective expectation it will produce a tax profit within a period which is commercially viable for this industry

Consequently the Commissioner will exercise his discretion in paragraph 35-55(1)(c) from May 200Y to 30 June the subsequent year to allow your non-commercial losses.

Detailed reasoning

Whether a business activity has started to be carried on

The actual date of commencement of a business is a question of fact (see Goodman Fielder Wattie Ltd v. FC of T 91 ATC 4438 at 4446; (1991) 22 ATR 26 at 35).

For a business activity to have commenced a person must have:

· · made a decision to commence the business activity;

· · acquired the minimum level of 'business assets' to allow that business activity to be carried on;

· · actually commenced business operations.

When a business activity commences is like the question of whether a business is being carried on at all and depends on the 'large or general impression gained'.

There must be more than an intention to commence a business. There must be activity. There must be the acquisition of the minimum level of 'business assets' and the commencement of 'business operations'. Both are necessary to be able to conclude that a business has commenced.

There must be a commitment in terms of the actual business to be commenced. For example, if trees are to be grown, the trees must be planted, or at least a firm order must be placed for trees. If livestock are to be raised, the livestock must be acquired, not just the land where the activity will be conducted.

An appropriate business structure should also be in place.

There are a number of cases that have looked at this question and what are considered to be preparatory expenses.

In Case N 101, 81 ATC 560, a taxpayer purchased rural land early in 1978 with the intention of establishing a macadamia nut plantation. He claimed that he was carrying on a business of primary production on the land during the year ended 30 June 1978 and the business commenced when he purchased the land. The only things that had been done by 30 June were preliminary steps such as arranging the supply of electricity to the property, drawing up irrigation layouts, initiating steps to propagate trees. These activities did not themselves amount to the carrying on of a business.

In Case 90, 85 ATC 656, a taxpayer purchased a property on which to conduct a nursery. He acquired certain equipment comprising a pump, post hole digger, rotary hoe, rotary slasher, mower and sundry other items. He carried out some preparatory work to ready the land for cultivation but further work was necessary to combat soil erosion and wind damage. At best the taxpayer's activities amounted to no more than preparing the land for nursery operations to be conducted at some unspecified time in the future. These activities did not constitute a business which would produce assessable income.

In Case Q 105, 83 ATC 530, the taxpayers, who were full-time teachers, purchased 1,200 acres of run down rural land in 1972. Over the next few years, several thousand dollars were spent on farm machinery used for land clearing, building roads and mending fences. Portable buildings were also acquired. Apart from a small amount of agistment income, no income was received from the property until 1979 when the property was first stocked with 120 sheep. It was held that the primary production business began when the sheep were first purchased. Until then the taxpayers' operations were of a preparatory nature.

Application to your facts

We are considering if you were carrying on a business in the period from the time of purchase of the property early in 200X to the end of May 200Y.

The planned business activity was growing a variety of trees and when you take up residence in November 200Y you intend to run your own livestock.

You acquired the XX hectare property in early 200X and entered into an agreement to lease out YY hectares of the property to another party.. The house and surrounding paddock was not leased out.

In September 200X you developed an initial discussion paper as to the viability of the planned activities. You have developed an extensive business plan and completed research into suitability of different crops for your soils, climatic conditions and available markets.

You have provided a copy of your 'Business Plan.

Trees had been ordered for delivery in time for planting in August 200Y.

For the period to end of May 200Y you were in the planning stage with no final decisions on the type of trees to be planted. Soil testing to assist in this decision making had not been completed until January 200Y. The preparation to get the soil into a suitable condition so that trees could be planted will not be completed until June/July 200Y.

When considering the factors above, it is considered that from the date of purchase until May 200Y year you have not acquired the minimum level of 'business assets' to allow that business activity to be carried on and you have not actually commenced business operations. You have not made any commitment in terms of purchasing any trees or stock.

Comparison of your circumstances to the above quoted cases also supports the conclusion that you were in the planning or preparatory stage and the business had not commenced.

Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

· · whether the activity has significant commercial purpose or character (this comprises aspects of some of the other indicators)

· · whether the taxpayer has more than just an intention to engage in business;

· · whether the taxpayer has a purpose of profit as well as a prospect of profit

· · whether there is repetition and regularity of activity

· · whether the activity is similar in kind and manner to those of the ordinary trade in that line of business

· · whether the activity is planned, organised and carried on in a businesslike manner directed at making a profit

· · the size, scale and permanency of the activity, and

· · whether the activity is better described as a hobby, a form of recreation, or a sporting activity.

It can be seen that a number of these factors cannot be applied to your situation for this period as there are no crops planted or no livestock being run. If we were to try and apply these factors, the general impression would have to be that a business is not being carried on. The scale cannot be determined, there is no repetition or regularity and it cannot be determined if it is carried on in a similar manner as there is only a plan and intention until the trees were ordered in May 200Y.

Holding costs of the property

Holding costs such as interest, borrowing expenses and rates may be deductible prior to the commencement of the relevant income earning activities. The Commissioner's view on this matter is set out in Taxation Ruling TR 2004/4.

It follows from Steele [Steele v. FC of T 99 ATC 4242; (1999) 41 ATR 139 (Steele) that interest incurred in a period prior to the derivation of relevant assessable income will be 'incurred in gaining or producing the assessable income' in the following circumstances:

· the interest is not incurred 'too soon', is not preliminary to the income earning activities, and is not a prelude to those activities;

· the interest is not private or domestic;

· the period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income are lost;

· the interest is incurred with one end in view, the gaining or producing of assessable income; and

· continuing efforts are undertaken in pursuit of that end.

In this case it would appear that each of these criteria has been met in the 200X income year. The property excluding the house and 1 hectare of surrounding land has been purchased with the intention of conducting a primary production business on the land. You have continued to complete research and develop plans with the view to commencing the operations. Your activity has been delayed somewhat due to financial circumstances while awaiting the sale of your house. The land has been leased out temporarily. You moved to the farm to live permanently in the recent year, you intended to start tree planting in August 200Y. You ordered the trees in May and June 200Y with the planting commencing in October 200Y.

Normally where a property is leased out for agistment purposes the amount of deductions is limited to the income derived. In this case it is only a temporary measure until you move to the property and there is the clear intention to carry on a business. It was not for the purpose of leasing it out.

The house and 1 hectare of land are used for private purposes. A value of approximately $X00,000 has been put on this section of the property. The deductions for interest, borrowing costs and rates are allowable, but will have to be apportioned to take into account the private component.

Because the property is jointly owned and the business is to be conducted jointly each party will only be entitled to their 50% share of these expenses.

Non Commercial losses

For the 2009-10 and later income years, division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless (relevant to this division):

· you meet the income requirement and you pass one of the four tests

· the exceptions apply

· the Commissioner exercises his discretion.

In your situation, one partner meets the income requirement and passes one of the four tests and consequently there is no requirement for the Commissioner's discretion from May 200Y to 30 June 20ZZ.

The second partner does not meet the income requirement (that is, their taxable income, excluding their business losses, exceeds $250,000) and they do not come under any of the exceptions. The business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

The relevant discretion may be exercised for the income year in question where:

· it is in the nature of your business activity that there will be a lead time before a tax profit can be produced

· there is an objective expectation your business activity will produce a tax profit within a commercially viable period for your industry.

Having regard to your full circumstances, it is accepted that it is in the nature of your business activity to require a lead time and that there is an objective expectation it will produce a tax profit within a period which is commercially viable for this industry.

Consequently the Commissioner will exercise his discretion for this partner from May 200Y to 30 June 2010.