Edited version of private ruling

Authorisation Number: 1011800751450

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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 and 2010-11 financial years?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commenced on

1 July 2009

Relevant facts

The arrangement that is the subject of the private 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,

· business plan,

· profit and loss statement for the years ended 30 June 2009 and 2010 and

· projected income and expenditure for the years ended 30 June 2012 to 2016.

You commenced your farming business several years ago. The farming area was expanded with the purchase of three additional tracts of land.

Initially, the farming was conducted under a farm sharing arrangement with a successful farming neighbour who supplied all plant and labour for a share of the sale of the proceeds from the sale of produce. This agreement changed gradually as you progressively acquired equipment. With the self supporting machinery, the sharefarmer became a contractor to you to farm the property using your machinery. That arrangement then turned into one of a consultancy.

The property has been your permanent home and place of business since 2002.

In 2002, you engaged a prominent farm consulting firm to undertake a review of operations and prepare a revised business plan.

You subsequently initiated a substantial change in the enterprise mix and mode of operation of the farming business.

Your property is well located and close to markets, transport and large towns.

Some of your farming area is licensed to a neighbour, under a long term licence agreement that is subject to renewal at three yearly intervals. This option has been chosen to reduce production risk and to keep the overall operation on a simple basis.

On the termination of the licence arrangement, it is recommended that the property reverts to more of a farming enterprise utilising all arable land, reducing the livestock enterprise. In order to achieve this, it is recommended that all spraying, sowing and harvest operations are carried out with reliable contractors thus reducing the requirement to capitalise a full farming plant.

You own a collection of well maintained small equipment suitable for normal property repairs.

You employ an experienced full-time manager as well as casual staff and specific purpose contractors as required, including a specialist agronomist to assist in maximising the pasture production to achieve maximum gains.

You maintain and improve the quality of your farming business with:

· well planned maintenance programmes,

· managing livestock loads to avoid land degradation in the event of poor seasonal conditions,

· the use of cell grazing techniques in livestock grazing to manage ground cover and encourage carbon retention and build up,

· direct drill operations on all farming operations to prevent soil erosion and land degradation, and

· preservation of natural timber within the government regulations.

To date, this mixed farming enterprise has not realised its profit potential, largely due to the direct and indirect effects of drought conditions.

Drought conditions have affected your land from 2002 until late 2010 when the drought lifted. You have provided drought maps to show that your farm area was in the drought declared region for the majority of this time.

During drought, income is reduced through reduced production and in the case of livestock, lower market prices exist as producers attempt to offload stock.

The drought caused you to reduce stocking rates. Lower weight gains were attributed to pasture loss and marginal conditions.

There is also very little scope to reduce fixed overhead costs in drought times and in fact total costs rise due to additional costs such as hand feeding stock.

In addition to the reduction in livestock trading profits caused by the drought, the ability to increase income from the crop licencing arrangement was also significantly impaired by the drought as this affected the crop yields and profits of the licensee concerned.

The lifting of drought conditions from 2010 is expected to facilitate a profit although it will take time for pastures to recover, reinstatement of fertilizer programs and timing of re-stocking activity.

General maintenance on the property has been maintained over recent years with all improvements being of high quality.

You expect to make a tax profit in the 2011-12 financial year and subsequent years.

In the 2009-10 financial year you sold all your livestock due to the drought and poor pasture. As a result the animals did not have the usual weight gain and therefore you received a lower price than what you received in the 2008-09 financial year.

With the drought lifting, you predict an increased gross profit per head. If you received the price obtained per head in the 2009-10 financial year, your business would have made a profit.

The cash flow analysis shows a modest profit in the 2011-12 and 2012-13 financial years and a much improved result in future years when farming areas are maximised.

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

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 35-1.

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 35-55.

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

Reasons for decision

Summary

It is considered your failure to achieve a profit was due to the special circumstances envisaged under paragraph 35-55(1)(a) of the ITAA 1997. Therefore the Commissioner will exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997 and the losses from your primary production business for the 2009-10 and 2010-11 financial years are not required to be deferred under section 35-10 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. This ruling has, therefore, been determined on the basis of accepting your statement that you were carrying on the business of primary production.

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 do not satisfy subsection 35-10(2E) of the ITAA 1997 for the 2009-10 financial year. You indicate that this will also be the case in the 2010-11 financial year.

Therefore as you do not satisfy the income requirement 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 can exercise a discretion where certain special circumstances apply. Special circumstances in this context are those outside the control of the business operator, and include drought, flood, bushfire or some other natural disaster.

To apply the discretion in paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner should be satisfied that the business activity is affected in the relevant year by the special circumstances.

Information provided confirms that the area of your farm was drought affected. Unfavourable weather conditions leading to drought was outside your control and therefore it is accepted as a special circumstance as this term is used in paragraph 35-55(1)(a) of the ITAA 1997.

In your case it is accepted that the drought conditions significantly affected your business operations. As a result of the drought you have reduced your livestock numbers and incurred additional costs on hand feeding stock. As the pastures were of poor condition, you were forced to sell your livestock before they gained their usual weight. Consequently you received a lower price for the livestock sold. It is considered that the losses from your business activities are directly related to the drought.

Your activity would have made a tax profit in the year ending 30 June 2010 if you received the same price you previously got for your fattened livestock. Therefore the Commissioner is satisfied that your farming activity would have made a profit in the year ended 30 June 2010 had it not been for the drought. Similarly, as the drought only lifted in the 2010-11 financial year, the Commissioner considers that your business is affected in this year by the drought.

The Commissioner accepts that your business activity was affected by special circumstances that were outside your control, namely drought conditions. Therefore, the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997 has been granted for the 2009-10 and 2010-11 financial years. The Commissioner is satisfied that it would be unreasonable to apply the rule in section 35-10 of the ITAA 1997 in relation to your business activity. This means that the loss for your business activity can be taken into account in calculating your taxable income for the relevant years.

Note:

The issue of this ruling of itself does not constitute a decision of the Commissioner under subsection 35-55(1) of the ITAA 1997 that the loss deferral rule in subsection 35-10(2) of the ITAA 1997 does not apply to you for the income year in question. That decision can only be made in issuing you your assessment, following lodgment of your income tax returns for the relevant years. You can lodge these returns on the basis that the Commissioner is bound to make this decision as set out in this ruling, where the facts set out in the ruling do not differ materially from the actual facts concerning your business activity.