Edited version of private ruling

Authorisation Number: 1011803892654

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Ruling

Subject: non-commercial losses

Question 1

Will the Commissioner exercise the discretion under paragraph 35-55(1)(c) 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 financial year?

Answer

No.

Question 2

Will the Commissioner exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997 to allow you to include any losses from your primary production activity in your calculation of taxable income for the 2009-10 financial year?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2010

The scheme commenced on

July 1991

Relevant facts

You purchased your first property some time ago. Since then you have purchased a number of other properties.

Since the original purchase, time, money and a considerable amount of work has been done to develop the properties to their present situation. This work has been in partnership with a local authority where erosion control, vegetation and soil management have been achieved. You have also taken on property management courses through this government agency.

The properties have been developed with pasture management, fencing, laneways, stockyards, soil erosion, contouring, tree planting, water systems, dam constructions, numerous improvements including sheds, stables and other facilities.

Your properties grow a majority of the feed associated with your business.

Your livestock activity has been carried on for 20 years.

In the last few years you also commenced breeding other livestock. This activity involves considerable upfront outlay of expenses such as the purchase of animals, stud service fee, veterinary costs and special fencing. Once a build up in the numbers is achieved, a profit can be made by the sales of the yearlings.

In the last two years, the livestock industry has been affected by a virus and loss of value in yearlings due to the global financial crisis. The intention has always been to achieve a profit from the additional livestock breeding to supplement the original livestock income.

Your business has been affected over the past seven years by a prolonged drought which has resulted in low market prices and increased expenses. Your properties have undergone extreme drought proofing.

You have provided your profit and loss statement and livestock trading account for the years ended 30 June 2009 and 2010.

The drought forced you to sell most of your livestock in the recent year.

You have stock and plant with values in excess of $400,000. Interest on borrowing are one of the major expenses.

Livestock are now being sold for $X00, however during the drought the price was much lower at $XX0.

With the lifting of the drought and some of the best stock prices for sometime, you are hopeful that the properties will turn to a positive position through trading and breeding in the near future.

Once property development is completed and once drought and seasonal conditions improve, then profitability will be obtained.

You predict a taxable profit in 2012-13 financial year.

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).

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

Reasons for decision

Summary

It is considered that the length of time your primary production business requires to make a tax profit is not simply a result of the nature of the activity. Rather your individual circumstances, for example, the ongoing development of your business and your decision to introduce additional livestock commence a few years ago, have substantially affected the period that will elapse before a tax profit is made.

Also, you have been unable to provide objective evidence of the commercially viable period to make a tax profit for your type of activity. Without this information the Commissioner is not able to conclude that the 22 years your activity will take from commencement to the achievement of a tax profit is within a period that is commercially viable for your industry.

Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997.

Furthermore, the Commissioner is not satisfied that the business would have made a profit but for the drought. 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 activities are 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 do not satisfy subsection 35-10(2E) of the ITAA 1997.

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.

For an applicant who carries on a business activity and does not satisfy subsection 35-10(2E) of the ITAA 1997 for the most recent income year ending before the application is made, paragraph 35-55(1)(c) of the ITAA 1997 states the Commissioner may decide that the loss deferral rule in subsection 35-10(2) does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply that rule because the business activity has 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)).

Therefore, in order to exercise the discretion, the Commissioner must be satisfied that there is an objective expectation, based on evidence from independent sources, that your business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period.

Also, for the Commissioner to exercise the discretion, you must be able to show that the reason your business activity is producing a loss is inherent to the nature of the business and is not peculiar to your situation.

The phrase 'objective expectation' was discussed in the Administrative Appeals Tribunal case of Scott v. Commissioner of Taxation [2006] AATA 542; VS2005/31-33, where it was said:

…in determining a commercially viable period, the test is primarily an objective one based on independent sources. According to the Commissioner, this approach was taken by the Federal Court in Commissioner of Taxation v Eskandari (2004) 134 FCR 569 where Stone J said, at 581-582:

In some cases it may be a straight forward exercise to identify the industry in which the business activity takes place. Some industries are well-established and the basis for an ''objective expectation'' can readily be based on a comparison between the tax payer's business and other businesses within that industry, particularly where businesses or business associations within the industry produce material such as annual reports or industry papers ...

Despite what Stone J said, Mr Scott contended that there were other circumstances which had to be taken into account when determining the commercially viable period expressed in the Olives Australia document. However, according to the Commissioner, this is impermissible because, as the Federal Court held in Eskandari, in most cases only objective material will be considered. It is only where, because of the nature of the industry, there is very little or no objective evidence that recourse may be had to the circumstances of the tax payer. That is not the case in the olive industry, which has been established for centuries. I agree with that submission. It seems to me that if it were permissible to take into account subjective considerations of each individual grower, there might be an almost infinitely variable period which could be described as the commercially viable period.

Further, in the case of Scott, additional plantings made at a later time were not permitted to be included in the commercially viable period, as follows:

The fact that a grower elects not to plant sufficient trees at the outset to ensure the business is commercially viable is a decision for that individual grower. Such a grower could not expect the Commissioner to exercise his discretion under s 35-55 in his or her favour because, to do so, would effectively render nugatory the rule dealing with losses from non-commercial business activities.

The sole reliance on objective evidence and the impermissibility of subjective considerations was further emphasised in the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 as follows:

2.30 The taxpayer is required to establish objectively that the business is commercial in nature and will become profitable in a commercially viable timeframe. Objective evidence from independent sources can include evidence from an individual or organisation experienced in the relevant industry, such as industry or regulatory bodies, tertiary institutions, industry specialists, professional associations, government agencies or other independent entities with a similar successful business activity. Evidence from independent sources can also include evidence from business advisers (such as business plans), financiers and banks.

2.34 For taxpayers that do not meet the income requirement, the Commissioner may exercise a discretion after an application by a taxpayer, where the Commissioner is satisfied that - based on evidence from independent sources - the business will produce assessable income greater than available deductions, in a timeframe that is considered commercially viable for the industry concerned.

2.35 The discretion is not intended to be available in cases where the failure to make a profit is for reasons other than the nature of the business, such as, a consequence of starting out small and needing to build up a client base, or business choices made by an individual that are not consistent with the ordinary or accepted practice in the industry concerned - such as the hours of operation, location, climate or soil conditions, or the level of debt funding.

Further, the Explanatory Memorandum provides the following relevant examples:

Tracey carries on a business of primary production from breeding and selling cattle. Their profit projections indicate that they do not expect to make a tax profit for six years.
Independent evidence provided by Tracey indicates the lead time period begins from the commencement of the activity and includes the time taken to raise the females to a breeding age, allowing for the gestation period of those animals to finish, and finishes when the progeny have reached a saleable age. On the evidence provided, the period for a typical business activity of breeding and selling cattle to become commercially viable is no greater than three years. Therefore, Tracey will not be able to produce a tax profit within a period that is commercially viable for the industry concerned and the Commissioner will not be able to exercise the discretion to allow the losses.


Joe earns in excess of $250,000 and has a substantial rural property which he and his wife visit most weekends. The property has a family residence and sheds and, apart from one area of the property where a few goats are kept, is otherwise developed with nut trees.

Joe planted a large number of nut trees on the land in 2007, and has been claiming his losses from this activity, having passed the real property test in prior years. As his income is higher than $250,000, Joe applies to the Commissioner seeking the exercise of the discretion in new paragraph 35-55(1)(c) to allow him to access his losses in 2009-10.

In support of his application, Joe provides a letter from the secretary of the Nut Tree Growers' Association that states that yields from that number and type of trees would ordinarily be sufficient to allow Joe to make a profit within about six years. This is the industry norm for growers of that type of nut tree. However, because the soil on the property is not very fertile and the site does not get a lot of sun, Joe accepts that the lead time for his particular nut-growing activity will be nine years not six years. Joe otherwise manages his nut tree orchards in accordance with industry management practices.

Having examined the case, the Commissioner concludes that, despite the large number of trees on the property and the fact that the business is being conducted in accordance with industry management practices, the discretion should not be exercised in Joe's favour. This is because the lead time for this activity to become profitable is greater than the industry norm: the failure to make a profit within a commercially viable period is due to factors that are peculiar to Joe's local environment. Despite the fact that these factors are out of Joe's control, and the fact that the activities are otherwise carried on in a commercially viable way, the excessive lead time before making a profit for Joe's activities are caused by the poor soil quality and lack of sunlight. The Commissioner does not exercise the discretion in Joe's favour because there is an excessive lead time before making a profit, when compared to other businesses in the industry.

Paragraphs 84 and 85 of Taxation Ruling TR 2007/6 state:

The Commissioner needs to be satisfied that there is an objective expectation that the business activity will satisfy a test or produce a tax profit in some future income year falling within a period that is commercially viable for the industry concerned. If the business activity is not expected to satisfy a test or produce a tax profit within this period then the discretion will not be exercised.

The objective expectation does not have to be held by, or attributed to, a particular person. The Commissioner need only be satisfied that, based on the available supporting material, an objective expectation exists.

In your case, you commenced your primary production activity several years ago. You have since bought further properties and have applied significant resources towards improving the property.

It is accepted that it is in the nature of your business activity to require a lead time before it produces a tax profit. However, there must also be an objective expectation this lead time is within a period which is commercially viable for this industry. For the purposes of addressing this point, subjective considerations, such as the condition of property at purchase, location, climate or soil conditions or the level of debt funding are not relevant.

Your decision to introduce other livestock in the last three years has also impacted on the length of time required before your farm activity will make a profit. Like the ongoing improvements to the property and your level of debt, these are individual business decisions affecting your activity rather than an inherent characteristic of the industry.

You predict that your enterprise will not produce a tax profit until the 2012-13 financial year, or in the 22nd year of operation. It is considered that the fact that your activity will require 22 years for it to become profitable is not simply a result of the nature of the activity. Rather your individual circumstances have substantially impacted on the length of time required before a tax profit is made.

You have not provided objective evidence of the commercially viable period to make a tax profit for your type of activity. Without this information the Commissioner is not able to conclude that the 22 years your activity will take from commencement to the achievement of a tax profit is within a period that is commercially viable for your industry.

Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(c) 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.

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, including those such as drought, flood, bushfire or some other natural disaster, that have affected that activity.

Under paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner may decide that the rule in section 35-10 of the ITAA 1997 does not apply to a business activity if the Commissioner is satisfied that it would be unreasonable to apply that rule.

Taxation Ruling TR 2007/6 sets out the Commissioner's interpretation on the exercise of the discretion under paragraph 35-55(1)(a) of the ITAA 1997. Paragraph 47 of TR 2007/6 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 and affect all business within a particular industry. It is highlighted in paragraph 13A of TR 2007/6 that for those who do not satisfy the income requirement, the Commissioner may exercise the discretion if the business would have made a profit but for the special circumstances.

In your case, the Commissioner accepts that your business activity was affected by special circumstances that were unusual and outside your control, namely drought.

However, it is hard to conclude that the business would have made a profit if the drought had not occurred. Your business was not showing a profit before the commencement of the drought conditions. It is acknowledged that there was a reduction in livestock prices, forced sales and the increased expenditure in feed as a result of the ongoing drought conditions. However, there is insufficient evidence to show that but for the drought, your business would have made a profit.

As the Commissioner is not convinced that in the absence of the drought the business would have been profitable for the 2009-10 financial year, the discretion under paragraph 35-55(1)(a) of the ITAA 1997 will not be granted for the 2009-10 financial year. Therefore, the loss deferral rule will apply to losses made from your business activity in the 2009-10 financial year.