Edited version of private ruling

Authorisation Number: 1011837348730

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Ruling

Subject: non commercial losses

Question

Will the Commissioner exercise the discretion in section 35-55 of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your business activity in your calculation of taxable income for the 2006-07 to 2009-10 financial years?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2007

Year ended 30 June 2008

Year ended 30 June 2009

Year ended 30 June 2010

The scheme commenced on

1 July 2006

Relevant facts

You hold relevant tertiary qualifications and are member of the relevant industry professional body.

In the 20XX-XX financial year, you started investigating the viability of commencing a new business activity.

You undertook substantial research to learn more about the industry conducted in Australia as well as the production methodologies used.

You lodged an expression of interest with the government department and then participated in training in order to qualify as a participant in the auction industry leases.

You were successful in purchasing a lease and also obtained a licence from the government department.

You were granted a lease during 20XX.

You submit that you commenced a primary production business during 20XX.

You prepared a business plan in which you expected to generate income in the 20XX-XX financial year.

Your business plan provides two business activity streams: growing your livestock in a contained environment; and harvesting of pre-existing livestock.

You will wait to harvest the pre-existing livestock until the juveniles have matured as you submit that it is uneconomical to do so any earlier.

You have undertaken the following activities:

· baseline environmental study, annual renewal

· licence

· surveys and boundary marker placement

· equipment construction

· purchase containers

· record keeping.

During 20XX, your property markers were stolen and were not replaced for X months.

You experienced delays in the construction of property infrastructure. These works were completed mid 20XX.

The delays caused you to revise your initial business plan, you now expect to commence generating income in the 20XX-XX financial year and make a profit 20XX-XX financial year.

You have submitted independent evidence your livestock take between three to five years to mature.

You anticipate the infrastructure will be in place for the growing of livestock in the 20XX-XX financial year.

You do not satisfy subsection 35-10(2E) of the ITAA 1997 as your adjusted taxable income exceeded $250,000 in the 20XX-XX financial year.

You do not satisfy subsection 35-10(4)(b) of the ITAA 1997 as your non-business income exceeded $40,000 in the 2006-07, 2007-08, 2008-09 and 2009-10 financial years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 subsection 35-10

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

Income Tax Assessment Act 1997 section 35-55

Reasons for decision

For the 2009-10 and later income years, Division 35 of the Income Tax Assessment Act 1997 will apply to defer a non-commercial loss from a business activity unless:

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

· the exceptions apply, or

· the Commissioner exercises his discretion.

In your situation, you do not satisfy any of the four tests; you do not satisfy the income requirement for the 2009-10 and none of the exceptions apply. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

Special circumstances (first limb)

The Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the financial year where the business activity is affected by special circumstances outside the control of the operators of the business activity.

No exhaustive definition is given of 'special circumstances' but the paragraph does include drought, bushfire and other natural disasters.

The question of what constitutes special circumstances has been judicially considered on many occasions. In the Federal Court case of Minister for Community Services and Health and Another v Chee Keong Thoo 78 ALR 307, Burchett J considered special circumstances in the context of the Health Insurance Act 1973 and made the following observation at 324:

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 and Youth Affairs v Barrett and Another 52 ALD 499 special was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed at 504 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) 6 ALD 1 at 3:

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 can be seen that to determine what is special circumstances, we need to look at the context in which the phrase is used. Also, it is clear that special circumstances will be something out of the ordinary or unusual. Special circumstances in paragraph 35-55(1)(a) is used in the context of a situation occurring such that it would be unreasonable for the Commissioner to apply the loss deferral rule for a particular year or years.

For this to be the case, 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 pass a test (if appropriate) or make a tax profit. Clearly, if the business activity would not have passed a test or 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 as the legislative note to paragraph 35-55(1)(a) indicates.

Nature of the activity (second limb)

The Commissioner's discretion in paragraph 35-55(1)(c) of the ITAA 1997 may be exercised for the financial year where 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.

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.

Interaction between the limbs

As stated above, ordinarily the operation of the first limb is confined to those situations in which the business activity has been affected by special circumstances outside the control of the operators of that activity where, had these circumstances not existed, the activity would have passed a test or made a tax profit.

However, the first limb may also apply to a business activity affected by such circumstances during a time when 'because of its nature' it is not able to meet a test or produce a tax profit, but this time is still 'within [the] period that is commercially viable for the industry concerned'. In such a case, the enquiry is not whether the activity would have met a test or produced a tax profit had the special circumstances not existed (paragraphs 35 55(1)(b) and (c) already recognise that there are reasons outside the control of the operators of the activity why this would not have occurred, regardless of the existence of the special circumstances).

In such cases the appropriate enquiry will be whether or not the special circumstances have meant that there is no longer an objective expectation that within the period that is commercially viable for the industry concerned the activity will either meet a test or produce a tax profit.

Where the special circumstances are the sole reason why the activity can no longer objectively be expected to meet a test or produce a tax profit within the period that is commercially viable for the industry concerned, but the activity is now expected to consistently produce a profit at some later time, the discretion may be exercised.

Your circumstances

You have provided independent evidence to that it takes three to five years for your livestock to mature. You commenced your business in the 20XX-XX financial year and expect to pass the assessable income test in the 20XX-XX financial year, seven years after commencing your business and expect to make a profit in the 20XX-XX financial year.

It therefore follows that the commercially viable period will have passed by the time you expect to meet one of the four tests and pass the income requirement or make a tax profit.

The various delays due to unfavourable weather and contractor support and availability are subjective and impermissible considerations, as affirmed in the cases of Eskandari and Stone and cannot be used as a determinative factor in this private ruling.

It is accepted that the theft of your object of possession may be regarded as special circumstances beyond your control, for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. However, the information you have provided does not point to a reasonable expectation that the business activity would have met the income requirement and passed one of the four tests or made a tax profit within the commercially viable period, had it not been for the theft of the markers.

As submitted by you, there were various other delays encountered which were unrelated to the theft. Furthermore, your business had been operating for over X months, with no livestock yet established or harvested and no essential works undertaken, prior to the theft of the object. This would further indicate that you would not have passed a test or made a tax profit even if the theft had not taken place.

Given a consideration of the full circumstances of your situation, it is considered the reason your activities have continued to make a loss is not inherent to the nature of the business or as a result of special circumstances. Accordingly the Commissioner will not exercise his discretion to allow your business losses in the 2009-10 financial year.