Edited version of private ruling

Authorisation Number: 1011842967154

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Ruling

Subject: Non-commercial losses

Question

Will the Commissioner exercise the discretion in 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 business activity in your calculation of taxable income for the income years?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You commenced a primary production business activity a number of years ago.

You purchased the land on which you carry out your activity in several stages, and you have gradually increased your stock over a number of years.

You have only sold small numbers of stock as you wish to build numbers.

The area that the activity was carried out on was in severe drought conditions for the period from when you commenced your activity to the present time.

The drought was recently revoked in your area.

You have provided testament from an industry body regarding the time to generate income from your particular activity. This time had ended prior to the income years under consideration for the purposes of this private ruling.

You believe that this time is not achievable in a drought situation.

You expect that in the coming income year that you should have sufficient income to make the operation profitable due to the change in the seasonal situation in your area of operation.

Your income for non-commercial loss purposes is above $250,000 in the current income year and you expect this will be the case in the future income years as well.

Relevant legislative provisions

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

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

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

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Current income years

The Commissioner will exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for an applicant who does not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 if certain requirements are satisfied for the year concerned.

For the discretion to be exercised, the business activity must have started to be carried on and, for the excluded years:

· because of its nature, it has not produced, or will not produce, assessable income greater than the deductions attributable to it and

· 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) of the ITAA 1997).

The note to subsection 35-55(1) of the ITAA 1997 states that paragraphs 35-55(1)(b) and 35-55(1)(c) of the ITAA 1997 are intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income.

In order to determine whether the Commissioner will exercise this discretion, we will need to determine if the abovementioned requirements have been satisfied.

Business activity started to be carried on

The first requirement to be satisfied is that the business activity must have started to be carried on.

You stated in your private ruling application that your business activity has commenced and this requirement is satisfied.

Nature of the business activity

The second requirement to be satisfied is that, for the excluded years, the business activity has not produced, or will not produce assessable income greater than the deductions attributable to it because of its nature.

The current income years will therefore satisfy this requirement if the loss is the result of the nature of the business activity.

Paragraphs 71 to 73 of Taxation Ruling TR 2007/6 state in relation to the meaning of 'because of its nature':

71. As stated at paragraph 11 of this Ruling, the discretion is intended to be available for a commercial activity which fails to satisfy any of the tests for reasons outside the control of the operator. This is confirmed by the EM, which states at paragraph 1.48:

The discretion is provided to ensure that certain individuals who carry on genuine commercial businesses are not disadvantaged due to particular circumstances which prevent them from satisfying tests 1 to 4.

72. In addition, paragraph 1.51 of the EM comments:

This arm of the safeguard discretion …. will ensure that the loss deferral rule in section 35-10 does not adversely impact on taxpayers who have commenced to carry on activities which by their nature require a number of years to produce assessable income. Examples of activities which could fall into this category are forestry, viticulture and certain horticultural activities.

73. Example 1.6 of the EM provides an example of such an activity. In this example, the Commissioner exercises the discretion for an activity that was established as a commercially viable operation and is expected to be highly profitable. However as it is an agricultural activity that requires time for growth and harvesting before becoming profitable it cannot satisfy any of the tests (specifically, either the Assessable Income Test, or the Profits test) until such time as the impact of that inherent restriction passes.

Paragraphs 77 and 78 of TR 2007/6 state:

77. Therefore, the phrase 'because of its nature' refers to inherent characteristics of the type of business activity being conducted by the taxpayer, which are common to any business activity of that type. These inherent characteristics must be the reason why the activity is unable to satisfy any of the tests. The discretion is not intended to be available where the failure to satisfy one of the tests is for other reasons.

78. The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity…

Paragraph 80 of TR 2007/6 states:

80. The identification of this 'initial period' may often involve some practical difficulty, particularly where causes other than an inherent characteristic appear to be another reason why the business activity is unable to satisfy a test or produce a tax profit for a particular income year. Where both an inherent characteristic and some other factor are identified, this in itself will not mean that the requirement in subparagraph 35-55(1)(b)(i) or (c)(i) is no longer met. It is only where it is clear that the reason the activity is unable to satisfy a test is not because of any inherent characteristic, but because of some other factor, that this requirement will not be met.

The Macquarie Dictionary defines 'inherent' as:

adjective

1. existing in something as a permanent and inseparable element, quality or attribute.

The initial time that it takes to raise and sell the progeny is an inherent characteristic of a cattle farm business activity. It is a permanent and inseparable element, quality or attribute of this type of activity.

The purchase of additional land and your decision to sell only small amounts of stock to gradually increase the numbers are not inherent characteristics of this type of activity. These are business choices made by you as discussed above in paragraph 78 of TR 2007/6. The drought is also not an inherent characteristic of the activity.

Your circumstances are similar to those in Example 2.5 in the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 which states:

Example 2.5

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.

This example clearly states that the lead time period begins from the commencement of the activity. We consider that the lead time or the period that is commercially viable for the industry commences at the time of the commencement of the business activity, and does not commence or recommence from the time that the drought ceases in a particular locality.

We therefore consider that the inherent characteristics of your activity, that is, the time for raising and selling the progeny, has already ended. Any losses in the following income years would therefore be produced by some other factor such as the drought, purchase of additional land or the gradual increase in stock numbers, which are not inherent characteristics of the activity.

This requirement is therefore not satisfied for the current income years as any losses in these years are not attributable to the nature of the business activity.

Objective expectation about future performance

The third requirement to be satisfied is that the Commissioner must be satisfied that an objective expectation exists that the business activity will in some future income year falling within a period that is commercially viable for the industry concerned, produce assessable income for an income year greater than the deductions attributable to it for that year. The objective expectation must be based on independent information, where such information is available.

The lead time and commercially viable period for your industry has been determined from information supplied by you, and applies from the commencement of the business activity.

The information provided by you also indicates that you expect to make a profit from the business activity as from a later income year. This income year is outside of the commercially viable period. The relevant objective expectation about future performance therefore does not exist in this case, and this requirement is not satisfied.

Lead time

Your primary production activity would typically have a lead time. Your business activity is therefore of a kind contemplated by the note to subsection 35-55(1) of the ITAA 1997.

Conclusion

Although your business activity is of a kind contemplated by the note to subsection 35-55(1) of the ITAA 1997, it does not satisfy all of the relevant requirements in paragraph 35-55(1)(c) of the ITAA 1997.

The activity does not satisfy the requirements relating to the nature of the business and objective expectation about future performance for the current income years.

For these reasons, the Commissioner will not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include the loss from your primary production business activity in your calculation of taxable income for the current income years.

Future income years

The non-commercial loss provisions in Division 35 of the ITAA 1997 apply to defer losses from business activities. As you have stated that you anticipate that your activity will make a profit for the future income years, the non-commercial loss provisions and the associated discretions have no application to these income years. Accordingly, these income years have not been included in the above private ruling.

Another application for a private ruling can be made if circumstances change and it becomes necessary to consider the deferral of a loss from the business activity in these income years.

If you consider that your business activity was affected by the drought in the relevant income years, you may apply for another private ruling requesting the Commissioner to exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997 relating to special circumstances. The requirements for the exercise of this discretion where the income requirement in subsection 35-10(2E) of the ITAA 1997 is not satisfied are provided in paragraph 13 of TR 2007/6 and are that:

· 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 loss from your business activity that can not be taken into account in a particular year of income under the non-commercial loss provisions is quarantined. Such losses will be able to be offset in later income years when either a profit is made, or you satisfy one of the tests along with the income requirement.