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Ruling

Subject: Commissioner's discretion - special circumstances

Questions:

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 business in your calculation of taxable income for the 2006-07, 2008-09, 2009-10 and 2010-11 financial years?

Answer: Yes.

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 business in your calculation of taxable income for the 2005-06, 2011-12, 2012-13 and 2013-14 financial years?

Answer: No.

This ruling applies for the following periods

Year ended 30 June 2006

Year ended 30 June 2007

Year ended 30 June 2008

Year ended 30 June 2009

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commenced on

1 July 2005

Relevant facts

You commenced your primary production business activity in the 2005-06 financial year when you purchased a property as a going concern fully planted.

In the year of purchase, the previous owners of the property maintained ownership of the crop for that year under the contract of sale.

The region where the property is situated had been drought affected when purchased but had a specific water allocation to the holding, which, historically, had never been reduced, as well as a general allocation of water.

In the 2006-07 financial year, the specific water allocations to the holding were reduced for the first time by approximately 50%.

As a result of the water reductions, there was insufficient water to ensure the entire crop grew to maturity and harvest. Only one quarter of the property could be maintained. Your 2006-07 crop produced income of around $8,500.

In the 2008-09 financial year, specific water allocations returned to almost normal levels but general water allocations were just 9%. Only one quarter of the property could be maintained and your 2008-09 crop produced income of around $7,000.

With continued uncertainty over water allocations for the coming season, the plants were cut back at the end of the 2009 harvest to ensure survival over the next year. As a result, the 2010 crop was not worth harvesting and there was no income in the 2009-10 financial year.

Eight inches of rain in January 2011 caused a mildew disease that wiped out your entire 2011 crop.

You now intend to remove your remaining plants and will be planting other different crops in the 2011-12 growing season.

You will need to upgrade the farm equipment and infrastructure to accommodate the change in crops and you do not expect to produce a profit from these activities until after the 2013-14 financial year.

Your income for non-commercial loss purposes from the 2005-06 to 2010-11 financial years was more than $40,000 and less than $250,000, and you expect this to be the case for the 2011-12 to 2013-14 financial years.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Division 35

Income Tax Assessment Act 1997 - section 35-10

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

Reasons for decision

Under Division 35 of the ITAA 1997, a loss made by an individual from a business activity will not be deductible in the financial year in which it arises unless certain conditions are met. Losses that cannot be taken into account in a particular year of income, because of subsection 35-10(2) of the ITAA 1997, can be applied to the extent of future profits from the business activity, or are deferred until one of the tests is passed, the discretion is exercised, or the exception applies. 

Under the rule in subsection 35-10(2) of the ITAA 1997 a loss made by an individual from a business activity will not be taken into account unless: 

· the exception in subsection 35-10(4) of the ITAA 1997 applies; or  

· you satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 and one of the four tests is met; or  

· if you do not satisfy the income requirement or if one of the tests is not met, the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

Your assessable income from sources not related to this activity was more than $X0,000 in the 2005-06 to 2010-11 financial years. Therefore, the exception contained in subsection 35-10(2) of the ITAA 1997 does not apply.

Your income for non-commercial loss purposes is less than $250,000, therefore you satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997. However, your business activity has not satisfied any of the four non-commercial loss tests contained in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) and 35-45 (other assets test) of the ITAA 1997 in the 2005-06 to 2010-11 financial years. 

The Commissioner's discretion - special circumstances 

Where the income requirement is satisfied, the Commissioner's discretion, under paragraph 35-55(1)(a) of the ITAA 1997, can be exercised where a business activity is affected by special circumstances, outside the control of the operators, such that it is unable to satisfy any of the tests. 

Taxation Ruling TR 2007/6 sets out the exercise of the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 53 of this Ruling. 

Special circumstances are ordinarily those affecting the business activity such that it is unable to satisfy a test and it would be unreasonable for the loss deferral rule to apply. 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. 

Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to special circumstances outside the control of the business activity, including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of the paragraph. These events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affected the business activity.

2005-06 financial year

In the 2005-06 financial year, the previous owners of the property maintained ownership of the crops for that year under the contract of sale. As this was part of your purchase agreement, it was not outside of your control and is not considered to be 'special circumstances' for the purposes of paragraph 35-55(1)(a) of the ITAA 1997.

Therefore, the Commissioner is unable to exercise the discretion in relation to your activities for the 2005-06 financial year.

2006-07, 2008-09, 2009-10 and 2010-11 financial years

In your case, your business activity was affected by drought and the subsequent reduction of water allocations between the 200X-0X and 20XX-XX financial years. In addition to this, your entire 20XX-XX crop was destroyed by a mildew infection as a result of eight inches of rain that fell in January 20XX. It is accepted that the drought and subsequent reduction in water allocations as well as the excessive rainfall in January 20XX were all outside of your control and are considered to be 'special circumstances' for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. However, before the Commissioner can exercise the discretion you must be able to show that it was the special circumstances that prevented your activities from meeting one of the tests.

As a result of the ongoing drought conditions in the region in the 2006-07 financial year, specific water allocations to your holding were reduced for the first time. With this reduction in available water, you chose to maintain one quarter of crops. You received income of around $X,X00 for your 2006-07 crop. Had you been able to maintain the entire property you could have reasonably expected to receive around $XX,000 of income in the 2006-07 financial year. In the 2008-09 financial year, one quarter of your property produced income of around $7,000. Had you been able to maintain your entire property you could have reasonably expected to receive around $XX,000 of income in the 2008-09 financial year. Although there was no income was received in the 2009-10 financial year, as a result of uncertainty in on-going water allocations, it is reasonable to assume that your income could have reached the same levels of the previous year. Similarly, in the 20XX-XX financial year, your entire crop was wiped out by a mildew infection after excessive rain just prior to harvest. Again, it is reasonable to assume that your income could have reached the same levels as previous years, and produced at least $20,000 in assessable income.

The Commissioner is satisfied that your activities would have met the assessable income test if it had not been affected by special circumstances in the 2006-07, 2008-09, 2009-10 and 2010-11 financial years.

Therefore, the Commissioner will exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(a) of the ITAA 1997 in relation to your primary production activities for the 2006-07, 2008-09, 2009-10 and 2010-11 financial years.

2011-12 to 2013-14 financial years

For the 2011-12 financial year and later years, you have decided to start growing different crops. These crops are expected to produce assessable income in the year you commence. Therefore, the Commissioner is unable to exercise a discretion in relation to your new growing activities for these financial years.