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Ruling

Subject: Non-commercial losses

Question 1

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 activity in your calculation of taxable income for the 2009-10 to 2012-13 financial years?

Answer

No.

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include any losses from your primary production business activity in your calculation of taxable income for the 2009-10 to 2012-13 financial years?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2010
Year ended 30 June 2011
Year ended 30 June 2012

Year ended 30 June 2013

Relevant facts and circumstances

You do not satisfy the <$250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You carry on a primary production business which you commenced just over 10 years ago.

The business is undertaken on land which was not well maintained prior to you acquiring it.

Your primary production business made a tax profit in 3 out of its first 4 financial years. Since then you have consistently returned losses both in years with average rainfall and low rainfall.

The area in which you operate your business was drought declared for a number of recent years.

You have undertaken a program of significant infrastructure improvements on the property.

You presented a report from a consultant which states that your primary production business will be able to produce a profit by the 2013-14 financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 35-10(1)
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)(a)
Income Tax Assessment Act 1997 paragraph 35-55(1)(c)

Reasons for decision

For the years prior to the 2009-10 income year, all taxpayers have access to the four non-commercial loss (NCL) tests (the assessable income test, the profits test, the real property test, and the other assets test) in determining whether they are required to defer their business losses under the NCL provisions.

From the 2009-10 income year, the NCL legislation has been amended to include an income requirement. The four NCL tests are only available to taxpayers who meet the income requirement.

Consequently, if the income requirement is not met, the taxpayer must defer their business loss unless the Commissioner exercises a discretion. A discretion is only available in certain circumstances.

The income requirement under subsection 35-10(2E) of the ITAA 1997 is satisfied if your income for non-commercial loss purposes is less than $250,000. In your case, you do not meet the income requirement.

Paragraph 35-55(1)(a) of the ITAA 1997

The Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for a financial year where the business activity is affected by special circumstances outside the control of the operators of the business activity and the Commissioner considers that it would be unreasonable to require the loss to be deferred.

Taxation Ruling TR 2007/6 explains that for those individuals who do not meet the <$250,000 income requirement, the Commissioner considers that it would be unreasonable to require a loss to be deferred where but for the special circumstances, the business activity would have made a profit in that year.

Special circumstances are those circumstances which are sufficiently different to distinguish them from the circumstances that occur in the normal course of conducting a business activity.

It is accepted in your case that the drought constitutes special circumstances. However, this in itself is not sufficient for the discretion to be exercised. The Commissioner must also be satisfied that your activity would have made a profit but for the special circumstances. That is, the special circumstances discretion can only be exercised where it can be seen that it was only the special circumstances which caused a loss to be made.

You have stated that your primary production business losses in recent years have been due to the drought. Obviously the extent of the losses during this period has been contributed to by the drought. But this is not sufficient for the Commissioner to be able to exercise the special circumstances discretion. He must be satisfied that you would have made a profit but for the drought.

It is noted that in years in which the area in which your primary production business is situated experienced normal rainfall you still returned losses.

It would be expected that if it was only the drought that caused your primary production business to make a loss, then it would have made a profit in the year preceding the drought where normal rainfall was experienced.

The Commissioner is not satisfied that if it were not for the drought, your activity would have made a profit. Consequently, the Commissioner's discretion in respect of special circumstances will not be exercised.

Paragraph 35-55(1)(c) of the ITAA 1997

Under paragraph 35-55(1)(c) of the ITAA 1997, the Commissioner's discretion can be exercised where the business activity satisfies these requirements.

for an applicant who carries on the business activity who does not satisfy subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made - 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).

The note to this paragraph states that it is:

…intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. For example, an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

TR 2007/6 states that the 'lead time' discretion provided for by paragraph 35-55(1)(c) of the ITAA 1997 is available for a business activity if there is an initial period from when the activity commenced where the nature of the activity prevents a tax profit from being made.

The 'lead time' discretion is not available once a business activity has made a tax profit. This is because it is then clear that there is nothing inherent in the nature of the business activity that prevents a tax profit from being made. The only exception to this is where a business activity makes a tax profit on a one-off basis during the initial 'lead time' period. For example, a forestry operation may have a lead time of 20 years before harvesting its trees but may make a one-off tax profit in an earlier year due to a thinning operation. In that case, the one-off tax profit would not effect the lead time period.

In your case, your primary production business made a tax profit in 3 out of its first 4 financial years. It is apparent that your business did not have an initial period where a tax profit could not be made due to the nature of the business activity. The tax profits that your business made were not one-offs that fall within the exception discussed above.

It appears that a significant contributor to the losses of the business in later years is the significant expenditure you made to develop the property. This was required due to the fact that the property had not been adequately maintained prior to you acquiring it. This additional expenditure is an individual circumstance affecting your particular business activity rather than an inherent characteristic that affects all businesses in the industry. However, this is not a decisive issue. The fact that your primary production business made several tax profits in its earliest years shows that there was no initial 'lead time' period required for it to make a tax profit. Therefore, the Commissioner is unable to exercise the 'lead time' discretion in paragraph 35-55(1)(c) of the ITAA 1997.