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Ruling

Subject: Commissioner's discretion - special circumstances

Question:

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 2010-11 financial year?

Answer: No.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

In the 1990s, you invested in two units of a larger primary production business activity. Each unit represents one acre and consists of two elements, a property trust which owns the real estate and a grower's interest which owns the produce, similar to a stapled investment. There are over 700 units in the project.

Each year the grower's interest pays rent, in advance, to the property trust and each year the property trust distributes the rental income, in arrears, to the unit holder/beneficiary.

Your property trust distribution was almost $X,000 per unit in the 2010-11 financial year.

Your total income and expenses from the grower activity resulted in an overall loss of around $X,000 per unit in the 2010-11 financial year.

This activity has produced a profit in two of the last five years.

In the 20XX-XX financial year, the business activity was affected by drought and was required to purchase additional water and, as a result, the activity produced a loss. The activity passed the profits test in the 20XX-XX financial year.

In the 2010-11 financial year, the project was affected by heavy rain and disease.

According to the business activity grower's report for the year:

Demand for the product and, therefore, the prices offered remained low in the 2010-11 financial year.

The activity's previous buyer agreement was terminated at the end of the 2010 financial year and a new buyer was found for the current year only.

The region where the property is located, had record rainfall; more than twice the average.

The overall 20XX yield of almost X tonnes was approximately what was originally budgeted for.

The harvest was delayed by almost a month due to the cool, wet weather.

The new buyer totally rejected X tonnes of produce due to disease levels and paid $X per tonne less for around 250 tonnes for the same reason.

Your income for non-commercial loss purposes in the 2010-11 financial year was more than $XX,000 but less than $250,000.

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 $40,000 in the 2010-11 financial year. 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 2010-11 financial year. 

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.

In your case, your primary production business activity was affected by disease as a result of specific weather events.

It is accepted that these conditions were outside your control and are '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.

The business activity grower's report for the 2010-11 financial year stated that the total yield for the 2010-11 financial year was almost 3,200 tonnes. Of this, approximately 750 tonnes was rejected by the new buyer due to disease levels, leaving around 2,500 tonnes to be sold. Had the 750 tonnes not been rejected and the 250 tonnes not been diseased you would have still made a loss for each unit. Thus even when taking into account the affects of the special circumstances on income received, the activity would still have produced a loss.

The loss from your primary production business activity is due, in part to special circumstances and, in part to the project's previous buyer agreement terminating at the end of the 2010 year and the low demand for the product and, therefore, the prices being offered in 2011.

Your activities would not meet the assessable income, real property or other assets tests and the Commissioner is not satisfied that your activities would have met the profits test if it had not been affected by special circumstances.

Therefore, the Commissioner is unable to 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 business activity for the 2010-11 financial year.