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Ruling

Subject: Non-commercial losses

Questions

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 business of operating a vineyard in your calculation of taxable income for the 2009-10 financial year?

Answer: No.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

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.

The primary production business undertaken is primarily devoted towards the production of wine for sale.

The vineyard was originally planted in the early 1990's.

You purchased the vineyard in a number of acquisitions between 2006 and 2007.

You submit that you have spent considerable time and money replanting some of the vineyard blocks which were considered unviable for agriculture due to lack of previous maintenance, establishing further blocks for balance of product and adding to or repairing infrastructure on the property.

You expect to make a tax profit of approximately $40,000 in the 2012-13 financial year. This is based on an expectation that sales will increase more than 500% between the 2010-11 and 2012-13 financial years.

Relevant legislative provisions

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

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)

Reasons for decision

For the 2009-10 and following financial years there have been changes to the non-commercial losses legislation to limit the circumstances where business losses can be offset against other income.

The introduction of the income requirement test means that individuals with an adjusted taxable income for non-commercial loss purposes in excess of $250,000 for that year will not get access to the four tests. To be able to claim your losses in that year you have to be granted the Commissioner's discretion under section 35-55 of the ITAA 1997 or meet one of the exclusions.

Paragraph 35-55(1)(c) of the ITAA 1997 provides a 'lead time' discretion. It states that the Commissioner may decide that the loss deferral rule in subsection 35-10(2) does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply that rule because the business activity has 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)).

The note to paragraph 35-55(1)(c) of the ITAA 1997 refers to the paragraph being intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. It provides the example of the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income. 

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.

You have not provided any information regarding what is the commercially viable period for a vineyard. However, it can be assumed that as the vineyard was originally planted in the early 1990's it follows that the 'lead time' for your vineyard has expired. Your replanting of a portion of the vines does not fall for consideration because you purchased a pre-existing orchard, albeit in stages, with a commercial number of vines.

As for the condition of the property when purchased and your decision to purchase the vineyard in stages, these are subjective and impermissible considerations, as affirmed in the cases of Eskandari and Stone. The previous condition of the property cannot be used as a determinative factor in this private ruling.

Your inability to make a tax profit is not because of the nature of the business but due to factors unique to your situation. Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997.

Please note, even if the lead time had not expired, the Commissioner is not satisfied that you would return a tax profit by the 2012-13 financial year. We feel that it is unreasonable to forecast a 500+% increase in wine sales from the 2010-11 financial year to the 2012-13 financial year in the current market for wine. Furthermore, with a 500+% increase in wine sales we would expect an increase in cost of sales and other expenses of more than 140% which is what you have projected.