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Authorisation Number: 1012020772463

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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 financial year?

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 financial year?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2010
The scheme commenced on

1 July 1985

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· application for a private ruling

· non-commercial loss evidentiary checklist

· business plan

· independently sourced evidence

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 on the land is primarily devoted towards beef cattle, sheep and wool farming.

In the 1980's you commenced business. After a number of years you purchased more land.

Years later you sold all land and relocated your operations to a larger property. This new property was purchased in a run-down condition and over the past 10 years you taken steps to eradicate weeds, improve fencing, improve soil fertility and establish improved pasture

Holding and service charges on the borrowing to acquire the properties amount to over $XXX,000 per annum.

You have submitted maps showing that your property was situated in a drought affected area from 2003-04 to 2008-09.

You declared losses in your tax returns from the 1999-2000 to 2009-10 financial years.

You cite your lack of crop income due to the condition of the property, weather conditions and your holding and service charges as major reasons behind your business losses.

You have been able to rely on income from other sources to fund the farming operating expenses.

You recently retired from your employment to focus solely on your farming operations. You expect that your full-time commitment to your farming operations will reduce labour costs.

You intend to use your superannuation to pay off a portion of the outstanding loan on the property to reduce holding and service charges.

You estimate that you made a small profit in the 2010-11 financial year but you have yet to complete your records.

You expect to make a tax profit in the 2011-12 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 financial 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 submitted evidence that shows your property was situated in a drought affected area from the 2003-04 to 2009-10 financial years. 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 earlier non drought years your business consistently declared 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 conditions were experienced. You are unclear as to whether you have made a profit in the 2010-11 financial year but you expect to make a profit in the 2011-12 financial year. This coincides with your retirement and a significant reduction in holding and service fees. It can be argued that it is your full time commitment to the business and the reduced level of debt that is the cause of your expected profit and not the easing of drought conditions.

The Commissioner is not satisfied that if it were not for the drought, your activity would have made a profit in the 2009-10 financial year. Consequently, the Commissioner's discretion in respect of special circumstances will not be exercised for that year.

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 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 the commercially viable period for industry is. However, as you commenced business operations in the 1980's it follows that the commercially viable period has expired for the purpose of this private ruling. Also, following the decision in the case of Scott, your decision to purchase additional land over a period of time does not fall under consideration because you commenced operations with a commercial sized property.

Furthermore although your business experienced drought conditions, the drought did not affect your property until more than 15 years after the commencement of your business and this was well past what the Commissioner would accept as the commercially viable period for your industry. Therefore it cannot be said that the drought extended the commercially viable period in your instance.

The reason your business activity is producing a loss is peculiar to your situation and is not inherent to the nature of the business. Your decision to relocate to a larger property in a run down condition, your holding and service charges and your lack of crop income are subjective and impermissible consideration, as affirmed in the cases of Eskandari and Stone. The previous condition of the property and your method of financing cannot be used as determinative factors in this private ruling.

To conclude, the Commissioner cannot exercise his discretion in accordance with subsection 35-55(1) and paragraph 35-55(1)(c) of the ITAA 1997 for the 2009-10 financial year in your case because the objective commercially viable period has expired. Your inability to make a tax profit is not because of the nature of the business but because of various considerations, unique to your situation.