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Ruling

Subject: Non-commercial losses

Question 1

Will the Commissioner exercise the discretion under 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 2009-10 to 2014-15 financial years?

Answer

No.

Question 2

Will the Commissioner exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include any losses from your primary production business in your calculation of taxable income for the 2009-10 to 2014-15 financial years?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Relevant facts and circumstances

A partnership, of which you were one of the partners, operated a primary production business with planting taking place approximately 15 years ago.

The partnership was dissolved and you took over the business as a sole trader approximately eight years ago.

Our records show that the partnership declared tax losses from the activity in every income year until the partnership was dissolved.

You grow fruit producing plants on a portion of the total land area. The remaining land is used for other purposes.

You operate the farm with casual family staffing and contractors.

Other farming activities occur on the property.

You supplied a consultancy report which contained the following information:

The area where you operate this business is located on multiple properties.

All plants were planted approximately 15 years ago and have drip irrigation in place.

You have access to large quantities of water.

It is estimated that your usage in a dry season will be no more than half of the quantity available.

You have advised that your business activity was affected by a flood in the 2010-11 financial year, and prior to this, periods of drought.

Your income for non-commercial loss purposes exceeded $250,000 in the 2009-10 and 2010-11 financial years.

You are expecting that your income for non-commercial loss purposes will not exceed $250,000 in the 2011-12, 2012-13, 2013-14 and 2014-15 financial years.

You expect to make a tax profit in the 2012-13 financial year.

Relevant legislative provisions

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)

Income Tax Assessment Act 1997 Section 35-30

Reasons for decision

For the 2009-10 and later income years, Division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless:

o you satisfy the income requirement and you pass one of the four tests

o the exceptions apply, or

o the Commissioner exercises his discretion.

You do not satisfy the income requirement for the 2009-10 and 2010-11 financial years (that is your taxable income, reportable fringe benefits and reportable superannuation contributions but excluding your business losses, exceeds $250,000) and you do not come under any of the exceptions. Therefore, your business losses for these financial years are subject to the deferral rule unless the Commissioner exercises his discretion.

You have asked for the Commissioner's discretion for the 2009-10 to 2014-15 financial years.

You have projected your business will make a tax profit from the 2012-13 financial year. The non-commercial loss deferral provisions will not apply in a financial year where you make a tax profit. Therefore, the Commissioner will not exercise his discretion for the 2012-13 to 2014-15 financial years.

You predict you will pass the income requirement in the 2011-12 financial year. Therefore, you only need to pass one of the four tests in that year in order to claim your business loss. From the information provided it is highly likely that you will pass the assessable income test (as it has been passed in almost every year from 1998). Therefore, the Commissioner will not exercise his discretion for the 2011-12 financial year.

There are two discretions available to the Commissioner being, special circumstances and the nature of the activity. We will examine both of these discretions in relation to the 2009-10 and 2010-11 financial years.

Special Circumstances

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 states that for those individuals who do not meet the 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.

You have referred to drought in periods up to the 2009-10 financial year and flood in the 2010-11 financial year.

It is accepted that both drought and flood constitute 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.

In your case you previously operated the primary production business in partnership with planting taking place approximately 15 years ago. Losses were made by the partnership every year until the partnership was dissolved and you took over the business as a sole trader. You have not made a profit since taking over the business from the partnership.

After allowing for a lead time period, it would be expected that the partnership would have made a profit from the primary production business in its latter years. The fact that it did not and you have never achieved a tax profit in any financial year since taking over the business as a sole trader indicates that it is quite likely that the business would have a tax loss in the 2009-10 and 2010-11 financial years even if special circumstances had not existed.

It is also noted that the consultancy report stated that irrigation availability is solid (with usage in a dry season estimated to be no more than half the total available). You have not provided details of how the drought affected your business. For example, you have not indicated that your water allocation in the drought years was cut to less than that required.

You have not quantified the effects of the drought or the flood on your income and expenses. That is, you have not provided any calculations showing how much your deductions would have been reduced by, and how much your income would have been increased by, if there had not been a drought in the 2009-10 financial year or a flood in the 2010-11 financial year.

It is considered that you would be able to quantify the effect of the drought and the flood on your income and expenses by utilising income and expense figures from a financial year in which the business was not affected by special circumstances.

You have been involved in the operation of the primary production activity for many years, first though a partnership and then as a sole trader. The activity has never made a profit. Your losses for the 2009-10 and 2010-11 financial years were sizeable. It is likely that the drought and flood contributed to the extent of the losses. However, this is not sufficient for the Commissioner to exercise the special circumstances discretion. You have not demonstrated that your primary production business would have made a profit in the 2009-10 and 2010-11 financial years but for the drought and the flood. Therefore, the Commissioner is not able to exercise the special circumstances discretion for those years.

Nature of the activity

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

It is accepted that a fruit growing activity has a lead time before a tax profit can be achieved. This is because it is in the nature of such an activity that there will be a period of time before any income is produced. That is, the inherent nature of a fruit growing activity that precludes a tax profit from being made is the plants take several years from planting before fruit can be produced and harvested.

In your case, the plants were planted approximately 15 years ago. Industry information indicates that commercial yields commence three years after planting with full yields being realised after five years.

When you took over the entire business as a sole trader the plants should have already reached full production. You stated that you borrowed heavily to acquire the other partner's interest in the business. However, Taxation Ruling TR 2007/6 states at paragraph 78 that the level of debt funding is a business choice made by an individual and is not an inherent characteristic of a business activity.

It is not accepted that the business losses in the 2009-10 and 2010-11 financial years were caused by the inherent nature of the business activity. Therefore, the Commissioner will not exercise the discretion available in paragraph 35-55(1)(c) of the ITAA 1997 for the 2009-10 and 2010-11 financial years.