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Ruling

Subject: non-commercial losses - 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 farming enterprise 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

Your business activities are conducted under a partnership structure.

In the 2009-10 financial year the crop was impacted by a cyclone and an abnormal wet season. The cyclone did not cause direct crop damage as in destroying crops, but blew the plants over. This affected the quality of the harvestable produce and therefore the price received.

Approximate Income shortfall - $68,000.

Your actual figures show a loss of approximately $155,000 for the financial year.

If you add in the income shortfall and take out expenses for crop purchase, depreciation, water charges and interest expenses you make a small profit.

Your income for non-commercial loss purposes in the 2009-10 financial year was above $250,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 35-1

Income Tax Assessment Act 1997 - Subsection 35-10(2E)

Income Tax Assessment Act 1997 - Subsection 35-55(1)

Income Tax Assessment Act 1997 - Paragraph 35-55(1)(a)

Reasons for decision

Summary

The Commissioner is not satisfied that your farming activities would have made a profit in the 2009-10 financial year had it not been affected by these special circumstances. Therefore, the Commissioner is unable to exercise the discretion available in relation to your farming activities for the 2009-10 financial year.

Detailed reasoning

Section 35-1 of the ITAA 1997 provides that an income requirement must be met (along with certain other tests), in order to include losses from a business activity in your taxable income calculation. If the income requirement is not met, the Commissioner may exercise a discretion (in limited circumstances) to allow the inclusion of the losses.

The income requirement under subsection 35-10(2E) of the ITAA 1997 will be satisfied, if your income for non-commercial loss purposes is less than $250,000.

In your case, you do not satisfy the income requirement as your income for non-commercial loss purposes is above $250,000 in the 2009-10 financial year. Therefore your losses from this activity will be deferred unless you can obtain the Commissioner's discretion to allow these losses.

This change in the legislation for the over $250,000 taxpayers came into effect in the 2009-10 financial year and it effectively quarantines losses from all types of business activities whether they be primary production or non-primary production activities. A recent Administrative Appeals Tribunal decision (Applicant 1761 of 2011 and Commissioner of Taxation [2011] AATA 779 (3 November 2011)) gives a good explanation of this point at paragraph 10:

…….It should be observed at once that neither then nor now is Division 35 in any way concerned with an individuals integrity. Rather, according to a value judgement reflected in the terms specified in that division, Division 35 contains measures thought necessary by Parliament to maintain fiscal integrity in relation to income tax. ….

It is not questioning whether these taxpayers are carrying on a business, but in those years where there is a loss from the business activity, it will be deferred/quarantined to that business activity, unless in limited circumstances the Commissioner's discretion applies.

The Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the financial year where the business activity is affected by special circumstances outside the control of the operators of the business activity and certain other conditions are met.

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. For those individuals who do not satisfy the income requirement, special circumstances are those which have materially affected the business activity, causing it to make a tax loss or preventing it from making a tax profit.

Taxation Ruling TR 2007/6 sets out the Commissioner's interpretation on the exercise of the discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 53 of this ruling:

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. 

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 when carrying on a business activity and affect all businesses within a particular industry.

In your case, the region where your activities are conducted was affected by abnormal weather conditions. The crop was lodged due to a cyclone and the fields were water logged for long periods due to abnormally high rainfall.

It is accepted that these conditions were outside your control and, therefore, 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 caused your activities to make a tax loss/stopped you from making a tax profit (the activity will produce assessable income for an income year greater than the deductions attributable to it for that year).

You have provided an explanation and figures to show that there was an approximate income shortfall of $68,000 in the 2009-10 financial year. The partnership financial statements for the year have been provided showing a loss of approximately $155,000. If we add on the $68,000 shortfall in income this still gives a taxation loss of $87,000.

You have argued that certain deductions such as the crop purchase, depreciation, water charges and interest expenses should not be taken into account in calculating whether you would have made a profit. This argument is not accepted. You have to be able to show that the activity would have produced assessable income for an income year greater than the deductions attributable to it for that year, if it were not for the special circumstances that affected the activity. You cannot selectively leave out certain deductions.

The Commissioner is not satisfied that your activities would have made a tax profit in the 2009-10 financial year had it not been affected by these 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 activities for the 2009-10 financial year.