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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 claim the losses from your primary production activity in the calculation of your taxable income for the year ended 30 June 2011?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2011.

The scheme commences on:

In the year ended 30 June 2010

Relevant facts and circumstances

In your application for a private ruling you have provided the following information:

You operate a primary production activity that you commenced in the year ended 30 June 2010 and you carry on this activity as a business.

You have provided details of your activity and the scale of operation

You are seeking the Commissioner's discretion under special circumstances for a number of years due to a special circumstance.

The special circumstances prevented you from satisfying the assessable income test.

In the year ended 30 June 2011 you expected to generate income in excess of $20,000 from your primary production activity

Due to the special circumstance your production was significantly less

You have provided your projected income for the year ending 30 June 2012 showing that your income would be in excess of $20,000.

In response to our letter to you, you provided following information:

You purchased the activity in the year ended 30 June 2010 and you were not aware that your activity will be affected by the special circumstance in the future. You have provided evidence for your special circumstance. .

You have provided further information on your activity and evidence to support your projected income will be realistic.

You have provided details of the adverse effect of the special circumstance on your activity.

You have provided the actual and projected income for the year ended 30 June 2010 and future years :

Your income for non-commercial loss purposes was less than $250,000 for 2011 year.

In response to our request you provided following information:

Your application for a private ruling is in respect of a mixed activity.

You have withdrawn your application for a private ruling in respect of several future years.

You have provided production targets and supporting evidence.

Your activity is capable of generating income within months of its commencement.

In a telephone discussion, you confirmed that your activity did not satisfy any of the tests in Division 35 of the ITAA 1997 for the year ended 30 June 2011 and your assessable income from other sources for that year exceeded $40,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 35-55

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

Income Tax Assessment Act 1997 section 35-30

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

Income Tax Assessment Act 1997 subsection 35-10(2)

Income Tax Assessment Act 1997 subsection 35-10(4)

Reasons for decision

Division 35 of the ITAA 1997 applies to losses from certain business activities for the 2000-01 income year and subsequent years. Under the rule in subsection 35-10(2) of the ITAA 1997, a 'loss' made by an individual (including an individual in a general law partnership) from a business activity will not be taken into account in an income year unless:

· the 'Exception' in subsection 35-10(4) of the ITAA 1997 applies, or

· satisfy subsection 35-10(2E) of the ITAA 1997 for that year and one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 is met, or

· the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

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.

There is an 'Exception' under subsection 35-10(4) of the ITAA 1997, to the general rule in subsection 35-10(2) of the ITAA 1997 where the loss is from a primary production business activity and the individual taxpayer has other assessable income for the income year from sources not related to that activity, of less than $40,000 (excluding any net capital gain).

You have stated that your assessable income for the year ended 30 June 2011 exceeded $40,000. On that basis the exception in subsection 35-10(4) of the ITAA 1997, has no relevance for the purpose of this ruling.

You satisfy income requirement in subsection 35-10(2E) of the ITAA 1997 if the sum of the following is less than $250,000:

· your taxable income for that year;

· your reportable fringe benefits total for that year;

· your reportable superannuation contributions for that year;

· your total net investment losses for that year.

You have stated that your income for non-commercial purposes is less than $250,000 for the year ended 30 June 2011. On that basis you have satisfied the income requirement in subsection 35-10(2E) of the ITAA 1997 in that year.

In broad terms, the tests in Division 35 of the ITAA 1997 require:

(a) at least $20,000 of assessable income in that year from the business activity (section 35-30 of the ITAA 1997)

(b) the business activity results in a taxation profit in three of the past five income years (including the current year) (section 35-35 of the ITAA 1997)

(c) at least $500,000 of real property, or an interest in real property, (excluding any private dwelling) is used on a continuing basis in carrying on the business activity in that year (section 35-40 of the ITAA 1997), or

(d) at least $100,000 of certain other assets (excluding cars, motor cycles and similar vehicles) are used on a continuing basis in carrying on the business activity in that year (section 35-45 of the ITAA 1997).

You have not satisfied any of the tests in Division 35 of the ITAA 1997 for the year ended 30 June 2011. The exception in subsection 35-10(4) of the ITAA 1997 does not applied in relation to your primary production activity for the year ended 30 June 2011. Therefore the rule in subsection 35-10(2) of the ITAA 1997 will apply to defer any losses from your primary production activity for that year unless the Commissioner exercises the discretion in section 35-55 of the ITAA 1997 in relation to your activity.

Your primary production activity will only be potentially subject to these provisions if it is carried on as a business. If your activity is not carried on as a business, and cannot reasonably be expected to produce assessable income, for example it is carried on as a hobby, then you cannot claim general deductions in relation to it, regardless of the operation of Division 35 of the ITAA 1997.

Whether a business is being carried on depends on the 'large or general impression gained' (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all the indicators of carrying on a business, and no one indicator will be decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). These indicators are described in Taxation Ruling TR 97/11.

You state that you have carried on your primary production activity as a business from April 2010. This ruling is issued on accepting your activity is carried on as a business.

Paragraph 35-55(1)(a) of the ITAA 1997 sets out the first arm of the Commissioner's discretion as follows:

The Commissioner may, on application, decide that the 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:

(a) the business activity was or will be affected in the excluded years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster; or

Note: This paragraph is intended to provide for a case where a business activity would have satisfied one of the tests if it were not for the special circumstances.

The above paragraph refers to 'special circumstances' outside of the control of the operators of the business activity. No exhaustive definition is given of 'special circumstances' but the paragraph does include drought, bushfire and other natural disasters.

It can be seen that to determine what is 'special circumstances', we need to look at the context in which the phrase is used. Also, it is clear that 'special circumstances' will be something out of the ordinary or unusual. 'Special circumstances' in paragraph 35-55(1)(a) of the ITAA 1997 is used in the context of a situation occurring such that it would be unreasonable for the Commissioner to apply the loss deferral rule for a particular year or years. For this to be the case, it will not only be necessary that an event or situation has occurred which is of itself unusual, but that it has resulted in the business activity failing to pass a test. Clearly, if the business activity would not have passed a test even if the event or situation had not arisen, we cannot say that the business activity was affected by 'special circumstances' in the sense in which this term is used in paragraph 35-55(1)(a), as the Note to the paragraph indicates.

The Commissioner should be satisfied that the business had been affected by the special circumstances in order to apply the discretion in paragraph 35-55(1)(a) of the ITAA 1997.

You state the circumstance that occurred was special and it adversely affected your primary production activity. Due to that you could not satisfy the assessable income test in section 35-30 of the ITAA 1997 for the year ended 30 June 2011.

You were not in a position to predict that the circumstance will adversely affect your activity in the future. You have provided evidence from independent sources to support the occurrence of the special circumstance.

In terms of paragraph 35-55(1)(a) of the ITAA 1997, the circumstance can be considered as a special circumstance which was out of control of the operators.

The Commissioner accepts that circumstance in your case was a special and it affected your activity adversely. It is accepted that your activity would have received at least $20,000 assessable income and have satisfied the assessable income test for the year ended 30 June 2011 if the circumstance did not occur.

As your primary production activity has been affected by a special circumstance in the sense these terms are used in Division 35 of the ITAA 1997, the Commissioner will exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 in respect of your primary production activity for the year ended 30 June 2011. This means that any loss for your primary production activity can be taken into account in calculating your taxable income for that year.