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Ruling

Subject: NCL - Commissioner's discretion - Lead time.

Notice of private ruling

This private ruling replaces a previous private ruling. The earlier ruling no longer applies to you.

Question

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 primary production activity in your calculation of taxable income for the 2010-11 to 2012-13 income years?

Answer

No

This ruling applies for the following periods

1 July 2010 to 30 June 2013

The scheme commenced on

1 July 2002

Relevant facts and circumstances

You purchased a property with the intension of establishing a primary production activity. You sold the property to a related entity and leased it from that entity to continue the activity.

You are using part of the property to carry on the main activity.

You have provided actual and estimated income and expenditure statements for your business. As per the estimates you expect to receive a profit in the 2013-14 income year.

You have also provided documents from third parties and Government departments to substantiate your claim.

You have received income in excess of $20,000 from sales and satisfied the assessable income test in section 35-30 of the ITAA 1997 in the past.

You did not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 in the 2010-11 income year and do not expect to satisfy in the 2011-12 and 2012-13 income years.

You have requested the Commissioner to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the 2010-11 to 2012-13 income years.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 paragraph 35-10(2).

Income Tax Assessment Act 1997 paragraph 35-10(3).

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

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.

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

In your case you did not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 in the 2010-11 income year and do not expect to satisfy in the 2011-12 and 2012-13 income years.

You also do not satisfy the exception in subsection 35-10(4) of the ITAA 1997 as you have received at least $40,000 of non-primary production income in the above income years.

Your primary production activity will only be potentially subject to these provisions if it is carried on as a business. The Commissioner is satisfied that your activity is carried on as a business.

Commissioner's discretion - lead time

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:

(c) 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 states that the particular paragraph is intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. The note includes an example of an activity involving the planting of hardwood trees for harvest where many years would pass before the activity could reasonably be expected to produce income.

Paragraphs 77 and 78 of Taxation Ruling TR 2007/6, which discusses non-commercial business losses and the Commissioner's discretion, state:

Therefore, the phrase 'because of its nature' refers to inherent characteristics of the type of business activity being conducted by the taxpayer, which are common to any business activity of that type. These inherent characteristics must be the reason why the activity is unable to satisfy any of the tests. The discretion is not intended to be available where the failure to satisfy one of the tests is for other reasons.

The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity…

You purchased the property and commenced the activity in stages.

Based on the income and expenditure projections, you expect to receive a tax profit in the 2013-14 income year,

In a previous private ruling based on Tribunal cases, the Commissioner stated that the commercially viable period for your industry is not more than six years.

Although you have not stated the accepted number of years before the industry becomes commercially viable, you have provided references to argue your claim:

One of the references mentions 12 years for the activity. The reference does not provide a definition for the 12 year period. Paragraph 21 of the Taxation Ruling TR 2007/6 states that the period that is commercially viable for the industry concerned is the period in which it is expected that any business activity of that type, which is carried on in a commercially viable manner, would be expected to satisfy one of the tests or produce a tax profit. The paragraph in the ruling further states that it is not determined having regard to best practice in the industry concerned. Therefore, the Commissioner cannot accept 12 year as the commercially viable period for industry for the purposes of Division 35 of the ITAA 1997.

Some of the references you have provided indicated that income from commercial levels could be achieved in six years and full maturity can be achieved couple of years later.

The income and expenditure statements you provided indicated that you have received income from the activity quiet early. This income has steadily increased. However, you have not received sufficient produce compared to the references you have provided.

In the judgment Hall v FC of T [2006] AATA 360; 2006 ATC 2356; 64 ATR 1001, paragraph 51 states that there could be a range of potential causes for the delay in receiving a good harvest:

You have stated that the expenses are high due to the method you are using. However, the information you have provided states that you can receive a higher price for your product. This means that although your expenses are higher the income you receive will also be higher compared to the other producers.

You expect to receive a profit from your activity in the 2013-14 income year. You have not provided evidence to suggest that the commercially viable period for the industry is at least ten years.

Method of production

Your business focus has always been to use a special method of production.

You have provided independent evidence to suggest that additional 3-12 months are necessary to produce the product using your method.

You have been selling your produce four years after commencing your activity. Even if you commenced processing later, still you should have been profitable in the 2010-11 income year.

Effect of the unavoidable circumstances

You state that your activity was affected by unavoidable circumstances. You have provided independent evidence to confirm the unavoidable circumstances.

Paragraphs 24 to 27 of the Taxation Ruling TR 2007/6 discusses the interaction between the two limbs ('Special circumstances' and 'because of its nature') of subsection 35-55(1) of the ITAA 1997. Paragraph 26 of the ruling states:

In such cases the appropriate enquiry will be whether or not the special circumstances outside the control of the operators of the business activity have meant that there is no longer an objective expectation that within the period that is commercially viable for the industry concerned the activity will satisfy a test (or produce a tax profit)

Paragraphs 55 to 58 of the Taxation Ruling TR 2007/6 further discusses 'outside the control of the operators of the business activity':

For these other kinds of events, the operators of the business activity must show that the special circumstances were outside their control. The concept of 'control' was discussed in Secretary, Department of Employment, Education and Youth Affairs v. Ferguson (1997) 76 FCR 426; (1997) 48 ALD 593; (1997) 147 ALR 295 for the purposes of subsection 45(6) of the Employment Services Act 1994. At 76 FCR 438; 48 ALD 603; 147 ALR 306, Mansfield J said:

The expression in s45(6)(a) requires that the main reason for the failure was something that the person had within that person's control. The concept of 'control' in that context is one of fact, but I think it is intended to mean something which the person could have done something about.

And at 76 FCR 438, 48 ALD 603; 147 ALR 306:

It recognises the focus of the expression upon occurrences which the person concerned could not realistically prevent.

However, if the operators of the business activity fail for no adequate reason to adopt certain practices commonly used in their industry to prevent or reduce the effects of certain circumstances, such as for example pests or diseases, then that may point to the circumstances being within their control.

Similarly, the acquisition of a poorly run but promising business activity would generally be considered to be within the control of the business operator and as such would not, by itself, constitute special circumstances, even though the actions of the former operator may have been outside the control of the current operator.

You are conducting your primary production activity in an area affected by unavoidable circumstances. You purchased, sold, leased and commenced the activity during the time the area was affected by unavoidable circumstances.

As stated in paragraphs 55-58 of the Taxation Ruling TR 2007/6, it was within your control to purchase the property and commence the activity when the area was affected by these circumstances.

We do not consider that there is anything inherent or innate in the nature of your business activity which means that it has not yet been able to generate assessable income greater than the deductions attributable to it within the commercially viable period.

As stated above, for the Commissioner to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997, the activity should satisfy both subparagraphs (i) and (ii).

On the facts provided, the Commissioner is not satisfied that you have not received assessable income greater than the deductions attributable to it in the 2010-11 to 2012-13 income years because of the nature of your primary production activity (subparagraph (i)).

Based on the information provided, we note that the following has affected your activity from generating assessable income greater than the deductions attributable to it within the commercially viable period:

· Commencing the activity in stages.

· Excessive payments. Although you are conducting this activity in a smaller area you are leasing a bigger property.

· Rent. You are required to pay additional rent for the assets.

These additional payments also delay receiving profits within the commercially viable period.

The Commissioner is not satisfied that it is because of its nature, that your activity has not produced, or will not produce, assessable income greater than the deductions attributable to it in the 2010-11 to 2012-13 income years.

Therefore, the Commissioner will not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 in relation to your primary production activity for the above income years.

Accordingly, the Commissioner is not satisfied that it would be unreasonable to apply the rule in subsection 35-10(2) of the ITAA 1997 in relation to your business activity for the 2010-11 to 2012-13 income years.

Summary of reasons for decision

The Commissioner will not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 because, on the facts provided the Commissioner is not satisfied that it is because of the nature of your primary production activity that it did not/will not receive assessable income greater than the deductions attributable to it during the 2010-11 to 2012-13 income years.

Therefore, the rule in subsection 35-10(2) of the ITAA 1997 will apply to defer to a future income year any loss generated from your activity for those years. A deferred loss is not disallowed and will be deductible against any taxation profit from your activity, or similar business activity, in future years.

If your activity, or similar activity should satisfy an exception or satisfy the income requirement and one of the tests in Division 35 of the ITAA 1997 in any given year, then the whole of the deferred loss will be deductible in that year.