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Ruling

Subject: Commissioner's discretion

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 business activity in your calculation of taxable income for the 2009-10 to 2011-12 financial years?

Answer: No.

This ruling applies for the following period

Year ended 30 June 2010

Year ended 30 June 2011

Year ending 30 June 2012

The scheme commenced on

1 July 2009

Relevant facts

You commenced your primary production business activity in 19XX.

Since commencing the activity, you have purchased a further four properties.

Your business plan, developed in 2005, was to produce a high quality breeding herd of purebred livestock

Since then, you have more than tripled your livestock numbers, with almost half being purchased in 2011.

Some unforeseen events have affected the business:

Around a third of your livestock were taken from one of your properties and set back the rate of herd expansion.

The global financial crisis reduced your available cash flow to reduce the business debt, requiring higher interest rates to be borne for a longer period.

Floods in 2011 seriously affected sales and costs. All properties suffered damage to infrastructure and equipment and livestock could not be removed from the properties. Additional expenses were incurred for flood repairs.

Actual income and expenditure figures from 2008-09 to 2010-11 financial years shows livestock income of between around $15,000 and $90,000, and expenses of between around $480,000 and $500,000.

You project that your business activity will be profitable in the 2012-13 financial year.

Your income for non-commercial loss purposes in the 2009-10 and 2010-11 financial years was above $250,000 and you expect this will be the case for the 2011-12 financial year.

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)(c).

Reasons for decision

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 discretion to allow the inclusion of the losses.

You satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 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 was above $250,000 in the 2009-10 and 2010-11 financial years and you expect this will be the case in the 2011-12 financial year as well.

Nature of the activity

In order to exercise the discretion, the Commissioner must be satisfied there is an objective expectation, based on evidence from independent sources, that your business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period (paragraph 35-55(1)(c) of the ITAA 1997).

For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is producing a loss is inherent to the nature of the business and is not peculiar to your situation. For example, the discretion will not be available where the failure to make a profit is for reasons other than the nature of the business.

Where an operator chooses to carry on the business activities in a manner that does not produce a tax profit within the period that is commercially viable for the industry concerned, paragraph 35-55(1)(c) of the ITAA 1997 may not be satisfied.

As an example, in the case of Scott v. Commissioner of Taxation [2006] AATA 542 (Scott's Case), the court upheld the Commissioner's decision in not applying the discretion. Mr Scott initially planted olive trees in 1997 and 1998. He then planted further trees in July 2000. No income was produced in the subsequent four years.

The Commissioner contended that the losses fell outside the commercially viable period for that industry, which was determined on an objective basis.

In relation to the commercially viable period, Mr Scott argued that there were other circumstances which should be taken into account when determining this time frame. On this issue, the court expressed the following view:

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…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.

Over the years you have restructured your business, purchased new properties and increased your herd, but your business activity has essentially remained the same. You have provided projections to show you expect your activities to produce a tax profit in the 2012-13 financial year, or more than 15 years after you commenced.

You have not provided any evidence from an independent source to establish the commercially viable period for your industry/business.

Taking into consideration the information you have provided, the Commissioner is not satisfied that your business activity will produce a tax profit within the commercially viable period for your type of business.

The reason your business activity is currently producing a loss is due to the restructuring and continued expansion of your business and is not inherent to the nature of the business. Where the business does not produce a profit within the commercially viable period, the Commissioner is not able to exercise the discretion.

Therefore, the Commissioner is unable to exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(c) of the ITAA 1997 for the 2009-10 to 2011-12 financial years.

Special circumstances

You have asked the Commissioner to consider the affects some unforeseen events have had on the business.

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.

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 loss.

You have stated that the global financial crisis (GFC) reduced your available cash flow to reduce the business debt, requiring higher interest rates to be borne for a longer period. While these conditions were outside your control, they are not considered to be 'special circumstances' for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. In fact, since the GFC in 2008, you have continued to expand your debt levels by increasing your land holdings and livestock purchases.

In 2006, a number of livestock were taken from one of your properties and in 2011 floods caused damage to infrastructure and equipment.

It is accepted that these conditions were outside your control and 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 loss.

There is no evidence to show that the loss of a number of livestock in 2006 is the cause of your losses in the 2009-10 to 2011-12 financial years. Your own estimates of the addition expenses incurred as a result of the floods is $50,000. As your losses in the 2010-11 financial year are well in excess of $50,000, it can not be said that 'but for' the floods, your activities would have produced a profit.

The Commissioner is not satisfied that your activities would have made a profit in the 2009-10 and 2010-11 financial years, or would have been expected to make a profit in the 2011-12 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 to 2011-12 financial years.