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Ruling

Subject: non-commercial losses

Question

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 your share of losses from the partnership grape growing activity in the calculation of your taxable income for the 2010-11 financial year?

Answer: No

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

27 February 2005

Relevant facts and circumstances

You satisfy the <$250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You are a partner in a partnership which is in the business of wine grape growing.

Water allocation has been severely restricted in your area a number of years ago. Accordingly, yields available from the grape crops have decreased dramatically. Restrictions have gradually eased with full water allocation for the 2011-12 financial year.

You submit that your inability to meet the assessable income test in 2010-11 was also due to the market downturn.

In 2010 you had good summer rains.

You estimate that you have lost up to 7-10% of your plantings as a result of numerous years of water restrictions.

You expect to make $20,000 in assessable income in the 2011-12 financial year.

Before you became the owners of the business, the turnover was in excess of $20,000. Your turnover has been less than $20,000 since the introduction of water restrictions.

You have not satisfied any of the four tests set out under Division 35 of the ITAA 1997. The exception under subsection 35-10(4) of the ITAA 1997 does not apply.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 35-10(1)
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)

Reasons for decision

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

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

· the exceptions apply, or

· the Commissioner exercises his discretion.

In your situation, none of the exceptions would apply and although you satisfy the income requirement, you do not meet any of the four tests in the years of income under consideration. Your losses are therefore subject to the deferral rule, unless the Commissioner exercises his discretion.

The relevant discretion may be exercised for the income year in question where your business activity is affected by special circumstances outside your control.

'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, including drought, flood, bushfire or some other natural disaster.

For individuals who satisfy the income requirement, special circumstances are those which have materially affected their business activity, causing it not to meet any of the four tests. In this context, the Commissioner may exercise this discretion for the income year(s) in question where, but for the special circumstances the activity would have passed at least one of the tests.

In your case the circumstances which occurred in the 2008-09 income year are considered to be outside your control. The allocation of water is strictly controlled by the state government.

You have stated that your primary production business losses for the 2010-11 financial year have been due to water restrictions. In previous years you have shown that water restrictions have contributed significantly to your loss of income.

However this is not sufficient for the Commissioner to be able to exercise the special circumstances discretion for the 2010-11 financial year. He must be satisfied that you would have passed one of the four tests, in your case the assessable income test, in the 2010-11 financial year but for the special circumstances.

The more dramatic distinction between the last year in which you passed the assessable income test and your present situation is the change in average price received per tonne rather than the change in yields.

If the yield you had received in the 2010-11 financial year was the same yield as the last year in which you passed the assessable income test you would not have made $20,000 as average price per tonne received is significantly lower now than in the past.

Therefore, even if you had produced the same yield levels as prior to the water restrictions you would not have passed the assessable income test. You inability to make $20,000 in assessable income was predominantly due to low grape prices per tonne as opposed to water restrictions. The 2010-11 financial year can be distinguished from earlier years in which the discretion was granted as yield levels are higher and more in line with production figures pre water restrictions. Additionally, the effects of the water restrictions were mitigated by the good summer rains which occurred in the 2010 year.

It is considered that a change in prices received, especially in the wine industry, to be the result of ordinary market fluctuations that affects all businesses within your industry and not unusual, uncommon or exceptional. These are circumstances that might be reasonably expected to occur when carrying on a business activity and not special circumstances.

In summary, the Commissioner is not satisfied that if it were not for the drought, your activity would have passed the assessable income test in the 2010-11 financial years Consequently, the Commissioner's discretion in respect of special circumstances will not be exercised for that year.