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Ruling

Subject: Trust losses

Issue 1

Question 1

Was the trust carrying on a business of primary production in the years in which losses occurred from 1998 to 2010 allowing deductions of tax losses of earlier income years in terms of Division 36 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Issue 2

Question 1

Was there a change in the group which has controlled the trust under section 269-95 of the Income Tax Assessment Act 1936 (ITAA 1936) changing the deductibility of tax losses in terms of Division 36 of the ITAA 1997?

Answer

No

Question 2

Is the running by B of their current business through the trust an injection of income by an outsider to the trust which will disallow the taxation losses claimed in terms of section 270-15 of the ITAA 1936?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2012

Relevant facts and circumstances

Business operations

Property 1

The trust purchased a property in the 1990s. The property comprised several hundred acres of land suitable for cultivation and grazing. "A", worked overseas and appointed managers to run the trust operations.

Income was received from the farm operations and this information was provided.

The trust has accumulated losses from date of purchase until it was sold.

The property was sold in 2003 and the operations relocated to Property 2.

Property 2

This property comprised several hundred acres of prime cropping land consisting of a paddock purchased by the trust as well as a property owned by a family member available for use.

The trust had an informal share farming agreement with a local farmer to grow crops and split the proceeds. Due to drought conditions cropping attempts failed and no cattle was acquired due to the costs involved with hand feeding due to the absence of pastures.

The intention to farm is evidenced by the purchase of the equipment. A list of equipment was provided.

Income was received from the farm operations and this information was provided.

The trust has accumulated losses from 20XX to 20XX.

The property owned by the family member has been gifted to the trust in the financial year ended 30 June 2012 and the property is now farmed on behalf of the trust by B. The total area of cropping land is currently under cultivation and the intention is to crop the land twice a year.

There was always an intention of making a profit from the farming activities but circumstances prevented this. These circumstances included the absence of A overseas, drought conditions and the marriage of A.

B is in business as a tradesman and is contemplating running their business through the trust to recover the carried forward trust losses.

Trust structure

The trust was established as a discretionary trust in the 1990s.

The Trustee of the trust is a company. A was the director of the trustee company and held ordinary shares in the trustee company. The remaining ordinary shares were held by C and D.

A and B are specifically named as beneficiaries of the trust.

The trust deed names A as the Appointor with ultimate power to dismiss and appoint trustees.

At the establishment of the trust B was a minor.

In 2011 A was diagnosed with a terminal illness. As a result of this diagnosis, they are permanently incapacitated and have been admitted as a permanent patient to a nursing home.

Subsequently A was replaced as Appointor to the trust by C and B.

The shares in the trustee company have been transferred to C and B has been appointed as director.

C is the former spouse of A. B is the child of A and C.

No family trust election has been made by the trust.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 269-95

Income Tax Assessment Act 1936 Section 269-95(1)

Income Tax Assessment Act 1936 Section 269-95(2)

Income Tax Assessment Act 1936 Section 269-95(3)

Income Tax Assessment Act 1936 Section 270-10

Income Tax Assessment Act 1936 Section 270-15

Income Tax Assessment Act 1936 Section 270-25(1)

Income Tax Assessment Act 1936 Section 270-25(2)

Income Tax Assessment Act 1936 Section 272-95

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Division 36

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Issue 1

Question 1

Was the trust carrying on a business of primary production in the years in which losses occurred from 1998 to 2010 allowing deductions of tax losses of earlier income years in terms of Division 36 of the ITAA 1997?

Division 36 of the ITAA 1997 allows for the deductions of tax losses of earlier income years from the assessable income of later income years. The tax loss for a particular year is calculated with reference to allowable deductions. Allowable deductions may be claimed under the general section 8-1 of the ITAA 1997 or under a specific section of the Act. A major consideration in determining the deductibility of losses or outgoings is whether a business was carried on.

A primary production business is defined in subsection 995-1(1) of the ITAA 1997 as the carrying on of a business of:

(a) cultivating or propagating plants, fungi or their products or parts (including seeds, spores, bulbs and similar things), in any physical environment; or

(b) maintaining animals for the purpose of selling them or their bodily produce (including natural increase); or

(c) manufacturing dairy produce from raw material that you produced; or

(d) conducting operations relating directly to taking or catching fish, turtles, dugong, bêche-de-mer, crustaceans, or aquatic molluscs; or

(e) conducting operations relating directly to taking or culturing pearls or pearl shell; or

(f) planting or tending trees in a plantation or forest that are intended to be felled; or

(g) felling trees in a plantation or forest; or

(h) transporting trees, or parts of trees, that you felled in a plantation or forest to the place:

            i. where they are first to be milled or processed; or

            ii from which they are to be transported to the place where they are first to be milled or processed.

The term business is defined in subsection 995-1(1) of the ITAA 1997 to include any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Taxation Ruling TR 97/11 addresses the question of whether a taxpayer is considered to be carrying on a business of primary production. Paragraph 10 of Taxation Ruling TR 97/11 states that the definition of business in the ITAA 1997 simply states what activities may be included in a business. It does not provide any guidance for determining whether the nature, extent, and manner of undertaking those activities amount to the carrying on of a business. For this purpose it is necessary to turn to case law.

Paragraph 13 of Taxation Ruling TR 97/11 lists the following indicators that are relevant in determining whether primary production activities constitute the carrying on of a business:

· Whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators;

· Whether the taxpayer has more than just an intention to engage in business;

· Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;

· Whether there is repetition and regularity of the activity;

· Whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business;

· Whether the activity is planned, organised or carried on in a businesslike manner such that it is directed at making a profit;

· The size, scale and permanency of the activity; and

· Whether the activity is better described as a hobby, a form of recreation or a sporting activity.

Paragraph 15 of Taxation Ruling TR 97/11 states that no one indicator is decisive and there is often a significant overlap of these indicators. Paragraph 16 of Taxation Ruling TR 97/11 provides that the indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impression gained from looking at all the indicators, and whether these factors provide the operations with a commercial flavour. Further paragraph 17 of Taxation Ruling TR 97/11 emphasises that subject to all the circumstances of a case, where an overall profit motive appears absent and the activity does not look like it will ever produce a profit, it is unlikely that the activity will ever amount to a business.

Paragraph 18 of Taxation Ruling TR 97/11 provides a summary of the main activities of carrying on a business. This table is shown below:

(a) Significant commercial purpose:

The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators.

(b) Intention of the taxpayer:

The carrying on of a business is not a matter merely of intention. It is a matter of activity. It is appropriate to look at when the activities started and whether they add up to more than a mere intention to conduct a business. Determining whether a business has commenced or not is a complex issue but we consider that the main indicators of commencement are:

o purpose, intention and decision;

o acquisition of a business structure; and

o commencement of business operations.

Brennan J in Inglis v FC of T 80 ATC 4001 at 4004-4005; (1979) 10 ATR 493 at 496-497 said that:

The carrying on of a business is not matter merely of intention. It is a matter of activity. At the end of the day, the extent of activity determines whether the business is being carried on. That is a question of fact and degree.

(c) Prospect of profit:

Paragraph 48 of Taxation Ruling TR 97/11 states that it is important that the taxpayer is able to show how the activity can make a profit. It also states that it is not necessary for the primary production activities to make a profit in every year of income in order to classify the activities as a business of primary production. Thus, a taxpayer may be carrying on a business of primary production even though he/she is making a small profit or a loss in any given year of income.

(d) Repetition and regularity

The taxpayer should undertake at least the minimum activities necessary to maintain a commercial quantity and quality of product for sale. It is a feature of any business that similar sorts of activities need to be carried out on a regular basis. This repetition leads to the carrying on of a business.

(e) Is the activity of the same kind and carried on in a manner that is characteristic of the industry?

Paragraph 64 of Taxation Ruling TR 97/11 lists a number of factors which might be compared to others engaged in the same type of business:

o the manner and volume of sales

o the types of customers the taxpayer sells their product to

o what sort of expenses are incurred by the taxpayer

o the amount invested in capital items

o previous experience of the taxpayer

(f) Organisation in a business like manner and the use of system.

A business should be characteristically carried on in a systematic and organised manner rather than on an ad hoc or disorganised way. An activity should generally conform with ordinary commercial principles to amount to the carrying on of a business.

(g) Size and scale of the activity

This is merely an indicator and not a determinative test. The larger the scale of the activity the more likely the taxpayer will be carrying on a business of primary production, although this may not always be the case.

An activity carried out on a small scale may constitute the carrying on of a business if the taxpayer has the purpose of making a profit, there is repetition and regularity in the taxpayer's activities, the taxpayer informed himself of market conditions and the taxpayer organises his activities in a business-like way; FC of T v. JR Walker 85 ATC 4179; (1985) 16 ATR 331.

It is clear enough that activities may be said to be a business even though carried on in a small way but nonetheless before such activities can be said to be a business it must be possible to attribute some significant commercial purpose or character to the activity; Thomas v. FC of T 72 ATC 4094 at 4099; (1972) 3 ATR 165 at 171.

(h) Hobby or recreation

Paragraph 87 of Taxation Ruling TR 97/11 lists a number of factors which indicate that the taxpayer is often conducting a hobby:

· It is evident that the taxpayer does not intend to make a profit from the activity;

· Losses are incurred because the activity is motivated by personal pleasure and not to make a profit and there is no plan in place to show how a profit can be made;

· The transaction is isolated and there is no repetition or regularity of sales;

· Any activity is not carried on in the same manner as a normal, ordinary business activity;

· There is no system to allow a profit to be produced in the conduct of the activity;

· The activity is carried on a small scale;

· There is an intention by the taxpayer to carry on a hobby, a recreation or a sport rather than a business;

· Any produce is sold to friends and relatives and not to the public at large.

Summary

The trust has always had the intention to run a primary production business and to make a profit from the operations. The scale of the operations at Property 1 was sufficient to indicate that it was not in the nature of a hobby and the activities had a regularity consistent with the type of operations. The operations at Property 2 were at a much smaller scale and were severely hampered by drought. The trust purchased equipment for the purposes of crop farming but was not able to produce income from crops for a number of years. Due to the absence of A the trust appointed a manager at Property 1 and entered into a share farming agreement at Property 2. The difficulty experienced at Property 2 due to the drought is consistent with that experienced by other operations during this period. The trust has received income from cattle sales, crop income and income from the use of assets for all years except for a couple of years. The trust has not made a profit from the primary production activities until 2011 when a small profit was made. The property owned by the family member has been gifted to the trust in year ended 30 June 2012 and the property is now farmed on behalf of the trust by B. The total area of cropping land is currently under cultivation and the intention is to crop the land twice a year.

Conclusion

Based on all the indicators of carrying on a business listed in paragraph 13 of Taxation Ruling TR 97/11, it is concluded that the trust was carrying on a primary production business in the years in which losses occurred from 1998 to 2010.

Issue 2

Question 1

Was there a change in the group which has controlled the trust under section 269-95 of the ITAA 1936 changing the deductibility of tax losses in terms of Division 36 of the ITAA 1997?

Subsection 269-95(1) of the ITAA 1936 provides that a group controls a non-fixed trust if:

(a) the group has the power, by means of the exercise of a power of appointment or revocation or otherwise, to obtain beneficial enjoyment (directly or indirectly) of the capital or income of the trust; or

(b) the group is able (directly or indirectly) to control the application of the capital or income of the trust; or

(c) the group is capable, under a scheme, of gaining the beneficial enjoyment in paragraph (a) or the control in paragraph (b); or

(d) the trustee is accustomed, under an obligation or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the group; or

(e) the group is able to remove or appoint the trustee; or

(f) the group acquires more than a 50% stake in the income or capital of the trust.

Subsection 269-95(2) of the ITAA 1936 determines when a replacement group will be taken to have controlled the non-fixed trust from the time the original group began to control it in terms of subsection 295-95(3) of the ITAA 1936. The original group has to cease to control the trust only because of the death, incapacitation or breakdown in the marriage or relationship of an individual comprising or included in the original group. The replacement group has to begin to control the trust within one year after the death, incapacitation or breakdown in the marriage or relationship unless the Commissioner determines a longer period.

If the original group comprised of an individual, the replacement group has to consist of one or more of the individuals' family members as defined in section 272-95 of the ITAA 1936. If the original group included other members than the individual who has died or become incapacitated or whose marriage or relationship has broken down, the replacement group also has to include those other members.

The replacement group should begin to control the trust only because of the death, incapacity or breakdown in the marriage or relationship of the individual.

The beneficiaries, disregarding the individual who died or became incapacitated or whose marriage or relationship broke down or any replacement family members, has to remain the same before and after the change of control.

If a person or persons other than the replacement group began to control the trust only because of the death, incapacitation or breakdown in the marriage or relationship of the individual at some time during the period from when the original group ceased to control the trust until the replacement group began to do so and the control did not continue after the replacement group began to control the trust, the person or persons are taken not to have controlled the trust.

Conclusion

A was the director of the trustee company and held shares in the trustee company. A is specifically named as beneficiaries of the trust in the trust deed. The trust deed also names A as the Appointor with ultimate power to dismiss and appoint trustees.

C and D also held the shares in the trustee company.

B is specifically named as beneficiaries of the trust in the trust deed.

In xx A was diagnosed with a terminal illness. As a result of this diagnosis, they are permanently incapacitated and have been admitted as a permanent patient to a nursing home.

A was replaced as Appointor to the trust by C and B. The shares in the trustee company have been transferred to C and B has been appointed as director.

C is the former spouse of A. B is the child of A and C.

A as a member of the group that controlled the trust was replaced by family members due to incapacity within a year of them becoming incapacitated. The other members of the group that controlled the trust are also still members of this group. The replacement group will be taken to have controlled the trust from the time the original group began to control it and there was no change in the group which has controlled the trust under section 269-95 of the ITAA 1936 changing the deductibility of tax losses in terms of Division 36 of the ITAA 1997.

Question 2

Is the running by B of their current business through the trust an injection of income by an outsider to the trust which will disallow the taxation losses claimed in terms of section 270-15 of the ITAA 1936?

An outsider to the trust has two different meanings depending on whether or not the trust is a family trust. If the trust is not a family trust an outsider to the trust is a person other than a person with a fixed entitlement to income or capital of the trust or the trustee of the trust.

If the trust is a family trust an outsider to the trust isn't as restrictive. If a person ceases to become an outsider to the trust just before the scheme, they will still be deemed to be an outsider to the trust for the purposes of this test.

Under subsection 270-25(1) of the ITAA 1936, an 'outsider' to a family trust is a person other than:

(a) the trustee; or

(b) a person with a fixed entitlement to a share of the income or capital of the trust; or

(c) the individual specified in the trust's family trust election; or

(d) a member of the individual's family; or

(da) a trust with the same individual specified in its family trust election; or

(e) a company, partnership or trust that made an interposed entity election to be included in the individual's family group and the election was in force (including before it was made) when the scheme commenced; or

(f) a fixed trust, company or partnership where, at all times while the scheme was being carried out:

(i) the individual specified in the trust's family trust election; or

(ii) one or more members of the individual's family; or

(iii) the trustees of one or more family trusts, provided the individual is specified in the family trust election of each of those family trusts; or

(iv) any combination of the above, had fixed entitlements directly or indirectly, and for their own benefit, to all of the income and capital of the entity.

Under subsection 270-25(2) of the ITAA 1936, an 'outsider' to a non-family trust is a person other than:

(a) the trustee of the trust; or

(b) a person with a fixed entitlement to a share of the income or capital of the trust.

The income injection test contained in section 270-10 of the ITAA 1936 applies where:

o the trust has a deduction in the income year being examined

o there is a scheme under which:

(i) the trust derives an amount of assessable income

(ii) an outsider to the trust provides a benefit, directly or indirectly, to the trustee or a beneficiary or to an associate of the trustee or beneficiary; and

o a return benefit is provided to the outsider, and

o it is reasonable to conclude that the assessable income has been derived, or the benefits have been provided, wholly or partly (but not merely incidentally) because the deduction is allowable.

The definition of a scheme is very wide and includes any arrangement, or any plan, proposal, action, course of action, or course of conduct. The scheme must result in the trust deriving some assessable income.

The benefit provided by the outsider is defined to be money, a dividend, property (tangible or intangible), a right, an entitlement, a service, the extinguishment of a debt (including by forgiveness, waiver, or release), or the doing of anything that results in the derivation of assessable income, or anything not already listed that is a benefit or advantage. A return benefit also has to be provided to the outsider.

If the test is failed, a deduction for prior year losses is not allowable against the scheme assessable income.

Conclusion

The trust has not made a family trust election and therefore B is an outsider to the trust as he is not the trustee of the trust and does not have a fixed entitlement to a share of the income or capital of the trust.

The running of the business through the trust amounts to a scheme whereby a benefit is provided to the trust in the form of a means of earning assessable income. The benefit provided to the outsider consists of the outsider not having to include the income in his own assessable income.

If B runs his business through the trust they will not be able to claim the tax losses against the assessable income derived from this business.