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Ruling

Subject: no-commercial losses

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 2014-15 financial years?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2010
Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on

1 July 1995

Relevant facts and circumstances

You do not satisfy the <$250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You carry on a primary production business.

In the 1990's the land was purchased.

In the 1990's the first plantings were made.

In the 2000's the first crop was produced with basic equipment and facilities.

In the 2000's the produce started winning awards.

In the 2000's capital works were undertaken. A fully equipped production plant was built and significant upgrades were made to equipment.

You intend to produce a tax profit in the 2015-16 financial year.

You have submitted independent evidence from various sources in relation to the commercially viable period for your industry

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)(c)

Reasons for decision

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

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

· the exceptions apply

· the Commissioner exercises his discretion.

In your situation, you do not satisfy the income requirement (that is, your taxable income, reportable fringe benefits and reportable superannuation contributions but excluding your business losses, exceeds $250,000) and do not come under any of the exceptions. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

The third arm of the discretion in paragraph 35-55(1)(c) of the ITAA 1997 may be exercised for one or more financial years where:

(c) you have failed the income requirement, and

(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 greater than the deductions attributable to it for that year.

 The note to paragraphs b & c states:

Note: Paragraphs b & c are intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. For example, 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.

The type of feature contemplated by the phrase 'because of its nature', in the context in which it appears, is that referred to in the note quoted above. That is, that there is an inherent or innate feature of the activity resulting in an inability to produce income in the year of commencement and (in most cases) a number of years thereafter. This is borne out further by paragraph 1.51 of the Explanatory Memorandum for the New Business Tax System (Integrity Measures) Act 2000, which states:

This arm [paragraph 35-55(1)(b)] of the safeguard discretion will ensure that the loss deferral rule in section 35-10 does not adversely impact on taxpayers who have commenced to carry on activities which by their nature require a number of years to produce assessable income. Examples of activities which would fall into this category are forestry, viticulture and certain horticultural activities.

The note and the passage cited above do not support any view that the discretion should be exercised for any start-up activity that is yet, for example, to satisfy the assessable income test in section 35-30 of the ITAA 1997, simply because of the small scale on which it was started, or because a client base is being built up. Those sorts of constraints on being able to satisfy that test are far removed from the specific one referred to in the note and the Explanatory Memorandum.

The test to determine a commercially viable period is primarily an objective one based on independent sources. This approach was undertaken in the Federal Court case Commissioner of Taxation v. Eskandari (2004) 134 FCR 569 (Eskandari) where Stone J. said:

In some cases it may be a straight forward exercise to identify the industry in which the business activity takes place. Some industries are well-established and the basis for an "objective expectation" can readily be based on a comparison between the tax payer's business and other businesses within that industry, particularly where businesses or business associations with the industry produce material such as annual reports or industry papers…

Despite what Stone J said, Mr Scott contended that there were other circumstances which had to be taken into account when determining the commercially viable period expressed in the Olives Australia document. However, according to the Commissioner, this is impermissible because, as the Federal Court held in Eskandari, in most cases only objective material will be considered. It is only where, because of the nature of the industry, there is very little or no objective evidence that recourse may be had to the circumstances of the tax payer. That is not the case in the olive industry, which has been established for centuries. I agree with that submission. 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.

Further, in the case of Scott, additional plantings made at a later time were not permitted to be included in the commercially viable period, as follows:

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.

You have asked the Commissioner to exercise his discretion in relation to lead time.

The evidence you have submitted takes into account the current market conditions such as oversupply and the high value of the Australian dollar. The oversupply of a product is the result of ordinary market fluctuations that affects all businesses within that industry. Reduced product prices as a result of over supply might be reasonably expected to occur when carrying on a business activity and do not extend the commercially viable period.

Your business reached full production a number of years ago. It stands then that the start up period inherent to the nature of your activity is over.

We consider the commercially viable period for your industry is four to five years and you do not expect to make a tax profit until ten years after the commencement of the business. We do not consider that there is anything inherent in the nature of your business activity that prevented you from being able to produce a taxable profit within 4 to 5 years of commencing the business.

In conclusion, the requirements of paragraph 35-55(1)(c) of the ITAA 1997 have not been met. Consequently, you are not eligible for the Commissioner's discretion for the 2009-10 to 2014-15 financial years.