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Subject: NCL - Commissioner's discretion - Special circumstances and Lead time

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) 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 2009-10 to 2011-12 income years?

Answer

Yes.

This ruling applies for the following periods

1 July 2009 to 30 June 2012

The scheme commenced in

1 July 2003

Relevant facts and circumstances

You are operating a primary production activity.

Subsequent to purchasing the property you undertook various improvements to the property to convert the property to run a different species of livestock.

Significant investment has been incurred in facilitation the upgrades and introducing purpose built infrastructure to the property.

In the 2004-05 income year, you purchased your initial livestock to commence the activity.

You submit that the area you are conducting the activity was affected by unavoidable circumstance for a number of years.

You have provided evidence of the unavoidable circumstances and the industry lead time for the activity.

Although you expected to generate a profit earlier, due to the unavoidable circumstance, you are not able to do so till the 2012-13 income year.

Your income for non-commercial loss purposes is in excess of $250,000.

You have previously requested a private ruling with regards to your activity. The Commissioner did not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the activity. As your circumstances changed, you requested a new private ruling.

You have requested the Commissioner to exercise the discretion is paragraph 35-55(1)(a) of the ITAA for the relevant income years.

Relevant legislative provisions

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

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

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

Summary

The Commissioner will exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 because, on the facts provided the Commissioner is satisfied that it is because of the special circumstances that your primary production activity did not produce a tax profit within the commercially viable period.

You expect to generate a tax profit in the 2012-13 income year.

Therefore, the commissioner's discretion in paragraph 35-55(1)(a) will be exercised for the 2009-10, 2010-11 and 2011-12 income years.

Detailed reasoning

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 relevant 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:

77. 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.

78. 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 a property to commence a primary production activity. Subsequently you leased more properties to expand the activity.

You have stated that the commercially viable period for the activity is 3 to 4 years. You have provided evidence to confirm this commercially viable period.

You expected to generate a profit few years after purchasing the property and commencing the activity. However, you were not able to do so due to 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:

26 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':

55 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.

56 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.

57 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.

58 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 have provided evidence that the unavoidable circumstances affected your activity. You have provided further evidence to confirm that due to the unavoidable circumstances your activity cannot produce a tax profit prior to the 2012-13 income year.

The Commissioner is satisfied that the primary production activity was affected by unavoidable circumstances outside your control during the lead time for the industry. Had unavoidable circumstances not occurred, you had sufficient land to carry on the activity to generate a tax profit within the commercially viable period.

Paragraph 27 of the Taxation Ruling 2007/6 states:

26 …..However, where the special circumstances are the sole reason why the activity can no longer objectively be expected to satisfy a test (or produce a tax profit) within the period that is commercially viable for the industry concerned, but the activity is now expected to consistently satisfy a test within some later time, the discretion in paragraph 35-55(1)(a) may be exercised.

In view of the above, the Commissioner's discretion in paragraph 35-55(1)(a) will be exercised for the 2009-10 to 2011-12 income years.

Accordingly, the Commissioner is satisfied that it would be unreasonable to apply the rule in subsection 35-10(2) of the ITAA 1997 in relation to your primary production activity for the 2009-10 to 2011-12 income years.