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Ruling

Subject: NCL - Commissioner's discretion - Lead time.

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

1996-97 income year

Relevant facts

The business activity which commenced as early as the 1996-97 income year is owned and operated by you and your spouse.

Your first produce was ready for sale in the 2001-02 income year.

You sell your produce direct to the public from your property, through mail orders and on a wholesale basis to other businesses in the region.

To attract passing trade, you opened a new facility in the 2009 year. The new facility resulted in a dramatic increase in sales.

You claim that the new facility is a new venture and after expected initial set-up and establishment costs have been off set, the venture is expected to be profitable by the 2012-13 income year.

You state that there are two separate business activities within the one business, the previous activity you carried on and the new venture.

You have addressed the indicators stated in paragraph 45 of the Taxation Ruling TR 2001/14 and have decided that based on the indicators you are carrying on two separate activities.

You have stated that industry research indicates that it would be seven years plus before a self sufficient activity such as yours can expect to break even.

You have also provided independent evidence which states that a cash flow profit can be achieved in the very short term, however a tax profit will take longer to achieve.

It is also stated in the independent evidence that the time taken to become profitable would be dependent upon location and range of goods or services offered. It was noted that your particular circumstances may extend the period it would take to become profitable.

You have provided actual profit and loss statements for the past income years and the projections for the future income years.

Your income for non-commercial loss purposes for the past income years was above $250,000 and you expect the income to be in excess of $250,000 for the future income years too.

Previously you requested a private ruling for your activity. The Commissioner issued a private ruling and did not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the relevant income years.

Subsequently you requested a new private ruling as you have provided new information that was not available for the previous private ruling.

You have request the Commissioner to treat the new venture as a new business and to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the 2009-10, 2010-11 and 2011-12 income years.

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

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:

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.

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…

In considering whether or not this discretion would be exercised in your circumstances, it is first necessary to reach a conclusion as to whether or not the opening of a new venture constitutes a new activity separate from your earlier activity.

As part of this consideration it is noted that you established the first part of your activity in the 1996-97 income year. You are still continuing this activity. You have outsourced some of the elements of your activity.

You first produced your products in the 2002 year and made sales from a smaller facility at your property.

In 2008 you commenced building a larger facility incorporating various features to entertain the general public and to sell your products. Since the opening of this facility you have noticed a dramatic increase in visitation rates and product sales.

Paragraphs 37 to 46 of the Taxation Ruling TR 2001/14 discusses the meaning of a business activity, and lists some of the factors that may be relevant to whether a business is made up of separate and distinct business activities for Division 35 purposes.

You have addressed these factors and concluded that when these factors are considered with your circumstances, it would be concluded that your first activity and the new venture are separate activities. This is a question of fact, however, and although your arguments are not without merit, it is considered that on balance, the better conclusion is that the new venture merely expands on the existing business and all aspects of the business are part of one activity.

Paragraph 47 of the Taxation Ruling TR 2001/14 states:

To sum up, identification of what are the individual taxpayer's relevant business activities is to be done on a common sense basis without looking to create artificial distinctions between various parts of their overall business. This will often mean that the relevant business activity is the individual's whole business.

Looking at your circumstances from a common sense perspective, it is considered that the new facility and the first activity are part of the one overall business. It is arguably not unusual for activities such as yours to maintain their own identity and to sell direct to the public, or for such businesses to expand some of the aspects of the business to varying degrees, including in some cases the creation of other facilities on the property.

The accounts of the new facility shows that in the year you expect to receive a profit, 70% of the income is from selling the product produced in the first activity and only 30% is from other products sold at the new facility. This confirms that the main income from your newly built facility is still generated from products generated from the first activity.

It is accepted that in 2009 new facilities were constructed to expand the services offered to the public; but these facilities also accommodated activities previously conducted, that is products generated from the first activity. It would seem reasonable to conclude that the developments in 2009 represented an expansion of an existing business rather than the creation of a separate and distinct business activity. That is your business has expanded to include other activities to attract the passing tourist to purchase mainly the products produced by the first activity.

Having reached a conclusion of the factual issue of whether or not you are undertaking one or two separate activities, it is now necessary to consider how this fact affects the application of the Commissioner's discretion under paragraph 35-55(1)(c).

Having considered the first activity and the new facility carried out on the property is the one business activity, it is a business activity which commenced in the 1997 year. You have stated that industry research would indicate that it would be seven years plus before a self sufficient activity similar to yours can expect to break even. This period has now lapsed.

Your profit projections indicate that the business activity will not produce income greater than deductions attributable to it until the 2012-13 income year, 16 years after commencing the first activity. You have not provided independent evidence to suggest that the commercially viable period for your industry is 16 years.

As you have not been able to make a profit within any accepted commercially viable period for your activity, the Commissioner will not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 in relation to your business activity for the 2009-10 to 2011-12 income years.

Even if the first activity and the new facility was considered to be a separate activity (which we do not agree), the activity should satisfy both sub-paragraphs of paragraph 35-55(1)(c):

(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 new facility is capable of producing income soon after its commencement as shown in your accounts. The independent evidence you have provided mentioned that a cash flow profit can be achieved in the very short term, however a tax profit will take longer to achieve. This shows that it is not because of its nature that the activity has not produced income greater than the deductions attributable to it soon after its commencement.

It is also stated in the independent evidence that one would expect a similar facility opened up in the centre of town with heavy passing trade to be viable from the first year. He further states that this is not the case for a new facility set up on a remote area and has a limited variety of stock available. A remote facility such as this according to independent evidence cannot be viable from the first year.

This also shows that it is not because of the nature of your business that you have not produced income greater than the deductions attributable to it. The location could be one of the reasons that you have not been able to generate a profit earlier.

For the Commissioner to exercise the discretion, both sub paragraphs in paragraph 35-55(1)(c) should be satisfied. As it is not because of its nature, that the activity has not produced assessable income greater than the deductions, the Commissioner will not consider sub paragraph 35-55(1)(c)(ii). Therefore, the Commissioner will not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 in relation to your business activity for the 2009-10 to 2011-12 income years.

Accordingly, the Commissioner is not satisfied that it would be unreasonable to apply the rule in subsection 35-10(2) of the ITAA 1997 in relation to your business activity for the 2009-10 to 2011-12 income years.

Summary of reasons for decision

The Commissioner will not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 because, on the facts provided the Commissioner is not satisfied that it is because of the nature of your business activity that it did not receive assessable income greater than the deductions attributable to it for the 2009-10 to 2011-12 income years.

Therefore, the rule in subsection 35-10(2) of the ITAA 1997 will apply to defer to a future income year any loss generated from your activity for those years. A deferred loss is not disallowed and will be deductible against any taxation profit from your activity, or similar business activity, in future years.

If your activity, or similar activity should satisfy an exception or satisfy the income requirement and one of the tests in Division 35 of the ITAA 1997 in any given year, then the whole of the deferred loss will be deductible in that year.