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Ruling

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

Question:

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 to allow you to include 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 period

1 July 2009 to 30 June 2012

The scheme commenced on

1 July 2007

Relevant facts and circumstances

You conduct your primary production activity in partnership with your spouse.

The partnership has been involved in primary production for approximately 20 years.

The current primary production activity commenced approximately 15 years ago. After several years you had sufficient stock and were able to give up the previous primary production activity to concentrate on the new venture.

Tthe primary production activity was effectively shut down due to circumstances beyond your control. You took necessary steps to avoid the circumstances affecting your trading stock. However, you were unable to prevent the unavoidable circumstances affecting your activity.

It has taken many years to re-establish your business activity.

You had two revenue streams. When the business was shut down due to the unavoidable circumstances both revenue streams effectively ceased. However, during the 2007-08 year, for a period of two months, you received sufficient income and when extrapolated for 12 months you would have satisfied the assessable income test in section 35-30 of the ITAA 1997 and generated a tax profit.

How the 'special circumstances' caused the business activity to make a loss

Due to the special circumstances you were not able to generate the income you were expecting to receive for the 2007-08 year and the future income years. As a consequence you were unable to generate profits from the 2007-08 income year.

Your activity did not generate a profit from the commencement. However you have provided information to demonstrate that had it not been for the unavoidable circumstances, you would have received profits in the 2009-10 to 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)(a).

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

The Commissioner will exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 for the 2009-10 to 2011-12 income years.

For the above income years the rule in subsection 35-10(2) of the ITAA 1997 will not apply to defer to a future income year any loss that arises from your primary production activity. Accordingly, you are entitled to claim the losses incurred in your primary production activity for the 2009-10 to 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

· subsection 35-10(2E) of the ITAA 1997 is satisfied 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. If the income requirement is not met, the Commissioner may exercise discretion to allow the inclusion of the losses.

In your case, you do not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 in the 2009-10 income year and you do not expect to satisfy the income requirement in the 2010-11 and 2011-12 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.

Paragraph 35-55(1)(a) of the ITAA 1997 sets out the first arm of the Commissioner's discretion as follows:

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:

(a) the business activity was or will be affected in the excluded years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster; or

The Note to paragraph 35-55(1)(a) of the ITAA 1997 states that the particular paragraph is intended to provide for a case where a business activity would have satisfied one of the tests if it were not for the special circumstances.

Paragraph 41D of the Taxation Ruling TR 2007/6 explains that for individuals who do not satisfy the income requirement, the factors that must be satisfied before deciding whether to exercise the special circumstances limb of the discretion for an income year are that:

· the business activity is affected by special circumstances such that it is unable to produce a tax profit; and

· the business activity either satisfies at least one of the tests or is affected by special circumstances such that it is unable to satisfy any of the tests; and

· the special circumstances affecting the business activity are outside the control of the operators of the business activity.

Paragraph 35-55(1)(a) of the ITAA 1997 refers to 'special circumstances' outside of the control of the operators of the business activity. No exhaustive definition is given of 'special circumstances' but the paragraph does include drought, bushfire and other natural disasters.

The question of what constitutes 'special circumstances' has been judicially considered on many occasions. In the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation:

Those discretions are intended to be applied to a great variety of situations. In such a context, the core of the idea of 'special circumstances' is that there is something unusual or different to take the matter out of the ordinary course…

Later, in the Federal Court Case of Secretary, Department of Employment, Education, Training & Youth Affairs v. Barrett and Another (1998) 82 FCR 524 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed that:

The word 'special' must be read in context. In normal parlance it signifies that the event or circumstances in question are out of the ordinary or normal course.

Tamberlin J then quoted the following passage with approval from the AAT case of Re Beadle and Director-General of Social Security (1984) 1 AAR 362; (1984) 6 ALD 1:

An expression such as 'special circumstances' is by its very nature incapable of precise or exhaustive definition. The qualifying adjective looks to circumstances that are unusual, uncommon or exceptional. Whether circumstances answer any of these descriptions must depend upon the context in which they occur. For it is the context which allows one to say that the circumstances in one case are markedly different from the usual run of cases. This is not to say that the circumstances must be unique but they must have a particular quality of unusualness that permits them to be described as special.

It can be seen that to determine what is 'special circumstances', we need to look at the context in which the phrase is used. Also, it is clear that 'special circumstances' will be something out of the ordinary or unusual. 'Special circumstances' in paragraph 35-55(1)(a) of the ITAA 1997 is used in the context of a situation occurring such that it would be unreasonable for the Commissioner to apply the loss deferral rule for a particular year or years.

Paragraphs 48 and 49 of Taxation Ruling TR 2007/6 expand upon the events that can be accepted as 'special circumstances' and explains that it is not limited to natural disasters. In particular, paragraph 49 details some indicators of the affects on the business activity that could lead to the exercise of the discretion. Some of these indicators are:

· Destruction of stock or equipment.

· Delays in ploughing, planting, harvesting etc.

· Delay in growth of crops.

· Inability of operator to perform duties, and

· Loss of business opportunities.

To consider the discretion in paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner should be satisfied that the activity was affected by special circumstances outside the control of the operators of the business activity.

You state that the unavoidable circumstances significantly impacted on your business activity. You anticipate that your business activity will fully recover from the effects of the unavoidable circumstances within five years of the event or by the end of the 2011-12 income year.

You have stated that the business relied on two main sources for income. Up to now the main source of revenue has been from one of those streams.

When the business was shut down due to the unavoidable circumstances, the revenue streams effectively ceased. However, you believed that, when the earnings received for a two month period in the 2007-08 income year was extrapolated for a 12 month period, you would have satisfied the assessable income test in section 35-30 and generated a profit in the 2007-08 income year.

You have also provided projections to show that you would have received a profit in the 2009-10 to 2011-12 income years had it not been for the unavoidable circumstances.

Based on the information provided, the Commissioner is satisfied that:

· the business activity was affected by special circumstances such that it was unable to produce a tax profit in the 2009-10 to 2011-12 income years; and

· the business activity satisfied at least one of the tests in Division 35 of the ITAA 1997 (the assessable income test in section 35-30 of the ITAA 1997); and

· the special circumstances affecting the business activity were outside your control.

Accordingly, the Commissioner is satisfied that 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. This means that the losses from those years can be claimed in the years they arise.