Edited version of your private ruling

Authorisation Number: 1012259898772

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Commissioner's discretion

Question 1

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 business activity in your calculation of taxable income for the 2009-10 and 2010-11 income years?

Answer

No.

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include any losses from your business activity in your calculation of taxable income for the 2009-10 and 2010-11 income years?

Answer

No.

This ruling applies for the following periods:

year ending 30 June 2010

year ending 30 June 2011

The scheme commences on:

01 July 2002

Relevant facts and circumstances

The arrangement that is the subject of this ruling is described below. The following documents have been relied upon to reach a decision:

· your application for private ruling which we received on the exercise of the Commissioner's discretion in section 35-55 of the ITAA 1997 incorporating your answers to the questions contained in the application form and enclosed documents.

· additional information which we received.

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

You commenced your business several years ago.

You are a partner in a partnership carrying on a primary production business.

You hold some of the partnership interest. The other partner holds the remaining interests.

Your partnership operates in a location in Australia.

Your partnership entered into a Licence Agreement with the land owners at the time.

Loss of contract

A contract was executed with a company in a year, the partnership was specifically established to provide products to that company.

The contract contains specification regarding the quantity of each type of products you are to provide.

The company eventually became another company through takeover/merger activity.

The initial contract was superseded by a new contract.

The new contract also contains specification regarding each type of products.

The initial term of contract is some years. Contract contains terms for extension of terms and holding over.

The new contract was not renewed when it lapsed. The non-renewal was not triggered by the concerns over your performance. This decision was outside your control and was not anticipated by you.

Your partnership had developed its business model based on the specific requirement of the contract. Your partnership has adopted an entirely different business strategy in the lead up to the non-renewal of the new contract and you revised your business model.

Your partnership expended significant time and resources to mitigate the effects of the loss of the contract.

In response to the non-renewal of the contract, a related entity was set up as a separate entity. This entity utilises the surplus products and purchases from the partnership at market value.

Change program

Your partnership undertook changing program, involving a shift away from some types of products in favour of other types of products.

The program was prompted by the downturn in the industry and lessening the reliance on and the eventual loss of the Contract.

Extraordinary weather events

A special weather event occurred in 2008 and 2009 in your regions.

This weather event occurring in three consecutive years were unprecedented and their impact on productivity could not be reduced.

This weather event occurring in these three years were more extreme than the predictions.

You have adopted the best practice to counter the impact of potential special weather events. You state that measures undertaken are comparable to best practice in the industry.

You state that your activity has not been affected by similar weather event prior to 2009-10 income year.

The weather event can result in reduced quality of your products.

The relevant Bureau of Meteorology weather station recorded temperature resulting in another type of special event happening in the 2009-10 season and the 2010-11 season.

The impact of this other weather event on your products depends on various factors.

Your activity has been damaged by this other weather event in the 2005-06 and 2006-07 income years.

You have invested significantly to protect your products from this other weather event.

The expert states that your estimated loss due to this other weather event in 2009-10 income year is not a normal annual occurrence.

Mismanagement of the neighbouring property

Your property shared a common boundary with another property, which was placed into voluntary administration.

The neighbouring property was abandoned, and its lack of management resulted in a condition which would have resulted in increased pressure in your property.

You wrote to demand immediate action to be taken to address the mismanagement issue. Your concerns were not addressed.

Your products experienced a condition from 2010.

You claim that the condition is caused by the condition of the neighbouring property.

Your program was not effective in controlling the condition this time, while it has been effective in the past.

You reported that with the same condition received, products react differently depending on their location.

The condition in 2009-10 income year have adverse residual effect in the 2010-11 year.

You reported that your products have not been affected by this condition previously.

General downturn in the industry

The combined effects of factors including Australian supply and demand changes, global financial markets and exchange rates have resulted in adverse impacts in your industry since a year.

You provided the prices for the products in the past years.

Your partnership business finds itself as a price taker. Price received by your partnership has consequently fallen as well.

The prices your partnership has been paid have been under the cost of production since 2008.

You do not rely on this downturn as a special circumstance.

Other past or estimated figures

You provided the estimated losses of income due to circumstances.

You provided the sales and volume your activity produced in the past and estimated them for 2012.

You provided the past income and expense summary for your partnership.

You provided the estimates of future income and expenses.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 35-10(2)

Income Tax Assessment Act 1997 Subsection 35-10(2E)

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

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

Reasons for decision

Summary

The Commissioner will not exercise his discretion in paragraph 35-55(1)(a) or paragraph 35-55(1)(c) of the ITAA 1997.

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.

You satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 if your income for non-commercial loss purposes is less than $250,000.

In your case, you do not satisfy the income requirement as your income for non-commercial loss purposes is above $250,000 in the 2009-10 and 2010-11 income years.

Your activity will only be potentially subject to these provisions if it is carried on as a business. You state that your activity is carried on as a business and this ruling is made on the basis of accepting this claim.

Special circumstances

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.

Your case

In your case, you argue that loss of the contract, mismanagement of the neighbouring property and extreme weather events are special circumstances that prevent your business from making a tax profit in the 2009-10 and 2010-11 income years, either viewed in respective own right or as a combination.

The loss of the contract does not amount to a special circumstance for the purpose of 35-55(1)(a) of the ITAA 1997. We acknowledge that this will impact detrimentally on you business. However, the cancellation of a contract is not considered to be something out of the ordinary or unusual, but a normal trading risk in the course of carrying on a business. Furthermore, even though you anticipated that the contract will be renewed and the non-renewal decision was outside your control, you were aware that the contract was due to expire on a date and that non-renewal was always a possibility. The statement made by the expert that you were "well aware of the contract expiry" and the program you initiated to lessen the reliance on the contract further demonstrate that the loss of the contract lacks the unusualness to be described as special. Therefore the Commissioner is not satisfied that the loss of the contract is a special circumstance for the purpose of 35-55(1)(a) of the ITAA 1997.

It is accepted in your case that condition and extreme weather events were outside your control. However, this in itself is not sufficient for the discretion to be exercised. The Commissioner must also be satisfied that special circumstances outside your control prevented you from making a tax profit in the 2009-10 and 2010-11 income years.

You provided estimations that if the condition and extreme weather events did not occur, you expected to have additional income of an amount in the 2009-10 income year, and additional income of an amount in the 2010-11 income year. That is, you expect the business would produce a net profit of an amount and another amount in the 2009-10 and 2010-11 income years respectively.

By comparing the performance of your partnership business in 2009-10 and 2010-11 income years to 2008-09, the following are observed:

The information you provided in the past sales and volumes produced table shows that the numbers of sales and volumes produced in the 2009-10 income year have increased from the 2008-09 income year by an amount and another amount respectively. At the same time, the total expense incurred has decreased from an amount to another amount. The net loss also decreased from an amount to another amount. Therefore you business activity has actually improved its performance from 2008-09 income year, negating the connection between the condition and extreme weather events and reduction of your business income in the 2009-10 income in the summary you provided and also the connection between the circumstances and the tax loss.

In relation to the 2010-11 income year, the sales and tonnes produced decreased by an amount and another amount respectively from the 2009-10 income year. However, the net change from the 2008-09 income year is a percentage increase in sales and another percentage decrease in tonnes produced. The total expense incurred has decreased from an amount to another amount and the net loss decreased from an amount to another amount. Therefore again, the business incurred less net loss than the 2008-09 income year.

The comparison shows that there is no significant reduction in your business performance in the 2010-11 and 2011-12 income years compared to the 2008-09 income year, which is before all the circumstances occurred. This suggests that it is more than likely that your business activity would have made a loss even if it had not been affected by these circumstances.

We acknowledge the possibility that the business has improved its practice and is now able to reduce net profit regardless of the circumstances. However, the following are also observed:

Your business activity has not made a profit since it commenced.

Your net profit for 2009-10 income year would be some amount if your estimated loss of income is accepted. This constitutes an increase in net income of some amount from the previous income year. This is some amount more than the greatest increase in income in the past and is more than the total increase in net income in the past.

Your estimations include the additional incomes and expenses that could have been avoided, but have not taken into account the additional costs that would have incurred had the additional income were achieved.

Furthermore, in addition to the special circumstances, it is evident from the information you provided that your business has been significantly affected by the general downturn in the industry and the loss of the contract, as demonstrated by the material change in the prices and sales. These circumstances are not unexpected and cannot be considered as special circumstances when carrying on a business activity.

From the information provided, the Commissioner cannot be satisfied that if it were not for those unfavourable circumstances, your activity would have made a tax profit in the 2009-10 and 2010-11 income years. Therefore, the Commissioner is unable to exercise the discretion available in accordance with paragraph 35-55(1)(a) of the ITAA 1997 for the relevant years.

Nature of the activity

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…

Your case

You claim that the business activities associated with the business following

· non-renewal of the contract or

· change programs commenced

· are substantially different to those in the past.

Where there are separate business activities, Division 35 of the ITAA 1997 needs to be applied to each business activity separately.

The question of whether there are one or separate business activities is a question of fact and overall impression. There are a number of factors which can be considered in determining whether there are one or separate/multiple business activities. These include the location of each activity, the assets used in each activity, the goods and services produced by each activity, the interdependency of the activities and any commercial links between the activities.

We accept your assertion that the sales of different product types are capable of producing their own assessable income and that the market price and volume for one product are materially different to the market price and volume applicable for another product. However the following factors strongly indicate that the business following grafting/replanting or non-renewal of the contract is not a new business activity:

· Both business activities are carried on at the same land.

· There is no significant difference in the type of goods produced.

· The nature of income derived is same - from sales of produce from land.

· Both activities are governed by significantly similar market conditions.

We acknowledge that the business was initially established with the particular company as the predominant purchaser and it has since significantly diversified its produce, and now has a range of purchasers ordering predominantly different products. However this change does not make the activity a new activity. Your current activity is in essence still the same as the original activity carried on. Furthermore, the area you changed a percentage of your activity, which means that the remaining percentage of your activity remains unchanged.

Based on the facts and the overall impression, we do not accept that business activity following change program or the non-renewal of the contract is a new business. We consider that you are continuing the same business although you have taken a commercial decision in relation to product varieties. As your activity is not a new activity, the commercially viable period for the industry concerned is from the original date of commencement.

In order for the Commissioner to exercise his discretion in paragraph 35-55(1)(c) of the ITAA 1997, you have to demonstrate that the reason your business activity failing to make a profit within the commercially viable period is inherent to the nature of the business and is not peculiar to your situation (subparagraph 35-55(1)(c)(i) of the ITAA 1997).

The information you have provided demonstrate that the activity is capable of generating assessable income in the second income year after your business commenced. You have provided the income generated.

The loss is more appropriately described as attributable to your commercial decision you made in the running of your business, which resulted in significant expenditures exceeding the assessable income of the business since commencement. The consequences of business choices made by an individual are not inherent characteristics of a business activity and would not result in the requirements of subparagraph 35-55(1)(c)(i).

Therefore, the Commissioner is not satisfied that anything inherent in the nature of your business activity has prevented you from being able to produce a tax profit in 2009-10 and 2010-11 income years.

Furthermore, even if the nature of the business was the reason for the tax loss, you still need to satisfy the Commissioner that, based on evidence from independent sources, that your business activity will produce a taxation profit within a commercially viable period (subparagraph 35-55(1)(c)(ii) of the ITAA 1997).

You stated that your activities will produce a profit of an amount in the 2011-12 income year before interest. Assuming that the interest expenses are less than the amount, you will produce a tax profit in the 2011-12 income year. You have not provided sufficient evidence to enable the Commissioner to conclude that a number of years is within a period that is commercially viable for your industry. We acknowledge that your change program needs time and will impact on your profitability in the short term. However, the commercially viable period cannot be determined by commercial decisions an individual business operator may make.

From the information provided, you have not demonstrated that the business has not produced a tax profit in 2009-10 and 2010-11 income years due to the nature of the business nor that your business will make a tax profit within a period that is commercially viable period for your industry. Therefore, the Commissioner is unable to exercise the discretion available in accordance with paragraph 35-55(1)(c) of the ITAA 1997 for the relevant years.