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Ruling

Subject: Non-commercial losses - Commissioner's discretion - special circumstances

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 income year ended 30 June 2012?

Answer

No.

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 to allow you to include any losses from your business activity in your calculation of taxable income for the income year ended 30 June 2013?

Answer

No.

This ruling applies for the following period

Years ended 30 June 2012 and 30 June 2013

The scheme commenced on

1 July 2006

Relevant facts

You have conducted a business activity for a number of years.

You have a business plan to improve the property and build up animal numbers.

You have made a loss in the 2011-12 income year and expect to make a profit in the 2012-13 and future income years. No profits have been made in previous years.

Costs exceeded revenue due to property being run down by the previous owner. A large amount of capital purchases over the last few years have also led to a substantial depreciation expense (in an effort to improve the business functionality).

You have had some stock die this year

Your adjusted income for non-commercial losses purposes is in excess of $250,000 in the year ended 30 June 2012.

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)

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

Reasons for decision

Summary

It is considered that there are no special circumstances in the 2011-12 income year that would allow the Commissioner to grant a discretion under paragraph 35-55(1)(a) of the ITAA 1997 to include any losses from your business activity in your calculation of taxable income. The fact that costs exceeded revenue because the property was purchased in a rundown state, a large amount of capital purchases have given rise to high depreciation, some animal deaths and still building up your herd are not considered to be unusual, unexpected or out of the ordinary for this industry. These factors are a normal occurrence or more about the way you have gone about your particular activity.

The Commissioner cannot exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 to include any losses from your business activity in the calculation of your taxable income for the 2012-13 income year as you have predicted a small profit in this year and we are not at a point in time where proper consideration can be given to the matter that special circumstances prevented you from making a profit in that year.

Detailed reasoning

For the non-commercial losses rules to apply to an individual they have to be carrying on a business for taxation purposes. We are not disputing that you are carrying on a business. It is accepted that you are carrying on a business. The effect of the non-commercial losses legislation is to restrict the circumstances where a business loss can be offset against other income.

Changes were made to the operation of the non-commercial losses rules to apply for the 2009-10 and later income years to further restrict the circumstances where a business loss can be offset against other income for certain taxpayers, with the introduction of an 'income requirement'. The rules have become very restrictive and mean that the losses for these taxpayers will be quarantined to the business activity except for the very limited circumstances where the Commissioner's discretion can be applied in a year.

To satisfy the income requirement for an income year the sum of the following has to be less than $250,000; your taxable income for that year; your reportable fringe benefits total for that year; your reportable superannuation contributions for that year; your total net investment losses for that year. For the purposes of calculating your taxable income you do not take into account any excess from the business activity affected by the non-commercial losses. You have provided information indicating that you do not meet the income requirements therefore the new restrictions will apply to you for 2009-10 and later income years.

Under these changes you do not have access to the four tests. You are limited to getting the Commissioner's discretion or one of the exceptions. The exceptions do not apply in your situation.

There are two types of discretions. These are commonly referred to as the 'special circumstances' discretion and the 'lead time' discretion.

You have not applied for a lead time discretion. Your activity has been in existence for over five years and would be outside the lead time for this industry.

Your only option is to obtain the special circumstances discretion and you have applied for this discretion on the basis that: the property was purchased in a rundown state, a large amount of capital purchases have given rise to high depreciation, some animal deaths occurred in the 2011-12 income year and you are still building up your animal numbers to the required amount.

Special circumstances

The Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the income years in question where the business activity is affected by special circumstances outside the control of the operator of the business activity, that prevent the activity from making a profit in that year.

This is a three step process:

1) You have to show that the circumstances are considered to be 'special' in terms of this legislation;

2) You have to show that the circumstances were outside your control; and

3) You have to show that it was these special circumstances that prevented the activity from making a profit in the applicable years.

You have asked the Commissioner to consider a discretion for the 2011-12 and 2012-13 income years. You had a loss in the 2011-12 income year and have forecast a small profit in the 2012-13 income year.

The Commissioner can only use his discretion in years where there are losses. For the 2012-13 income year you have forecast a profit. Also at this point in time, based on the facts that you have provided, it is impossible to show that special circumstances prevented you from making a profit in this year. The Commissioner cannot use his discretion for this year under paragraph 35-55(1)(a) of the ITAA 1997.

There is a loss in the 2011-12 income year and the possible exercise of a discretion in this year will be considered.

Section 35-55 of the ITAA 1997 provides that the Commissioner can decide that section 35-10 of the ITAA 1997 does not apply where he is satisfied that it is unreasonable for it to apply.

Paragraph 35-55(1)(a) of the ITAA 1997 provides that the Commissioner can exercise the discretion where certain special circumstances apply.

Paragraph 35-55(1)(a) of the ITAA 1997 refers to 'special circumstances' outside of the control of the operators of the business activity, including drought, bushfire and other natural disasters. However the list is not meant to be exhaustive. There are a range of other circumstances which may be considered as special.

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.

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.'

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.'

It then has to be shown that the special circumstances, in the case of those that do not meet the income requirement, prevented them from deriving a profit from the business activity in that income year. For example, you may have a business that is normally profitable but during a severe drought water supply may be affected to the extent that water allocations are cut and crops cannot be irrigated to the correct level. Assuming normal prices were received in that year, it could be shown that the reduction in yield due to drought (special circumstances) was the reason that a profit was not produced in that year. The Commissioner may exercise the discretion to allow the losses to be offset against other income in that year.

Taxation Ruling TR 2007/6 outlines the Commissioner's views on the obtaining of a discretion:

Paragraph 32 explains the phrase 'outside the control of the operators of the business activity' has the meaning that the 'particular circumstances' are not a consequence of the operator's actions or inactions.

Paragraph 47 explains that to qualify as special circumstances the circumstances must go beyond the normal or expected fluctuations in business, weather or market conditions. Ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity as well as trading downs and risks associated with running a business will not be considered to be special circumstances.

Paragraph 58 indicates, 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.

Application to your case

1. You purchased the property in a rundown state

This issue is specifically addressed in the ruling and it is not considered to be special circumstances outside your control.

2. Substantial depreciation expense

A business activity of this nature is going to require the purchase of capital equipment on which depreciation can be claimed. This would be normal part of any business process and not be linked to special circumstances.

If you have had to acquire extra equipment due to the rundown state of the property this would not make it special circumstances. Special circumstances may occur for example if a large amount of equipment was destroyed by fire and you had to replace it and this increased expense prevented you from making a profit in that year.

3. Some stock did die during the year

You have not indicated that there has been any excessive number of deaths during this year. A number of deaths could be expected in this type of activity and would not be considered special circumstances.

4. Still building up your animal numbers

This does not fit the definition of special circumstances. There is nothing unusual or unexpected, it is part of the normal process of developing this type of activity.

The circumstances you have outlined that have affected your business activity to prevent it from making a profit are not considered to be special circumstances for the purposes of the non-commercial losses legislation. Therefore the Commissioner cannot exercise his discretion for the 2011-12 income year. As stated above, the Commissioner cannot exercise the discretion under special circumstances for the period 2012-13 at this point in time.