Edited version of your private ruling

Authorisation Number: 1012449930605

Ruling

Subject: Non-commercial loss - 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 primary production business activity in your calculation of taxable income for the 2011-12 to 2015-16 financial 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 primary production business activity in your calculation of taxable income for the 2011-12 to 2015-16 financial years?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commenced in:

2001

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

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.

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

You are a partner to a partnership carrying on a primary production enterprise.

You commenced your partnership activity in 200X.

You purchased an additional property for the primary purpose of expanding your business operation.

The greatest impact on the business's profitability is the cost of debt associated with the property purchased.

The interest charges and the depreciation deductions are the main contributors to the business losses.

The partners established a secondary non-primary production business activity.

The non-primary production business aims to assist your primary production activity by accelerating debt reduction, minimising interest expenses and providing working capital to where required. This business has performed well.

Since the initial drawdown of the loan, the debt has reduced significantly.

The reduction in debt will reduce interest costs and provide additional working capital. This will lead to increased sales and profitability and ensure the long term viability of your activity.

In the relevant financial year, there were two other circumstances which affected your primary production activity. As a result no sales were made in the relevant financial year and "a larger than normal loss" was incurred.

You have made a large sale in subsequent financial year.

The partnership activity satisfies the real property test in the relevant financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 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 is unable to exercise the discretion available in paragraph 35-55(1)(a) or paragraph 35-55(1)(c) of the ITAA 1997 in relation to your primary production business activity for 2011-12 to 2015-16 financial years.

Detailed reasoning

Non-commercial loss

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 the calculation of taxable income in an income year unless:

· the income requirement in subsection 35-10(2E) of the ITAA 1997 and one of the four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 are satisfied, or

· the Commissioner exercises the discretion in section 35-55 of the ITAA 1997, or

· the 'Exception' in subsection 35-10(4) of the ITAA 1997 applies.

You stated that your income for non-commercial loss purposes is likely to be more than $250,000, therefore, you have not satisfied the income requirement in subsection 35-10(2E) of the ITAA 1997.

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

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.

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 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.

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.

Interest and depreciation expenses

In your case, you have argued that:

· High borrowing costs is the "greatest impact" that would prevent your business from making a tax profit in the 2011-12 to 2015-16 financial years;

· The interest charges and the depreciation deductions are the "main contributors" to your business losses.

As discussed previously, 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.

The high level of interest expenses is a consequence of a business choice made by you and/or your partner, not a "special circumstance" outside your control. It does not have "a particular quality of unusualness that permits [it] to be described as special." Therefore the Commissioner is not satisfied that the high interest expenses is a special circumstance for the purpose of paragraph 35-55(1)(a) of the ITAA 1997.

The same applies to the depreciation expenses. Therefore it is also not a special circumstance for the purpose of paragraph 35-55(1)(a) of the ITAA 1997.

Therefore any impacts of the interest and depreciation expenses on your activity's ability to produce a tax profit cannot be taken into account in deciding whether the discretion in paragraph 35-55(1)(a) should be exercised.

Other circumstances

You have also argued that two other circumstances have contributed to the loss in the relevant financial year.

It is possible that these two circumstances can qualify as special circumstances. However the converse can also be argued. Hence more information is required before we are able to determine if these two circumstances can qualify as special circumstances.

We have not asked for the required information to decide on this issue as your activity cannot satisfy all the factors to allow the Commissioner to exercise the special circumstances limb of the discretion in any case.

Assuming that these two circumstances are special circumstances, your application states that these two circumstances have resulted in "a larger than normal loss produced". This implies that your business would still have incurred a tax loss even if these two circumstances did not occur. This has been confirmed by your tax agent during the conversation, where she stated that your business activity would still have incurred a tax loss due to the impact of the interest expenses. Furthermore the fact that your business activity has a history of making losses in the five years preceding the relevant financial year also negate the link between these two circumstances and any tax loss in the 2011-12 to 2015-16 financial years.

Therefore we are not satisfied that your business activity would have made a profit in the relevant financial year, or would have been expected to make a tax profit in the subsequent to 2015-16 financial years, had it not been affected by these two circumstances.

As such, the Commissioner is unable to exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(a) of the ITAA 1997 for the 2011-12 to 2015-16 financial 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 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…

In your case, the partnership returns you have lodged demonstrate that your activity has been capable of generating assessable income before the relevant years you are applying the Commissioner's discretion for.

The Commissioner is not satisfied that anything inherent in the nature of your business activity has or would have prevented you from being able to produce a tax profit in the 2011-12 to 2015-16 financial years. Any loss is more appropriately described as attributable to the commercial decision you made in the running of your business, which resulted in expenditures exceeding the assessable income of the business. The discretion in paragraph 35-55(1)(c) is not intended to be available in cases where the failure to make a profit is for reasons other than those that are inherent in the nature of the business. The requirements of paragraph 35-55(1)(c) of the ITAA 1997 have not been met.

As such, the Commissioner is unable to exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(c) of the ITAA 1997 for the 2011-12 to 2015-16 financial years.