Edited version of your private ruling

Authorisation Number: 1012472239602

Ruling

Subject: Non commercial losses

Question 1

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 XXXX breeding business activity in your calculation of taxable income for the 2009-10 to 2014-15 financial years?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commences on:

2009

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.

Your business is conducted from a farm.

You conducted a review of business's current state and future direction and identified some material changes that were necessary to ensure future profitability. You have implemented significant changes.

The business operations up until that point had enabled the development of a high quality herd of animals. The breeding work that had been undertaken provided a basis for the continued development.

Through your research, you identified alternative revenue source.

You have applied your knowledge of genetics to breed animals.

You forecast that the business will achieve a breakeven position by the 2014-15 financial year and be profitable from 2015-16 financial year. This will be achieved from a forecasted increase in revenue.

You have invested in farming equipment and processes.

You have not satisfied the income requirement as your adjusted taxable income has exceeded $250,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 35-1.

Income Tax Assessment Act 1997 - Section 35-10.

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

Summary

The farming is a new and separate activity. Therefore your commercially viable lead time begins in the 2009-10 financial year. However, the amount of time until the activity makes a profit is not due to the inherent nature of your business but is predominantly as a result of you.

Detailed reasoning

For the 2009-10 and later income years, Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997) applies to defer amounts attributable to a business activity that a taxpayer could otherwise deduct under the Act that exceed the taxpayer's assessable income from the business activity unless:

the taxpayer meets the income requirement in subsection 35-10(2E) of the ITAA 1997 and passes one of the four tests outlined in paragraph 35-10(1)(a) of the ITAA 1997

the Commissioner exercises his discretion set out in section 35-55 of the ITAA 1997 for the business activity in that year, or

the business activity is a primary production business, or a professional arts business, and the taxpayer's assessable income for that year (except any net capital gain gains) from other sources that do not relate to that activity is less than $40,000.

Broadly, the income requirement outlined in subsection 35-10(2E) of the ITAA 1997 states that the taxpayer's taxable income (with certain adjustments) is less than $250,000.

As your taxable income for the purposes of subsection 35-10(2E) of the ITAA 1997 exceeds $250,000, you will not meet the income requirement. You will also not meet the condition relevant to taxpayers in a primary production business, or a professional arts business, as your assessable income from other sources is not less than $40,000.

Accordingly, in order for you to be able to deduct amounts which exceed your assessable income from your business activity, the Commissioner must exercise his discretion in section 35-55 of the ITAA 1997.

The Commissioner's discretion in section 35-55 of the ITAA 1997

Section 35-55 of the ITAA 1997 allows the Commissioner a discretion not to apply the rule in subsection 35-10(2) of the ITAA 1997 if he is satisfied that it would be unreasonable to apply the rule because:

the business activity was or will be affected in the relevant income years by special circumstances outside the control of the operators of the business activity (special circumstances), or

in the case of taxpayers who do not meet the income requirement in subsection 35-10(2E) of the ITAA 1997(lead time):

because of the nature of the business activity, it has not produced, or will not produce, assessable income greater than the deductions attributable to it, and

there is an objective expectation, based on evidence from independent sources 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 (that is, there is a lead time between the commencement of the activity and the production of assessable income).

Separate business activity

In order to determine the lead time of the business activity, that is, the period during which the activity will not produce a tax profit because of the nature of the industry and during the commercially viable period (discussed later), it needs to be ascertained when the business activity commenced.

The question of whether there are one or multiple business activities is a question of fact and overall impression. There are a number of factors which can be considered to help determine whether there are one or separate/multiple business activities.

These include the location of each of 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: Taxation Ruling TR 2001/14.

You state that you started a new business activity in the 2009-10 financial year of farming.

Therefore, a new business of farming commenced in the 2009-10 financial year. As the new activity commenced in the 2009-10 financial year, the commercially viable period of the activity must be taken from that point.

Lead time discretion

For the failure to produce a tax profit to be 'because of its nature', the failure must be because of some inherent characteristic that your business activity has in common with other business activities of that type and is not peculiar to your situation. For example fruit trees will generally not produce fruit for a number of seasons after planting and this inherent characteristic prevents the activity from producing any tax profit during this period.

Where the activity's failure to produce a tax profit is because of such an inherent characteristic, the requirements will be met for any income year within the period from the time the business activity starts, to the end of the last income year in which that characteristic still affects the activity's ability to produce a tax profit (the 'initial period').

Where this initial period has passed, any continuing failure to produce a tax profit will be for reasons outside of the requirements and the discretion will not be exercised.

The period that is commercially viable for the industry concerned is the period in which it is expected that any business activity of that type, which is carried on in a commercially viable manner, would be expected to produce a tax profit. It is not determined having regard to best practice in the industry concerned.

Where an operator chooses to carry on the business activities in a manner that does not produce a tax profit within the period that is commercially viable for the industry concerned, paragraph 35-55(1)(c) of the ITAA 1997 will generally not be satisfied. For example, as a consequence of starting out on a small scale, the hours worked, the need to build a client base or the progressive planting of a crop over a number of years.

In the case of Scott v. Commissioner of Taxation [2006] AATA 542, the Commissioner's decision was upheld in not applying the discretion. Mr Scott initially planted olive trees in 1997 and 1998. He then planted further trees in July 2000. No income was produced in the subsequent four years.

The Commissioner contended that the losses fell outside the commercially viable period for that industry, which was determined on an objective basis.

In relation to the commercially viable period, the taxpayer argued that there were other circumstances which should be taken into account when determining this time frame. On this issue, the court expressed the following view:

It seems to me that if it were permissible to take into account subjective considerations of each individual grower, there might be an almost infinitely variable period which could be described as the commercially viable period…The fact that a grower elects not to plant sufficient trees at the outset to ensure the business is commercially viable is a decision for that individual grower. Such a grower could not expect the Commissioner to exercise his discretion under s 35-55 in his or her favour because, to do so, would effectively render nugatory the rule dealing with losses from non-commercial business activities.

More recently these principles were similarly applied in Case 1/2013 2013 ATC 1-050 where Senior Member McCabe stated:

The applicant has chosen to take a more gradual approach. No one quibbles with the wisdom of her decision, and I am told it is a common practice in the industry. But she is unable to satisfy the first leg of the test in s 35-55(1)(c). In those circumstances, it would not be reasonable to exercise the discretion in her favour.

The commercially viable period for cattle breeding is considered in the Explanatory Memorandum for the Tax Laws Amendment (2009 Budget Measures No. 2) Act 2009, where at Example 2.5 the following example is provided:

Tracey carries on a business of primary production from breeding and selling cattle. Their profit projections indicate that they do not expect to make a tax profit for six years.

Independent evidence provided by Tracey indicates the lead time period begins from the commencement of the activity and includes the time taken to raise the females to a breeding age, allowing for the gestation period of those animals to finish, and finishes when the progeny have reached a saleable age. On the evidence provided, the period for a typical business activity of breeding and selling cattle to become commercially viable is no greater than three years. Therefore, Tracey will not be able to produce a tax profit within a period that is commercially viable for the industry concerned and the Commissioner will not be able to exercise the discretion to allow the losses.

Therefore, assuming the acquisition of a fully stocked breeding herd at the commencement of the activity (not progressively acquired), their maturing to a breeding age gestation for the optimum age commercially viable period for your activity is approximately Y years.

You have stated that your activities will achieve a breakeven position by the 2014-15 financial year and be profitable and pass the assessable income test in the 2015-16 financial year, or seven years after you commenced. You have provided a projected profit and loss statement to confirm this.

The lead time of Y years for the activity will have passed in the 2012-13 financial year.

The period estimated by you (7 years) before the activity is able to achieve a profit is outside this.

Where a business does not produce a profit within the commercially viable period for the industry, the Commissioner is not able to exercise the discretion.

The reason your activities continue to make a loss is peculiar to your situation and is not inherent to the nature of the business.

Therefore, the Commissioner will not exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(c) of the ITAA 1997 for the 2009-10 to 2014-15 financial years.

Further issues for you to consider

Where you can't claim your loss in the current year under the non-commercial loss rules, your losses are deferred until a future year when your activities produce a profit.