Edited version of your private ruling

Authorisation Number: 1012519581790

Ruling

Subject: Carrying on a business of livestock grazing

Question 1

Are you carrying on a livestock grazing business?

Answer

No

Question 2

Is the property being purchased considered to be a replacement business asset under the small business Capital Gains Tax (CGT) concessions under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) should another small business asset be sold?

Answer

No

This ruling applies for the following period:

1 July 2013 to 30 June 2014

The scheme commences on:

The scheme is in contemplation

Relevant facts and circumstances

You and your spouse are considering the purchase of a rural property which will be financed through a Bank. You intend to use the property to fatten livestock for trade.

The livestock will be purchased either direct from livestock breeders or through the local livestock markets. You intend to sell the livestock through the local livestock markets.

You will employ agricultural consultants for management advice when necessary and engage local expertise and consultants when required to ensure that the operation is conducted in line with industry standards.

You and your spouse will spend approximately two days per week doing the physical labour on the property.

You and your spouse will be attending field days, industry conferences and short courses if appropriate to further your knowledge of the industry.

Your business plan indicates that your activity would make a trading profit prior to taking interest expenses into account.

You advised that you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 8-1.

Income Tax Assessment Act 1997 Division 152.

Income Tax Assessment Act 1997 Subdivision 152-A.

Income Tax Assessment Act 1997 Subdivision 152-E.

Income Tax Assessment Act 1997 Section 152-410.

Income Tax Assessment Act 1997 Subsection 152-10(1).

Income Tax Assessment Act 1997 Section 328-110.

Income Tax Assessment Act 1997 Section 152-15.

Income Tax Assessment Act 1997 Section 152-35.

Income Tax Assessment Act 1997 Section 152-40.

Reasons for decision

Question 1

Summary

You are not carrying on a livestock grazing business. Therefore income from your proposed livestock grazing activity is not assessable under section 6-5 of the ITAA 1997 and losses or outgoings are not deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

Section 6-5 of the ITAA 1997 includes income according to ordinary concepts as assessable income. For taxpayers carrying on a business, amounts received in the ordinary course of business operations are assessable income. Conversely, any loss or outgoing incurred in the course of carrying on such a business is deductible pursuant to section 8-1 of the ITAA 1997.

Therefore in order to determine whether income from your proposed cattle grazing activity is assessable under section 6-5 of the ITAA 1997 and losses or outgoings deductible under section 8-1 of the ITAA 1997 it is necessary to determine whether your proposed activity constitutes carrying on a business.

Carrying on a business

Whether a taxpayer is carrying on a business must be determined on the basis of the facts of each particular case. There is no statutory definition or test of 'carrying on a business', other than the exclusion that a business does not include the occupation as an employee (section 995-1 of the ITAA 1997).

In Martin v Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548 Webb J said:

'The test is both subjective and objective. It is made by regarding the nature and extent of the activities under review as well as the purpose of the individual engaging in them, and as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.'

Taxation Ruling TR 97/11: "Am I carrying on a primary production business" provides guidance of the indicators that are relevant to determine whether or not a person is carrying on a business. The courts have held that the following indicators are relevant:

· whether the activity has a significant commercial purpose or character (this indicator comprises many aspects of the other indicators);

· whether the taxpayer has more than just an intention to engage in business;

· whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;

· whether there is repetition and regularity of the activity;

· whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

· whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;

· the size, scale and permanency of the activity; and

· whether the activity is better described as a hobby, a form of recreation or a sporting activity.

In determining whether a taxpayer's activities amount to the carrying on of a business, consideration is given to the overall impression gained after examining the activities as a whole and the intention of the taxpayer undertaking it. Therefore regard should be had to all of the above indicators and no single indicator will be determinative in any particular case.

Significant commercial purpose or character

This indicator generally requires the taxpayer show that its activities are carried on for commercial reasons and in a commercially viable manner.

The phrase 'significant commercial purpose' is referred to by Justice Walsh in Thomas v FC of T 72 ATC 4094. In this respect it was stated that the 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other characters. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators. Any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the business should also be considered but are not necessarily determinative.

You and your spouse have had exposure to livestock operations through living in the district for many years and dealing with many livestock producers in a professional capacity. You will employ agricultural consultants when necessary for management advice and you and your spouse will be attending field days, industry conferences and short courses, if appropriate, to further your knowledge of the industry.

You have also prepared a business plan which outlines your proposed activity and will engage local expertise and consultants when required to ensure that the operation is being conducted in line with industry standards.

However your business plan also indicates that whilst the proposed activity may have a commercial purpose, it will not be carried out in a commercially viable manner. In this respect, any trading profit generated by the activity would be eroded by interest expenses, resulting in the activity incurring a considerable loss per annum.

The intention of the taxpayer

It is considered that the taxpayer must have more than an intention of engaging in business, there must be an activity that supports the stated intentions to demonstrate a business is being carried on.

Paragraph 40 of TR 97/111 provides that the Commissioner considers that this indicator relates to:

· whether the activity is preparatory to or preliminary to the ultimate activity;

· whether there is an intention to make a profit; and

· whether the activity is better described as a hobby or the pursuit of a recreational or sporting activity.

A reasonable prospect of profit can be evidenced through the conduct of research, consultation with industry experts or obtaining advice on the running of the activity and its likely profitability before commencement of the business.

You have provided information which indicates that you have an intention to engage in business however there is no information which indicates that you have an intention to make a profit given the losses that are expected to result from the activity.

In this respect whilst the forecasts provided indicate you may make a trading profit, this is prior to taking into account expected interest expenses. When these expenses are taken into account the activity would be operating at a considerable loss.

Prospect of profit

In the matter of Hope v The Council of the City of Bathurst (1980) 144 CLR 1, Justice Mason noted that usually the carrying on of a business is such that the activities are:

'…engaged in for the purpose of profit on a continuous and repetitive basis'.

Further, in Ferguson v FC of T 79 ATC 4261 it was noted that an immediate purpose of profit making in a particular income year does not appear to be essential. Instead, it is important to demonstrate that it is likely that profit can be earned from the venture at some stage, either now or in the future. It is also necessary to demonstrate that this can occur with the business being carried on in the same form as it is now.

Your business plan shows that the scale on which you will conduct your activity is insufficient for it to be profitable.

Repetition and regularity

It is often a feature of a business that similar sorts of activities are repeated on a regular basis. The repetition of activities by the same person over a period of time on a regular basis helps to determine whether there is the 'carrying on' of a business.

You propose to purchase young livestock from either livestock breeders or through the local livestock markets, graze them for a period of time, and then sell them at the local livestock market.

Is the activity of the same kind and carried on in a manner that is characteristic of the industry?

An activity is more likely to be a business when it is carried on in a manner similar to that in which other participants in the same industry carry on their activities. Lord Clyde in The Commissioners of Inland Revenue v Livingston and Others (1927) 11 TC 538 at 542 said that:

'... the test, which must be used to determine whether a venture ... is, or is not, "in the nature of trade", is whether the operations involved in it are of the same kind, and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made.'

You and your spouse will spend approximately two days per week undertaking the physical labour on the property. If appropriate, you will also attend field days, industry conferences and short courses to further your knowledge of the industry.

Your activity will involve the purchase of young livestock for the purpose of fattening them over a period and they will be subsequently sold through the livestock market. You will also engage local expertise and consultants when required to ensure that the operation is being conducted in line with industry standards and employ agricultural consultants when necessary for management advice.

Organisation in a businesslike manner and the use of system

In Newton v Pyke (1908) 25 TLR 127 the court suggested that business should be conducted systematically rather than on an ad hoc basis. Therefore an activity should generally conform with ordinary commercial principles to amount to the carrying on of a business.

You will engage an industry expert to inspect the property prior to purchase to ensure that it is capable of running the proposed activity. You have a business plan in place that projects profit/loss prior to interest expenses and you and your spouse intend to spend approximately two days per week doing the physical labour on the property.

Size or scale of the activity

The larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business, however this is not a determinative test.

The larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business of primary production. However, this is not always the case. The size or scale of the activity is not a determinative test, and a person may carry on a business though in a small way (Thomas v FC of T 72 ATC 4099; ATR 171).

Your activity is small in size.

Hobby or recreation

If the taxpayer's activities are being conducted primarily for pleasure or because of an interest in the activity, the fact that the activities may be done on a substantial scale is not enough to decide that a business is being carried on.

In Ferguson v Federal Commissioner of Taxation 79 ATC 4261; 9 ATR 873 at ATC 4265; and ATR 877, it was said:

'..… if what he was doing is more properly described as the pursuit of a hobby or recreation or an addiction to a sport, he will not be held to be carrying on a business, even though his operations are fairly substantial'.

Indicators of a hobby include those where the activity is carried on a small scale and there is no plan in place to show how a profit can be made. In this respect whilst you have provided a business plan, this indicates that the activity is not capable of generating a profit now or in the future.

Conclusion

Albeit you may be approaching the activity in a businesslike manner, your proposed activity does not have the potential or prospect of profit making. This factor and the small size and scale of the operations, limited time that you and your wife will spend on the activity and lack of commercial viability, it is considered that your proposed livestock grazing operations do not constitute a business.

As your proposed livestock grazing activity is not a business, the income from that activity is not assessable under section 6-5 of the ITAA 1997 and any loss or outgoing is not deductible under section 8-1 of the ITAA 1997.

Note: The carrying on a business of primary production is a 'status' that can change as the nature and level of your activity changes. You should evaluate the nature and level of your activity on a regular basis to decide whether your status may be subject to change.

Question 2

Summary

The property being purchased is not considered to be a replacement business asset under the small business CGT concessions under Division 152 of the ITAA 1997 should another small business be sold.

Detailed reasoning

A small business roll-over under Subdivision 152-E of the ITAA 1997 allows you to defer the making of a capital gain from a CGT event happening in relation to one or more small business assets if the basic conditions in Subdivision 152-A of the ITAA 1997 are satisfied for the gain (section 152-410 of the ITAA 1997).

The basic conditions under subsection 152-10(1) of the ITAA 1997 require that:

(a) a CGT event happens in relation to a CGT asset of yours in an income year;

(b) the event would have resulted in a gain;

(c) at least one of the following applies:

(i) you are a small business entity for the income year;

(ii) you satisfy the maximum net asset value test;

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership;

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

(d) the CGT asset satisfies the active asset test.

As you are not carrying on a business in the current year you are not a small business entity (section 328-110 of the ITAA 1997). However you have advised that you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997.

Therefore it is necessary to consider whether you satisfy the CGT asset active asset test in section 152-35 of the ITAA 1997 which requires the replacement asset to be an active asset.

Section 152-40 of the ITAA 1997 provides the meaning of an active asset and states:

152-40(1) A *CGT asset is an active asset at a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a *business that is carried on (whether alone or in partnership) by:

(i) you; or

(ii) your *affiliate; or

(iii) another entity that is *connected with you; or

(b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

As your property will not be used in the carrying on of a business it will not satisfy the active asset test under section 152-40 of the ITAA 1997. Therefore you do not satisfy the basic conditions for relief under subsection 152-10 of the ITAA 1997 and you are not eligible to choose small business roll-over under Subdivision 152-E of the ITAA 1997.