Edited version of your private ruling

Authorisation Number: 1012613469633

Ruling

Subject: Non-commercial losses

Question 1

Will the Commissioner exercise the discretion in subsection 35-55(1) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your primary production activity in the calculation of your taxable income for the 2011-12 financial year?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

1 July 200X

Relevant facts and circumstances

You purchased a property in the 200X financial year.

The property included immature crops that had been planted a number of years prior to you purchasing the property.

In 200Y you undertook a more structured and professional approach to harvesting the crop.

You have stated that the maturing the crop was adversely affected by circumstances outside of your control being insufficient and inconsistent rain necessary to achieve the required growth and maturity.

You have provided rainfall data for your property over the relevant periods.

During the initial number of years of owning the property the annual harvest was small due to the immature age of the crop.

You consider the crop is mature in terms of quality and volume.

You have provided evidence from an industry expert who states that in normal conditions, the crop usually reaches its maximum potential in 4-5 years.'

To increase your income stream, you established a partnership/share farming arrangement with a partner with strong selling and distribution channels established into the market.

During the 20XX financial year, the business harvested XXXX products with an average sell price of $XX per item.

Your sales report for this period states that you were only able to pick half of the previous year's quantity and this had a major impact on sales and revenue. The report states that the reason for this is unclear; it could be due to heavy harvesting the previous year resulting in a lower yield or differential harvesting locations.

Your total expenditure for the 20XX financial year was $XXXX.

You have provided actual income and expenditure figures for the 20YY financial year and budgeted income and expenditure for the subsequent financial years. Your projections show you expect to produce a profit in the 20ZZ financial year with a total of XXXX products expected to be sold at an average of $XX per item.

You began the process of splitting to expand your crop in order to reach a more commercial scale of production. Each year you plan on increasing your crop until the 20VV financial year. This gradual splitting process reduces the impact on production.

Your projections show you expect to sell XXXX products in the 20VV financial year at an average price of $XX per item.

During the 20XX financial year, you received a termination payment which caused you to fail the income requirement set out in subsection 35-10(2E) of the ITAA 1997.

Prior to the 20XX financial you satisfied the income requirement and pass the assessable income, real property and other assets tests of Division 35.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 35-10(1).

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 not convinced that your primary production activity would have produced a profit in the absence of drought conditions. Therefore the Commissioner will not grant the discretion to allow you to include the loss in your taxable income for the 20XX financial year.

The Commissioner is not satisfied that 14 years is the commercially viable period for your primary production activity and therefore will not exercise the discretion for the 20XX financial year.

Detailed reasoning

For the 2009-10 and later income years, Division 35 of the Income Tax Assessment Act 1997 will apply to defer a non-commercial loss from a business activity unless:

• you satisfy the income requirement and you pass one of the four tests

• the exceptions apply, or

• the Commissioner exercises his discretion.

In your situation, you do not satisfy the income requirement (that is your taxable income, reportable fringe benefits and reportable superannuation contributions but excluding your business losses, exceeds $250,000) and you do not come under any of the exceptions. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

The Commissioner's discretion - special circumstances 

The Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the financial year where the business activity is affected by special circumstances outside the control of the operators of the business activity.

Special circumstances are those circumstances which are sufficiently different to distinguish them from the circumstances that occur in the normal course of conducting a business activity. For those individuals who do not satisfy the income requirement, special circumstances are those which have materially affected the business activity, causing it to make a loss. The Commissioner may exercise this discretion for the income year(s) in question where, but for the special circumstances:

• your business activity would have made a tax profit

• the activity passes at least one of the four tests or, but for the special circumstances, would have passed one of the four tests.

In the context of Division 35 of the ITAA 1997, special circumstances are ordinarily those affecting the business activity such that it would be unreasonable for the loss deferral rule to apply. TR 2007/6 states at paragraph 47:

ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances. These fluctuations are expected to occur on a regular or recurrent basis when carrying on a business activity and affect all businesses within a particular industry.

You have stated that the maturing of your crop has been adversely affected by insufficient and inconsistent rainfall. It is accepted that these conditions were outside your control and, therefore, are 'special circumstances' for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. However, before the Commissioner can exercise the discretion you must be able to show that it was the special circumstances that caused your activities to make a loss.

You have shown in your budgeted income and expense report that you expect to produce XXXX items at full production without the adverse low rainfall. You project that the quality of product will achieve you a sell price of $XX per item. This would produce income of $XXXX. However, based on your actual expenditure for the 20XX financial year of $XXXX your primary production activities would still have returned a loss had the weather events not occurred.

The reason your primary production activities did not produce a profit was more a result of the low volume of crop harvested and your high expenditure levels than the effects of the weather.

As the Commissioner is not convinced that in the absence of the drought the business would have been profitable for the 20XX financial year, the discretion under paragraph 35-55(1)(a) of the ITAA 1997 will not be granted for the 20XX financial year.

The Commissioner's discretion - lead time

The relevant discretion may be exercised for the income year in question where:

• it is in the nature of the business activity that there will be a period of time before it can be expected to pass one of the four tests

• there is an objective expectation your business activity will produce a tax profit or meet one of the four tests within a commercially viable period for your industry.

This discretion is intended to cover a business activity where there is an inherent period of time between the commencement of the activity and the production of any assessable income. For example, 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.

For the discretion to be applied there needs to be an inherent or innate feature of the activity resulting in an inability to produce income in the year of commencement and (in most cases) a number of years thereafter. Further examples that fall into this category are forestry, viticulture and certain horticultural activities.

The advice that you provided states that in normal conditions, the crop usually reaches its maximum potential in 4-5 years. Your crop was established a number of years prior to you purchasing the property and therefore was close to or had already reached maturity.

You have provided information that predicts you will make a profit in the 20ZZ financial year which is ten years since you purchased the property and 14 years after the crop was available for harvest.

The Commissioner is not satisfied that 14 years is the commercially viable period for your primary production activity and therefore will not exercise the discretion for the 20XX financial year.