Edited version of your written advice

Authorisation Number: 1013102193365

Date of advice: 4 October 2016

Ruling

Subject: Non-commercial losses

Question

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 primary production business activity in your calculation of taxable income for the 2015 to 2017 financial years?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2015

Year ended 30 June 2016

Year ending 30 June 2017

The scheme commenced on:

1 July 2014

Relevant facts and circumstances

You do not satisfy the <$250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You carry on a business of breeding livestock for the purpose of sale as well as the provision of stud services at above average market rates due to the rarity of this particular line, and the production and sale of products made from by-products of your animals

You commenced business operations in the 20XX financial year.

You initially purchased a small number of animals of suitable genetic strain for your elite breeding line, some of which were pregnant. This resulted in some live births, increasing your herd within a short period.

You now have a larger number of livestock on account, some of which are pregnant, due to birth in 2017.

Due to the rarity of suitable quality genetic lines available in this specialised market within Australia, you have commenced your activities on a small scale, choosing to purchase only those animals meeting or exceeding the elite standards for which your stud intends to become known.

You are currently also sourcing additional stock for by-product purposes, to enable you to take advantage of your identified niche market of products made from this.

You have submitted financial information for the relevant years showing no income from sales, though these years showed a livestock trading profit due to natural increase.

You have submitted a profit projection for the years 2017 to 2021 which shows you will generate some income from both the stud services of your elite line, as well as from your other products in the 2017 financial year.

You have submitted an estimated livestock trading account for the years 2017 to 2021 which indicates you will generate income from sales in the 2018 year.

You intend to make a tax profit in the 2018 and subsequent financial years.

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)(c)

Reasons for decision

For the 2009-10 and later financial years, Division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless:

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

• the exceptions apply

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

• it is in the nature of your business activity that there will be a period before a tax profit can be produced

• there is an objective expectation your business activity will produce a tax profit within the commercially viable period for your industry

Application of paragraph 35-55(1)(c) of the ITAA 1997

In order to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997, the Commissioner must be satisfied that there is an objective expectation, based on evidence from independent sources, that your business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period for the industry (paragraph 35-55(1)(c) of the ITAA 1997).

The Commissioner's discretion in subsection 35-55(1) of the ITAA 1997 reads -

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)).

Note:

Paragraphs (b) and (c) are intended to cover a business activity that has a lead 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.

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 Commissioner accepts that your livestock breeding activity has a lead time between the commencement and producing any assessable income.

Paragraph 21 of the Taxation Ruling TR 2007/6 states that 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 satisfy one of the tests in Division 35 of the ITAA or produce a tax profit.

The commercially viable period for livestock breeding will be from the commencement of the business activity and includes a time for completion of the following activities:

• raising females to a breeding age;

• allowing for the gestation period of those animals to finish; and

• raising the progeny to a saleable age

In your case, you purchased a number of mature females, some of which were pregnant at that time, resulting in progeny within a short time after you commenced business activities. This effectively reduces the commercially viable period available to you, as the first of the three activities has already passed and the second was in progress at the commencement of your business activities.

It follows that in your particular circumstances; the Commissioner considers it reasonable that the commercially viable period for your primary production activities would be a period no longer than two to three years.

Taxation Ruling TR 2007/6 states that the 'lead time' discretion provided for by paragraph 35-55(1)(c) of the ITAA 1997 is available for a business activity if there is an initial period from when the activity commenced where the nature of the activity prevents a tax profit from being made/one of the four tests from being passed.

This 'lead time' (in the case of primary producers, this is usually the same as the commercially viable period) discretion is not available once a business activity has made a tax profit. This is because it is then clear that there is nothing inherent in the nature of the business activity that prevents a tax profit from being made. The only exception to this is where a business activity makes a tax profit on a one-off basis during the initial 'lead time' period. For example, a forestry operation may have a lead time of 20 years before harvesting its trees but may make a one-off tax profit in an earlier year due to a thinning operation. In that case, the one-off tax profit would not affect the lead time period.

In your case, you commenced your activities late in the 20XX financial year. You expect to commence receiving some income from your activities in the 2017 financial year and you expect to make a tax profit in the 2018 financial year, being the relevant full year since the commencement of your activities.

Having regard to your full circumstances, it is accepted that it is in the nature of the business activity that has prevented you from making a profit and that you expect to make a tax profit within a commercially viable period for your industry, taking your particular circumstances into account.

Therefore, the Commissioner will 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 primary production business activity in your calculation of taxable income for the relevant financial years.