Edited version of private advice

Authorisation Number: 1051581014669

Date of advice: 23 December 2019

Ruling

Subject: Non-commercial losses

Question

Will the Commissioner exercise the discretion to allow you to include any losses from your breeding and fattening business in the calculation of your taxable income for the 2018 to 2023 financial years?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2018

Year ended 30 June 2019

Year ending 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2022

Year ending 30 June 2023

The scheme commences on:

1 July 2017

Relevant facts and circumstances

You have operated a breeding and fattening business. For the income years to 2017 you incurred net losses. For the 2018 you made a net profit as a consequence of selling your entire herd due to the (ongoing) drought.

All of your property is used for breeding and fattening.

Due to drought, you were forced to de-stock all of your stock during the 2018 income year. This has led to extraordinarily high income during the 2018 income year. The resulting profit is not taxable because your accrued quarantined trading losses fully offset the profit achieved for the same enterprise. The quarantined losses are due to your non-farm adjusted taxable income for non-commercial loses purposes income being greater than $250,000.

The drought will lead to continuing losses over subsequent years while awaiting rain, the breaking of the drought, pasture rectification treatments, repurchase of breeding stock at inflated prices and a herd rebuilding program. Note that stock sales are delayed and halved during a herd rebuilding program that requires all female stock to be retained; and because it takes two years for new births to grow out to saleable weight. Breeding stock are expensive to purchase after a drought because all businesses are competing to purchase limited surviving breeding stock at the same time once drought Is over.

You undertook the forced selling of the majority of your breeding herd during 2018, due to the ongoing drought and the rapid escalation of feed costs. You have calculated that the alternative of retaining stock through the drought by purchasing drought feed would have cost approximately $X to date on feed alone, excluding labour and overhead costs. The decision to sell almost your entire breeding herd, that you had rebuilt since the ten year drought that ended in 2011, was not easy but has proved the best management direction for your business as it alleviates an additional debt which would have contributed to future years ongoing losses. The drought has not yet ended and it cannot be foretold how long it will last. This shows that although the sale of most trading stock caused an extraordinary profit during the 2018 income year it has proven to be the best decision.

You request that all quarantined losses accrued to date be offset against non-farm income for the 2018 income year and losses in future years be offset against non-farm income for a period of five income years (that is, 2019 to 2023 income years inclusive) on the basis of financial hardship caused by drought. The five year recovery period is based on the drought breaking any time from July 2019 with the return of normal seasonal rainfall patterns. You have requested that ruling also applies to the 2018 income year. Although a profit resulted in this income year, it was an extraordinary profit due to the forced sale of the whole herd. The hardship therefore commenced during the 2018 income year and it is your understanding that he hardship provisions have been included in this legislation for this type of situation.

You have supported your claims with a state Government Department media release which states that the current drought began in mid-2017. It includes a drought map which shows that your property is located in an area which drought affected.

You have not met the criteria required to receive any form of government drought assistance.

The ruling application is based on an assumption that the drought broke in July 2019. The business losses and cash flow budgets are based on this. These budgets show that cash flow losses will continue right through to the end of the 2023 income year. You have provided the following projected profit and losses figures:

• Actual figures for the 2016 to 2018 income years; and
• Projected figures for the 2019 to 2023 income years (returning to profit in the 2024 income year).

Your business is a breeding operation that relies on a normal level of breeders. The hardship and losses caused by the drought have already happened and will not cease until the 2024 income year (when you expect a return to profitability) even if the drought has already broken. This is because it is not until then that the trading stock would have been rebuilt through a combination of purchase and natural increase to normal business trading levels.

Your income for non-commercial loss purposes is more than $250,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 35-1

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)(a)

Income Tax Assessment Act 1997 Paragraph 35-55(1)(c)

Reasons for decision

Summary

The Commissioner is not satisfied that your breeding and fattening farming activities would have made a profit in the income year ended 30 June 2019 but for the special circumstances. Therefore the Commissioner will not exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(a) of the ITAA 1997 for the income years of the ruling.

Detailed reasoning

Section 35-1 of the ITAA 1997 provides that an income requirement must be met (along with certain other tests), in order to include losses from a business activity in your taxable income calculation. If the income requirement is not met, the Commissioner may exercise discretion to allow the inclusion of the losses.

The income test requirement is in subsection 35-10(2E) of the ITAA 1997 and is passed if your income for non-commercial loss purposes is less than $250,000. In your case, you do not satisfy the income requirement as your income for non-commercial loss purposes is above $250,000.

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.

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 to 53 of this Ruling:

Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to special circumstances outside the control of the business activity, including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of the paragraph. These events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affected 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.

In your case, you have carried on a business of breeding stock for sale and have done so for the past X years. In prior years this business activity has not been profitable. From the middle of 2017 your business has been affected by drought. This required selling all your livestock which you did during 2018. This resulted in a net operating profit for the 2018 income year.

It is accepted that the drought is outside your control and, therefore, accepted as 'special circumstances' for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. However, this by itself did not cause your business activity to make the losses in question and where, but for those circumstances, a profit would have been made.

The Commissioner notes the inherent unprofitability of the business, as borne out by its consistent record of losses, and no reasonable expectation of profitability in the future. The Commissioner is not satisfied that your farming activities would have made a profit had it not been affected by special circumstances, that is, it would have made a loss without the drought. See paragraph 50A and example 7A at paragraph 129A of TR 2007/6.

The Commissioner concludes that it would be reasonable in these circumstances for the loss to be deferred, and not exercise the special circumstances limb of the discretion. Therefore, the Commissioner will not exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(a) of the ITAA 1997 for years of the ruling..