Edited version of private advice

Authorisation Number: 1051738441243

Date of advice: 14 August 2020

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 productionbusiness activity in your calculation of taxable income for the 20XX to 20XX financial years?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

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

You commenced business operations on 1 July 20XX as part of a partnership.

You carry on a business on XX hectares of land in Australia. This valley has been in drought conditions for more than 2 years. In late 20XX drought affected the area where the farm is located and became so severe that your local water authority issued a direction to cease all river pumping.

The business aims to be the market leader using intensive yet sustainable production systems.

To establish the business, significant capital has been invested in centre irrigation technology covering XX hectares of cropping land. Once established, the operating costs of this irrigation equipment are expected to be for electricity and machinery maintenance, which are modest costs. This should allow a return to profitability.

You believe that, had the extreme drought conditions not occurred, the business would now be profitable.

You project that full production will be achieved once all irrigation equipment is operational in the financial year ending 30 June 20XX.

The partners recognise that future drought conditions pose the biggest risk to profitability and have therefore invested in extensive irrigation to minimise this risk.

The extensive drought conditions have extended the lead time required to reach profitability. You now anticipate that the business will be profitable in 20XX and have provided financial projections to support this view.

You have provided an independent consultant's report to support the view that such a business requires between 2.5 and 3 years to attain commercial viability.

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 financial 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.

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 may not be satisfied.

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.

TR 2007/6 does not support any view that the discretion should available where the failure to make a profit is for reasons other than the nature of the business, such as, a consequence of starting out small and needing to build up a client base, or business choices made by an individual that are not consistent with the ordinary or accepted practice in the industry concerned - such as the hours of operation, location, climate or soil conditions, or the level of debt funding.

It appears that a significant contributor to the losses of the business in later years is the effects of an extreme drought which restricted your access to irrigation water from the nearby river and thus extended the lead time required to achieve commercial viability for your business.

However, you have supplied independent evidence that a 3-year lead time would be an appropriate lead time to establish commercial viability and this discretion concerns the first 3 years.

The Commissioner will therefore exercise his discretion for the relevant years.