Edited version of private advice

Authorisation Number: 1051852867121

Date of advice: 23 June 2021

Ruling

Subject: Commissioner's discretion - non-commercial losses

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) 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 income year ruled on?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

You do not satisfy the <$250,000 income requirement set out in subsection 35-55(2E) of the ITAA1997.

XXX in State B was drought effected from mid-2017 until mid-2020.

You previously had carried on a primary production business of farming livestock as a partnership with your parent and a company where you were the sole director, which commenced on 1 July 20xx.

You received professional advice that the partnership structure was not in the best interest of the partners.

You ceased the partnership.

You now carry on a primary production business activity as a sole trader. This commenced on 1 July 20xx.

The business activity operates on a farm near XXX in State B.

The business activity during 20xx was that of farming livestock.

During 20xx/xx financial year you sold the livestock due to the effect of drought.

In 20xx, after the poor livestock outcome, you decided to grow crops such as wheat.

The crop growing resulted in low yield due to drought.

You incurred a primary production loss in the 20xx financial year of $xx

You also incurred a primary production loss in the 20xx financial year of $xx

In the 20xx/xx financial year, you intend to purchase farming equipment to assist in the planting and cultivation of crops that is approximately $xx in value.

Your intention is that during the 20xx/xx financial year, you will make a profit from crop growing.

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)

Reasons for decision

Detailed reasoning

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 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.

There are two discretions available to the Commissioner under section 35-55 of the ITAA 1997, being lead time and special circumstances.

Lead time

The lead time discretion 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. 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 any income.

For a taxpayer who does not satisfy the income requirement the lead time discretion may be exercised where there is an objective expectation, based on evidence from independent sources that, within a period that is commercially viable for the industry concerned, the activity will produce a tax profit.

Special circumstances

The special circumstances discretion may be exercised for the financial year in question where your business activity is affected by special circumstances outside your control.

For individuals who do not satisfy the income requirement, the business activity must have been materially affected by the special circumstances, causing it to make a loss. In this context, 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; and

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

Taxation Ruling TR 2007/6 sets out the Commissioner's interpretation on the exercise of the discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 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.

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.

Where special circumstances occur during a business's lead time, the lead time may be extended and the additional time is allowed under the special circumstances discretion (paragraph 51 of TR 2007/6). This is demonstrated in Example 11 in TR 2007/6. In that example the taxpayer carried on a fruit growing business that has a lead time of five to six years. During the lead time period, the business suffered a fire which destroyed some of the trees and damaged many of those remaining. The taxpayer had to re-plant 40% of the trees and the development of fruit on another 30% of the trees was set back approximately two years. In this example, the Commissioner considered it appropriate to exercise the special circumstances discretion for an additional two years beyond the lead time period.

Your case

You carry on a farming business.

In mid-20xx, your location was identified as drought affected by the State B Department of Planning and Infrastructure (State B DPI).

As of 1July 20xx, your location was identified as no longer being drought affected by the State B DPI.

You commenced your farming of livestock during the drought in 20xx. You have advised that you did not make a profit during the 1 July 20xx to 30 June 20xx period.

Due to a restructure, you decided to continue on farming livestock from 1 July 20xx as a sole trader. As of 30 June 20xx, your business had yet to make a profit.

During 20xx, you undertook a new business activity to grow wheat crops during the drought. This resulted in low yield due to the severe weather conditions, such as the drought.

In 20xx-xx financial year, you intend to purchase farming equipment to assist with the planting and harvesting of crops into the future.

You have stated in your application that your business activities were affected by drought in the 20xx-xx income year which impacted the growth of the crops. However, you have not demonstrated that your farming business would have made a profit in the 20xx-xx financial year but for the drought.

You had commenced one business activity which had not made a profit during drought, and you then commenced a different business activity during drought fully aware of the impacts that drought can have.

Whilst drought is considered special circumstances for the purposes of paragraph 35-55(1)(a) of the ITAA 1997, your location was no longer affected by drought, as per State B DPI, during the period you were seeking Commissioner's discretion.

For the discretion to be exercised, the Commissioner must be satisfied that your activity would have made a profit but for the special circumstances. That is, the special circumstances discretion can only be exercised where it can be seen that it was only the special circumstances which caused a loss to be made.

Based on the information available, the Commissioner cannot accept that it is only the drought which causes your business to make losses.

Consequently, the Commissioner is unable to exercise the special circumstances discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the 20xx-xx financial year.