Edited version of private advice

Authorisation Number: 1051854883949

Date of advice: 25 June 2021

Ruling

Subject: Non-commercial losses - lead time - income requirement not met

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 business in the calculation of your taxable income for the 20XX-XX financial year?

Answer

No

This ruling applies for the following period:

Financial year ending 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 35-10(2E) of the ITAA 1997.

You purchased property midway through the 20XX-XX financial year.

The property had previously been used for primary production operations including livestock.

The property included infrastructure suitable for livestock operations.

You have provided that a large portion of the land and other assets included in the property sale, have been utilised for the commencement of a mixed farming business being predominantly livestock which you conduct in partnership (the Partnership).

You purchased livestock and planted a silage crop prior to 30 June 20XX.

The Partnership incurred large losses during the 20XX-XX financial year. A large portion of the expenses were depreciation expenses related to capital investment in the property and equipment for the activity.

The Partnership recorded income from silage crops in the 20XX-XX financial year.

The Partnership business plan provides for livestock to be purchased fatted and sold after 12 months.

The Partnership did not generate income from livestock sales during the 20XX-XX financial year as the livestock were not fattened sufficiently for sale by year end.

XX livestock were carried in the 20XX-XX and 20XX-XX financial years, approximately one third of the projected carrying capacity of the land.

Your business plan provides that you will increase numbers to two-thirds carrying capacity after a further year and then finally full capacity after X years.

The financial statements provided indicate that as at 30 June 20XX, the Partnership had bank loans outstanding of $XXX.

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 you do not come under any of the exceptions.

The Partnership business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

It is only in certain circumstances that the Commissioner has discretion to determine that it would be unreasonable for the loss deferral rule to apply.

Relevant to your application, the lead time Commissioner's discretion in paragraph 35-55(1)(c) of the ITAA 1997 may be exercised for a financial year where:

•                    you do not satisfy the income requirement; and

-        because of its nature, the activity has not produced, or will not produce, assessable income greater than the deductions attributable to it; and

-        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)).

For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is producing a loss is inherent to the nature of the business and is not peculiar to your situation. Taxation Ruling TR 2007/6Income tax: non-commercial business losses: Commissioner's discretion (TR 2007/6) provides at paragraph 78, that the consequences of business choices made by an individual (for example, the size and scale of the activity) are not inherent characteristics of a business activity.

In this case, despite the property having previously been used for livestock production, the Partnership incurred significant capital expenditure attributing to a large loss from the activity in the 20XX-XX financial year. The borrowing costs incurred to service the Partnership's high debt level also contributed to the loss. The scale of these expenditures is considered as a business choice, that being an individual circumstance affecting your particular business activity rather than an inherent characteristic that affects all businesses in the industry. It is not accepted by the Commissioner that the losses incurred where inherent to the nature of the business.

Paragraph 84 of TR 2007/6 provides that the Commissioner needs to be satisfied that there is an objective expectation that the business activity will satisfy a test or produce a tax profit in some future income year falling within a period that is commercially viable for the industry concerned. For taxpayers who do not pass the income test, if the business activity is not expected to produce a tax profit within this period, then the discretion will not be exercised.

For reasons of funding and the business choice to invest in capital expenditure with limited financial resources available, the Partnership has adopted a staggered approach to increasing the livestock numbers carried. It is the Commissioner's view that this will increase the period until there will be an objective expectation of profit from the activity. In this case, this period will be increased beyond what is considered commercially viable for the industry concerned.

As such, the Commissioner will not exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997 and you cannot claim a deduction for your losses against other income in the 20XX-XX income year.