Edited version of private advice

Authorisation Number: 1051959595833

Date of advice: 5 April 2022

Ruling

Subject:Commissioner's discretion - special circumstances - 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 business activity in your calculation of taxable income for the 20XX financial year?

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 meet the following tests under Division 35 of the ITAA 1997:

•                Assessable income test.

•                Real property test.

•                Other assets test.

You do not satisfy the less than $250,000 income requirement set out in subsection 35-55(2) of the ITAA 1997.

The station-sized property based in State was acquired by a trust (related entity) in Month XXXX.

In the XXXX income year, the trust began carrying on a primary production business activity which was a xxxx and xxxx farming operation.

A business decision was made to restructure the business to operate under your sole trader ABN commencing on 1 July XXXX.

This property is leased to you at market value from the trust (related entity).

You have X+ years of experience in the agricultural industry. Prior to business operations at the property, you operated a primary production business in this industry at a different property in another state.

You are also employed as a Manager with an agricultural company based in a neighbouring area.

Your business has not produced a profit since the 20XX income year:

•                20XX FY = $XX profit (operating at another property and under trust structure).

•                20XX FY = $XX loss (operating on another property and under trust structure).

•                20XX FY = $XX loss (incl XX of interest and 1st year operating on this property).

•                20XX FY = $XX loss (incl $XX of interest).

•                20XX FY = $XX loss (incl $XX of interest and $XX of depreciation).

•                20XX FY = $XX loss (incl $XX of rent and $XX of depreciation). Restructured to operate the business under your sole trader ABN.

•                20XX FY = $XX loss (incl $XX of rent and $XX of depreciation).

•                20XX FY = $XX loss (incl $XX of rent).

•                20XX FY = Expected loss of $XX (incl $XX of rent & $XX of depreciation). The depreciation was in regard to a xxxx vehicle plus accessories (xxxx vehicle = $XX and accessories = $XX). The xxxx vehicle was purchased for the purpose of clearing dams which would have cost $XX - $XX to hire contractors to do.

•                20XX FY = Expected loss (no figures - not lodged yet).

Xxxx has been drought-affected since mid-20XX as per "XXXX" - https://www.XXXX

You submit that the special circumstances required you to adapt and change the farming operations to accommodate the drought-affected seasons on a regular basis.

You have provided the following brief summary of your operations and farm management:

"We purchased XX xxxx in Month 20XX and an additional XX xxxx and xxxx. Due to the failed summer wet season in early-20XX and early-20XX, we sold all our xxxx in stages before Month 20XX.

We then de-stocked further except for ~X xxxx and a remaining XX xxxx.

Due to a period of poor rainfall seasons and the consistent drought conditions, we did not purchase any additional xxxx until mid-20XX due to a good early winter rain event. We then built our numbers up to the 20XX peak of XX.

On the back of this rain event, we purchased XX xxxxs to join and breed; however, a deterioration in ongoing rainfall forced us to again sell our xxxx livestock in stages. Our xxxx were sold by early 20XX.

In August we sold XX xxxx, (which were all remaining from the additional purchase of XX xxxx in Month 20XX), and by Month 20XX we had totally de-stocked the station of the remaining XX xxxx due to drought. The only livestock remaining on property were ~X xxxx.

In Month 20XX, we purchased XX xxxx to begin breeding and restocking off the back of a modest late Autumn break.

By Month 20XX, we had sent all of our xxxx away on agistment due to worsening drought conditions. This stock returned to the property in Month 20XX as a result of a good late summer rain.

During this period 20XX-20XX we supplement fed xxx with xxxx and the xxxx with xxxx all purchased from considerable distance away to get them through until the potential of a seasonal break; however, each time the season failed, and we remained in drought."

Your carrying capacity for xxxx and xxxx has been at X%.

You have projected that the business will make a profit of at least $XX in the future income year due to the following:

•                A good late summer rain has improved pastoral conditions for grazing.

•                Breeding numbers have improved as xxxx have returned from agistment.

•                Xxxx and xxxx have been brought onto the property through purchase.

The estimate of the projected profit is due to:

•                XX xxx sold at $XX per head for a total of $XX.

•                X xxxx sold at $XX for a total of $XX.

•                XX cast for age xxxx sold at $XX per head for $XX.

•                $XX-$XX of xxxx sold by Month 20XX.

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).

Taxation Ruling TR 2001/14.

Taxation Ruling TR 2007/6.

Reasons for decision

For the 2009-10 and later income years, Division 35 of the Income Tax Assessment Act 1997 will apply to defer a non-commercial loss (NCL) from a business activity unless:

•                you satisfy the income requirement, and you pass one of the four tests

•                the exceptions apply

•                the Commissioner exercises his discretion.

In your situation, none of the exceptions would apply and although you satisfy three of the four tests in the financial years under consideration, you do not satisfy the income requirement as your income for non-commercial loss purposes was above $250,000 in the financial years under consideration. Your losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

If you don't meet the income requirement, the Commissioner may exercise discretion to allow you to offset your loss if:

•                special circumstances occurred that were outside your control (paragraph 35-55(1)(a) of the ITAA 1997), or

•                due to the nature of the activity, there is

-        a lead time before the business will make a tax profit; and

-        an objective expectation, based on independent evidence, that it will make a profit in a time that is considered commercially viable for that industry (paragraph 35-55(1)(c) of the ITAA 1997).

Special circumstances

The relevant discretion under paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the financial year in question where your business activity is affected by special circumstances outside your control.

'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, including drought, flood, bushfire or some other natural disaster.

For individuals who do not satisfy the income requirement, special circumstances are those which have materially affected their business activity causing it to make a loss, In this context, the Commissioner may exercise this discretion for the financial year(s) in question where, but for the special circumstances the activity would have made a tax profit.

To determine what are 'special circumstances', we need to look at the context in which the phrase is used. Also, it is clear that 'special circumstances' will be something out of the ordinary or unusual. '

The question of what constitutes 'special circumstances' has been judicially considered on many occasions. In the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation:

Those discretions are intended to be applied to a great variety of situations. In such a context, the core of the idea of 'special circumstances' is that there is something unusual or different to take the matter out of the ordinary course...

Later, in the Federal Court Case of Secretary, Department of Employment, Education, Training & Youth Affairs v. Barrett and Another(1998) 82 FCR 524 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed that:

The word 'special' must be read in context. In normal parlance it signifies that the event or circumstances in question are out of the ordinary or normal course.

Tamberlin J then quoted the following passage with approval from the AAT case of Re Beadle and Director-General of Social Security (1984) 1 AAR 362; (1984) 6 ALD 1:

An expression such as 'special circumstances' is by its very nature incapable of precise or exhaustive definition. The qualifying adjective looks to circumstances that are unusual, uncommon or exceptional. Whether circumstances answer any of these descriptions must depend upon the context in which they occur. For it is the context which allows one to say that the circumstances in one case are markedly different from the usual run of cases. This is not to say that the circumstances must be unique but they must have a particular quality of unusualness that permits them to be described as special.

As stated at paragraph 14 of Taxation Ruling TR 2007/6 Income tax: non-commercial business losses:

Commissioner's discretion:

"The special circumstances must be outside the control of the operators of the business activity. Such circumstances are specifically defined to include drought, flood, bushfire or some other natural disaster4. In the case of other events, failure for no adequate reason to adopt practices commonly used in an industry to prevent or reduce the effects of special circumstances may point to the special circumstances not being outside the control of the operator."

At paragraph 47 of TR 2007/6, it states:

"...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."

Further, as stated at paragraph 49 of TR 2007/6:

"The special circumstances must have affected the business activity. Some indicators of the effects on the business activity that could lead to the exercise of the discretion in regard to the special circumstances' limb are:

•                destruction of stock or equipment (refer to Example 2 at paragraph 112 of this Ruling);

•                delays in ploughing, planting, harvesting etc (refer to Example 3 at paragraph 115 of this Ruling);

•                delay in growth of crops (refer to Example 4 at paragraph 118 of this Ruling);

•                inability of operator to perform duties (refer to Example 5 at paragraph 122 of this Ruling); and

•                loss of business opportunities (refer to Example 6 at paragraph 125 of this Ruling)."

In your case, the business activity on the property commenced during a period of drought and the decision was made to restructure the business and carry on the primary production business under your name as a sole trader. This decision was made whilst taking the environment and weather into consideration among other business issues.

Because the drought conditions continued to exist at that time, the drought would be considered normal or a usual situation for the business activity to be carried on.

Therefore, the continuous drought (from mid-20XX until now) is not considered 'special circumstances' for the NCL discretion under paragraph 35-55(1)(a).

Your supporting documents included:

•                An Xxxxs market appraisal by an individual where they have estimated the property has a carrying capacity of approximately XX xxxx or approx. XXX - XXX xxxx.

•                A letter written by a branch manager from Xxxxs stating that the property has the capacity to run XXX to XXX dry xxxx equivalents or XX to XX xxxx in normal rainfall years.

You have also provided the following statement:

"With a view on xxxx and adopting a slightly more conservative approach than the branch manager from Xxxxs Australia, you estimate that you have the capabilities to run ~XXX/XXX xxxx year in year, which in turn would cut an estimated X kg (conservatively) per head. This would return approximately XX bales, or XXX kg of xxxx with an average return of approximately $XX in normal rainfall years."

Based on the above supporting documents and your statement, you have made business decisions to operate the farm at X% carrying capacity. The prevailing weather and environmental conditions, among other considerations, have influenced your business decisions to carry on the business activity. This has directly affected your inability to derive more income compared to periods when the region is not experiencing drought and you would expect to receive greater rainfall.

Further, for the Commissioner to exercise the discretion under special circumstances, the Commissioner needs to be satisfied that the special circumstances have materially affected the business activity, causing it to make a loss. Your financial data provided does not indicate that the loss was mainly caused by the drought, rather it was caused mainly by interest expenses and depreciation (when the business activity was operated by the Trust), and by rent and depreciation since the business has been carried on by you as a sole trader.

As per your '20XX Financial Report draft', there is an expected loss of $XX from the activity. Included in the expenses that contributed towards the loss were $XX for rent and $XX for depreciation. The depreciation expense amount mostly represented the business decision to purchase a xxxx and accessories. Therefore, the special circumstance, if there are, have not materially affected the business activity, causing it to make a loss.

Accordingly, the Commissioner cannot exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the 20XX-XX financial year. Therefore any 'loss' for that activity cannot be taken into account in calculating your taxable income for the, 20XX-XX financial years.