Edited version of private advice

Authorisation Number: 1051960441260

Date of advice: 31 May 2022

Ruling

Subject: Commissioner's discretion - non-commercial losses - lead time

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 the calculation of your taxable income?

Answer

No.

This ruling applies for the following period:

The year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You meet the <$250,000 income requirement.

Your business activity did not meet any of the four tests in the income year relevant to this ruling.

You acquired a fruit farm in the income year four years prior to the income year of this ruling from a relative.

You live in a different state to the fruit farm.

Your relative helps out here and there, but not all the time, with the management of the fruit farm.

The area where your fruit farm is located low rainfall between the income year you acquired the fruit farm and the income year prior to the income year of this ruling. The price of water also increased during this time.

You have provided information about your income and expenditure from the income year you acquired the fruit farm to the income year of this ruling.

In the income year you acquired the fruit farm the season was already over, and you did not receive any income. However, in that year, the orchard did produce income of over $20,000, which went to the previous owner of the orchard.

In the income year prior to the income year of this ruling, and in the income year of this ruling, you did not have any income, and your only expenses were for water and council rates.

In all the income years since you acquired the fruit farm, your activity has met the assessable income test once.

In all the income years since you acquired the fruit farm, your activity has not made a profit.

During the income year prior to the income year of this ruling, you could not afford the water.

The fruit trees died in the calendar year which crosses the income year prior to the income year of this ruling, and the income year of this ruling.

You removed the dead fruit trees at the beginning of the income year following the ruling period.

You have been restricted from travelling to the fruit farm due to COVID-19 travel restrictions.

Due to the recent drought and Covid lockdowns you have decided to replant the fruit farm with a better variety. You did not secure new trees in the income year of this ruling because of shortages of labour and young trees from nurseries.

You are currently incurring costs to keep the land viable, such as maintaining the water facility.

You do not have a documented business plan or profit/loss forecast.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 35-5.

Income Tax Assessment Act 1997 section 35-10.

Income Tax Assessment Act 1997 section 35-55.

Reasons for decision

Summary

The Commissioner will not exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 because you were not in business, and even if you were in business, the drought conditions which existed did not cause your activity to be unable to pass one of the four tests in the relevant income year.

Detailed reasoning

For the 20XX-XX income year and later income 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

-          the Commissioner exercises his discretion.

Your assessable income from sources not related to this activity was more than $X in the 20XX-XX income year. The exception contained in subsection 35-10(4) of the ITAA 1997 for primary production businesses does not apply.

Your income for non-commercial loss purposes is less than $250,000, therefore you satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997. However, your activity has not satisfied any of the four non-commercial loss tests.

You will be required to defer your non-commercial losses, unless the Commissioner exercises the discretion for special circumstances in paragraph 35-55(1)(a) of the ITAA 1997.

The Commissioner's discretion for special circumstances

Where the income requirement is satisfied, the Commissioner's discretion can be exercised where:

-          the business activity is affected by special circumstances, such that it is unable to satisfy any of the tests; and

-          the special circumstances affecting the business activity are outside the control of the operators of the business activity.

In order for the Commissioner's discretion to be exercised, your activities must be carried on as a business, according to section 35-5 of the ITAA 1997.

Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion provides guidance on how the Commissioner's Discretion in subsection 35-55(1) of the ITAA 1997 may be exercised. 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 (paragraph 13 of TR 2007/6). They must be outside the control of the operator of the business activity (paragraph 14 of TR 2007/6). Special circumstances include, but are not limited to, drought, flood, bushfire or some other natural disaster.

To exercise the discretion, the Commissioner must be satisfied that the special circumstances materially affected the business activity, and the special circumstances were the cause of the business activities failure to satisfy any of the four tests in Division 35.

Application to your circumstances

You acquired your fruit farm. You carried on a fruit farming business. Your location was identified as having the lowest rainfall on record between the income year you acquired the fruit farm and the income year prior to the income year of this ruling.

It is accepted that drought is a special circumstance outside of your control for the purposes of the Commissioner's discretion in section 35-55 of the ITAA 1997. However, the Commissioner must be satisfied that there was business activity in the year you applied for the discretion, and furthermore, that it was the drought that caused your business activity not to pass the assessable income test in that year.

You have advised that you did not make any income during the income year in which you acquired the fruit farm, because the income from that period went to the previous owner. Since that income year, your fruit farm has only passed one of the four tests in Division 35 once. However, as of the end of the relevant period for this ruling, you have not made a profit from the business activity in any year.

You have stated in your application that your business activities were affected by drought and the rising price of water in the income year prior to the income year of this ruling, which impacted your ability to afford water. This meant that your fruit trees died, and you made no income.

As a result, in the income year of this ruling, you had no actively growing trees on your land, and you made no income. The only expenses you incurred during both the income year of this ruling and the income year prior, were to maintain the land.

Based on this information, you are not considered to be carrying on a business during the income year of this ruling. There is no evidence of business activity during that period. Your fruit trees died and had no prospect of profit because there would be no fruit to sell. You did not have any expenses that would be expected if you were undertaking business activities.

Even if you were carrying on a business during the income year of this ruling, you have not demonstrated that your fruit growing business would have passed one of the four tests but for the drought conditions. This is because:

-          The trees on your land died.

-          As a result, your fruit farm made no income and could not pass one of the four tests the income year of this ruling, and you incurred a loss.

-          The loss you incurred was due to expenses for holding the land. These expenses would have been incurred irrespective of the drought.

-          You did not incur any additional costs in the income year of this ruling due to the drought in particular. The loss in that year was not caused by the drought.

COVID-19

You have also made mention of the fact that COVID-19 caused travel restrictions which prevented you from travelling from your place of residence to your fruit farm. We have considered whether this is a special circumstance outside your control which prevented your business activity from meeting the assessable income test, if you were in fact carrying on a business in the income year of this ruling.

Although COVID-19 is a special circumstance outside of your control, the Commissioner is not satisfied that the travel restrictions prevented you from meeting the assessable income test, because you had already made the business decision to operate the fruit farm from a different state with an arrangement for your relative to help you, before COVID-19 travel restrictions were in place. The travel restrictions did not alter this arrangement with your relative, and you have not established a connection between the travel restrictions the fruit trees dying. The COVID-19 travel restrictions were not the ultimate cause for the fruit farm not passing one of the four tests in the income year of this ruling.

Conclusion

For the discretion to be exercised, the Commissioner must be satisfied that you were in business and your activity would have passed one of the four tests, but for the special circumstances. Based on the information available, the Commissioner cannot accept that it was the drought or COVID-19 which caused your activity to make no income and consequently be unable to pass one of the four tests.

The Commissioner is unable to exercise the special circumstances discretion under paragraph 35-55(1)(a) of the ITAA 1997.