Edited version of private advice

Authorisation Number: 1051979343100

Date of advice: 5 May 2022

Ruling

Subject:Deferral of 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 the taxpayer to include losses from a business activity in the calculation of their taxable income for the relevant income year?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.    The taxpayer operates a Primary Production business.

2.    This business has been operated by the taxpayer for many years.

3.    The main source of income for the business is via primary production sales.

4.    The property is considerable in size and will in normal seasons run a considerable amount of stock.

5.    Since 1 January XXXX, the property has been declared as being located in a fully drought-declared area.

6.    The business has been profitable in past years, but with ongoing drought conditions it has suffered significant losses due to increased operating costs and lack of revenue due to having to decrease stock numbers from the property due to lack of pasture.

7.    Significant expenditure has been incurred on the installation of feral dog fencing; this is imperative to ensure that when stock are re-purchased the stock are protected from predation by wild dogs which is a significant problem in this area.

8.    Actual income and expense figures for your Primary Production business for the past five years were supplied.

9.    The taxpayer does not qualify for an exception from the non-commercial loss rules as the taxpayer's assessable income (excluding any net capital gain) from sources not related to the primary production activity is more than $X.

10.  The taxpayer has provided the projected taxable income for non-commercial loss purposes which included taxable dividend income in the relevant income year.

11.  The real property that the taxpayer owns or leases with a value of at least $X is used in business activities.

12.  The taxpayer provided supporting documentation stating that the business would be profitable again in the XXXX income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 35-10

Income Tax Assessment Act 1997 section 35-40

Income Tax Assessment Act 1997 section 35-55

Reasons for decision

Summary

The Commissioner will exercise the discretion under paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow the taxpayer to include losses from their business activity to offset other assessable income in the calculation of their taxable income for the relevant income year.

The Commissioner is satisfied that the primary production business activity was affected in the relevant income year by special circumstances outside the control of the operator of the business activity, and it would be unreasonable to apply the rule in section 35-10 of the ITAA 1997 in relation to the taxpayer's business activity.

Detailed reasoning

For the XXXX-XX 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, or

-       the Commissioner exercises his discretion

Section 35-1 of the ITAA 1997 provides that an income requirement must be met (along with certain other tests), in order to include losses from a business activity in your taxable income calculation. If the income requirement is not met, the Commissioner may exercise his discretion to allow the inclusion of the losses.

The income requirement under subsection 35-10(2E) of the ITAA 1997 will be met if their income for non-commercial loss purposes is less than $X.

In this case, the income requirement under subsection 35-10(2E) of the ITAA 1997 is not met as the income for non-commercial loss purposes was above $X.

If the income requirement is not met, 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 his discretion for the income year(s) in question where, but for the special circumstances:

-       your business activity would have made a tax profit

-       the activity passes at least one of the four tests or,

-       but for the special circumstances, would have passed one of the four tests.

Special Circumstances

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. For those individuals who do not satisfy the income requirement, special circumstances are those which have materially affected the business activity, causing it to make a loss.

Taxation Ruling 2007/6 Income tax: non-commercial business losses: Commissioner's discretion sets out the Commissioner's interpretation of the exercise of the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997 (TR 2007/6). The following has been extracted from paragraphs 47 to 52 of this ruling:

47. In the context of Division 35, where the income requirement is satisfied, special circumstances are ordinarily those affecting the business activity such that it is unable to satisfy a test and it would be unreasonable for the loss deferral to apply. Subject to paragraphs 48 and 53 of this Ruling, ordinary economic, weather or market fluctuations 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. (Refer to Example 1 at paragraph 110 of this Ruling.)

However, substantial unexpected fluctuations of a scale not regularly encountered previously may qualify on a case-by-case basis.

48. Although not limited to natural disasters, paragraph 35-55(1)(a) refers to special circumstances as including drought, flood, bushfire or some other natural disaster. These events are taken to be special circumstances outside the control of the operators of the business activity.

49. 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 paragraphs 118 of this Ruling);

- inability of operator to perform duties (refer to Example 5 at paragraph 112 of this Ruling); and

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

50. In the situation where a business activity would have failed to satisfy a test even if the special circumstances had not occurred, it is unlikely that the Commissioner would consider it to be unreasonable for the loss deferral rules to apply and therefore the Commissioner would be unlikely to exercise the discretion. (Refer to Example 7 at paragraph 128 of this Ruling).

50A. Where the business activity is carried on by an individual who does not satisfy the income requirement and this activity would have made a loss even if it had not been affected by special circumstances, it is also unlikely that it would be considered unreasonable for the loss deferral rules to apply and therefore the Commissioner is unlikely to exercise the discretion (Refer to Example 7A at paragraph 129A of this Ruling).

51. However, in some cases, the business activity may still be within the lead time for the industry and because of the nature of the activity would therefore have failed to satisfy a test or produce a tax profit even if the special circumstances had not occurred. In such cases the special circumstances may extend the time within which that particular business activity could objectively be expected to pass a test, and the Commissioner could exercise the discretion under paragraph 35-55(1)(a). (Refer to Example 11 at paragraph 154 of this Ruling).

52. The discretion can be exercised in income years after the one in which the special circumstances have occurred if the effects of those special circumstances on a business activity continue such that it cannot satisfy any of the tests or produce a tax profit in those later years. However, there may be situations where the special circumstances in question, because of their continued existence, change, and become the ordinary or usual situation, in which case it would not be appropriate to exercise the discretion after that time. (Refer to Example 4 at paragraph 118 of this Ruling and Example 8 at paragraph 130 of this Ruling).

In this case, it is accepted that the drought conditions significantly affected business operations. The region was declared and continues to be fully drought affected since 1 January XXXX. The business has had to decrease stock numbers from the property due to lack of pasture.

The Commissioner accepts that your business activity was affected by special circumstances that were outside your control, specifically drought. The Commissioner also accepts that, in the absence of those circumstances a taxable profit would have been made in the XXXX income year. In this case, the real property owned or leased in the business activity is greater than $X therefore the real property test under section 35-40 of the ITAA 1997 is met. It has also been forecast that the business activity will be profitable in the XXXX income year as the special circumstances will no longer be present and the drought is over.

Accordingly, the Commissioner will exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 to allow you to include losses from your business to offset other assessable income in the calculation of your taxable income for the relevant income year.