Edited version of private advice

Authorisation Number: 1051991341877

Date of advice: 9 November 2022

Ruling

Subject: Commissioner's discretion - non-commercial losses

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow Person A and Person B to include their share of losses from their primary production partnership in calculating their taxable income for the period 1 July 20XX to 30 June 20XX?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Around 20XX you and your spouse purchased two properties and commenced carrying on your primary production business partnership.

In 20XX you purchased a third property nearby.

During the period between 200X and 20XX financial years, your partnership business carried on a mixed livestock operation while at the same time you were able to put together a herd of XXX breeding cows which had primarily Angus cross genetics.

The nature of the feeding and breeding operations carried on by the partnership up to the 20XX financial year were influenced or constrained by a number of factors including:

•         Insufficiently reliable water supply. The farm was highly susceptible to being impacted by drought, as a result it was not possible to implement a strategy of intensive genetic improvement.

•         The potential calving difficulties experienced by the younger XXXX Angus cows. Due to this, you incorporated genetic improvement to your core breeding herd. The crossing of your existing herd of predominantly XXXX Angus with XXXX breeds in 20XX provided easy calving and produced cattle with the ideal genetics.

•         The size of your land holding prior to the acquisition of the third property was insufficient to carry the number of core breeders necessary to produce a steady stream of calves throughout the year to satisfy market demands.

With the purchase of the third property, your total land holdings gave you the opportunity to develop a defined strategy which is to have a core breeding herd of at least XXX cows with the ideal genetics to breed your own calves, grow them out and produce a consistent stream of fat cattle for sale.

It was not possible to just purchase a core breeding herd with the genetic combination of XXXX Angus and XXXX due to their lack of availability. Additionally, for cattle tick resistance, it is most important that cattle are brought up in an area that they are exposed to cattle ticks from birth to develop a natural resistance.

The business experienced a severe drought that occurred in the 20XX, 20XX and 20XX calendar years resulting in reducing the number of livestock carried on the property.

You stated that the lead time to achieve your partnership business' objective of having a core breeding herd of XXX XXXX Angus cross XXXX breeders is between X and XX years.

Currently the partnership has a core breeding herd of XXX cows and you expect the partnership business would produce a tax profit in the 20XX financial year.

Your income for non-commercial loss purposes in the 20XX financial year was above $XXX.

You have requested the Commissioner to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to offset your share of the partnership loss against your other income for the 20XX to 20XX financial years on the basis of lead time.

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)(c)

Reasons for decision

The general rule in subsection 35-10(2) of Division 35 of the ITAA 1997 prevents losses from a non-commercial business activity carried out by an individual taxpayer (alone or in partnership) from being offset against other assessable income in the year in which the loss is incurred, unless:

•         the individual meets the income requirement and the business activity satisfies one of the 4 stipulated tests (paragraph 35-10(1)(a));

• an exception in subsection 35-10(4) applies; or
• the Commissioner exercises the discretion in subsection 35-55(1) for the business activity for one or more income years.

You have requested the Commissioner to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to offset your share of the partnership loss against your other income for the 20XX to 20XX financial years.

Under paragraph 35-55(1)(c) of the ITAA 1997, the Commissioner's discretion can be exercised where:

• the business activity has started to be carried on but because of its nature it has not produced, or will not produce, assessable income greater than the deduction attributable to it; and
• there is an objective expectation that within a period that is commercially viable for the industry concerned the activity will meet one of the tests or produce assessable income for an income year greater than the deductions attributable to it for that year.

The note to paragraph 35-55(1)(c) of the ITAA 1997 states that the particular paragraph 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.

Your partnership carries on a livestock feeding and breeding operation. It is accepted there are inherent features of the relevant industry that there is a lead time before any assessable income is produced.

However, in order to exercise the discretion, the Commissioner must be satisfied that there is an objective expectation, based on evidence from independent sources, that the relevant business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period for the industry concerned.

In any case, it should be noted that the commercially viable period for an activity is measured from the commencement of the business activity itself: Case 13/2011 2011 ATC 1-040 at [27]. A change to an aspect of that business activity which does not constitute a new discrete and distinct business activity, (see Taxation Ruling TR 2001/14), will not generally reset this commencement date.

In your submissions, you have stated that the partnership commenced a different or new livestock operation in the 20XX income year because of the improvements made to the partnership's livestock business activity, namely:

•         Improvements to land including water access, and increased land size to support larger herds.

•         Increasing the herd size through breeding and implementing a genetic improvement program to build up your own core breeding herd (due to the lack of availability of breeding cows with the genetic combination of XXXX Angus and XXXX and due to cattle ticks resistance reasons).

•         Improvement to cattle birthing: your changed breeding approach by using your existing herd of XXXX Angus cows but bringing in new Bulls to develop a genetically different herd that result in smaller calves and making calving easier.

•         Improvement to cattle profits because the XXXX Angus and XXXX cross cattle have good consumer demand.

•         Better profit projections as a result of the above improvements.

However, it is considered that the scaling up the size of production, the increasing the herd population, and the genetic improvement to the core breeding herd did not make your business activity a distinctly different business activity from what was being carried on before.

Division 35 of the ITAA 1997 applies to business activities and where activities are considered separate, the activity must be capable of standing alone as an autonomous commercial undertaking (paragraph 38 of TR 2001/14).

A cattle breeding business is about continuously improving and refining breeder herd management and genetic improvement plans using genetic and reproductive knowledge and technologies, to achieve desired production targets. The above improvements to your livestock operation in the 20XX financial year would reflect a natural evolution of a cattle breeding business activity and did not make your cattle breeding activity distinctly different enough to be a completely new and separate business activity for the purposes of Division 35 of the ITAA 1997.

In your case, the commencement of your partnership's cattle feeding and breeding was when the partnership started the livestock operation in around 20XX. Your acquisition of the third property and the improvements implemented to your business operation in the 20XX financial year did not constitute a new discrete and distinct business activity from the activity commenced before that.

You have advised that your livestock business operation will be profitable in the 20XX financial year which will be XX years after the original activity commenced. Therefore, even if we accepted that the commercially viable period for your industry is between X and XX years, which we do not, that period would have expired years prior to the period for which you are requesting the Commissioner's discretion.

Therefore, the Commissioner is unable to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include your share of any losses from your primary production partnership in calculating your taxable income for the 20XX to 20XX financial years.

Accordingly, the rule in subsection 35-10(2) of the ITAA 1997 applies to defer your share of the partnership business losses in these years. Where you cannot offset your share of your partnership business loss against your other income in a financial year, your loss is simply deferred and will be deductible against any tax profit from the activity, or similar business activity, in future years.