Edited version of private advice

Authorisation Number: 1052003340078

Date of advice: 21 July 2022

Ruling

Subject: Commissioner's discretion - non-commercial loss

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 primary production business in your calculation of 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

In a previous income year, you and your partner purchased a primary production property (the Business) with operational produce.

The previous owners took all their stock on hand and equipment.

Your intentions are to operate the business and sell to the general public in the near future.

Initially, you contracted all the work as you had no equipment and was not up to your satisfaction. Produce was unable to grow to its full potential during the relevant income year.

Over the past income years, you have been purchasing equipment to complete all the work yourselves.

You are currently waiting until Spring, to be able to plant vines and replace missing vines from some of the rows.

From the first income year harvest, you kept some produce for preparation for future years. This produce can take a while to age.

After the initial stage there is a secondary stage before sale to the relevant customers.

In the prior income year harvest, the excess produce were sold.

In the current harvest, you made approximately 3 times as much than the prior income year.

Your business plan sets out your goals.

As your property only produces certain produce, you will locally source other relevant produce.

Your income including taxable income, reportable fringe benefits, reportable super contributions and total net investment losses for non-commercial loss purposes for non-commercial loss purposes for the future income year is to be more than $XXX.

Your business activity will become commercially viable in the current and future income years.

You provided independent evidence from an industry specialist that advises the following:

             •           your business activity will become commercially viable in a future income year,

             •           in the 20XX and 20XX income years, the average rainfall between September 20XX to April 20XX was XXX mm. Resulting in an approximate increase of XXX mm compared to the average of the same period in prior years,

             •           the weather events from September 20XX to April 20XX had a detrimental effect on yields and overall cost of production. The weather conditions in October created a perfect situation for a primary event and multiple secondary events across the entire growing season. The rainfall pressure was intense which prevented access to the property which also restricted the prevention and control options from being applied.

             •           The event has the most detrimental effect on yield at flowering, flowering generally occurs on your property from middle of November into December, while vines are flowering the event has the potential to take out whole just forming bunches.

             •           rainfall across the growing period had a significant effect on canopy functionality and production. Yields were very low due to the high pressure of the event across the whole growing season.

             •           the event is not isolated to your property or region. It was widespread and includes other parts of Australia. The industry as a whole had significantly lower total production due to the increased events.

             •           this event has been outside the averages and the drought periods across 20XX and 20XX and added significant cost to overall production.

The event is a disease in produce. The disease is spread by rain events and wind. It is more prevalent in warm wet weather.

The event is an established disease that has 2 stages:

             •           Stage 1 occurs when the temperature drops and it rains during a 24 hour period.

             •           Stage 2 occurs when the humidity is high and the temperature remains colder. The disease spreads rapidly during this time.

Protective chemical programs can reduce the chance of the event from stages, however due to excess heavy rainfall, the effectiveness is reduced and adds significant cost to the overall cost of production.

The spores relating to this disease have the ability to survive 3 to 5 years in the soil.

Prior to acquisition, the location was subject to drought.

You do not satisfy any of the four tests under section 35-40 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 35-55

Reasons for decision

Summary

Yes, the Commissioner will not exercise the discretion to allow you to include any losses from your primary production business for the relevant income year.

Detailed reasoning

To claim a loss or apply for the Commissioner's discretion to allow the loss to be claimed, your activity must be in business.

In addition, it is normally required that you have commenced the business activity. Broadly, business is considered commenced if all the following three indicators are met:

•         decided to commence the business activity,

•         acquired the minimum commercial level of business assets to allow that business activity to be carried on,

•         actually commenced business operations.

If your loss making business is in primary production, and your assessable income from another source is less than $40,000 (excluding any net capital gain), you can offset your losses from your other income.

You must satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 to be eligible to offset your losses in the current year. If you do not satisfy the income requirement you must defer the loss or you can apply for the Commissioner's discretion in limited circumstances.

Subsection 35-10(2E) of the ITAA 1997 states you satisfy the income requirement if your income including taxable income, reportable fringe benefits, reportable super contributions and total net investment losses for non-commercial loss purposes is less than $250,000.

If you meet the income requirement, you must satisfy one of the four tests. If you pass, you can offset the loss in the year in question.

If you do not meet the income requirement or any of the four tests you can apply for Commissioner's discretion under section 35-10 of the ITAA 1997 to allow the claim. The Commissioner will only exercise the discretion in limited circumstances if:

•         there are special circumstances outside your control that have prevented you passing one of the four tests, or,

•         because the nature of the business, there is a lead time period before your business can pass one of the four tests or make a profit.

If there are no grounds for the Commissioner to exercise the discretion, the loss must be deferred for that income year.

Four Tests

The four tests are:

•         assessable income test (section 35-30 of the ITAA 1997),

•         profits test (section 35-35 of the ITAA 1997),

•         real property test (section 35-40 of the ITAA 1997),

•         other assets test (section 35-45 of the ITAA 1997).

Commissioner's discretion

If you do not pass one of the four tests, the Commissioner may exercise discretion under section 35-55 of the ITAA 1997 to allow you to offset your loss if:

•         the business activity was or will be affected in the excluded years by special circumstances outside the control of the operators of the business activity under 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 under paragraph 35-55(1)(b) of the ITAA 1997.

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

Paragraph 14 of Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: states 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 disaster. 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,

•                           delays in ploughing, planting, harvesting etc,

•                           delay in growth of crops,

•                           inability of operator to perform duties,

•                           loss of business opportunities."

Lead time

For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is not making a profit is inherent to the nature of the business and is not peculiar to your situation.

The note to paragraph (b) of subsection 35-55(1) of the ITAA 1997 does not support the view that the discretion should be exercised for any start-up activity that is unable to produce a profit because of the small scale on which it was started, or because a client base is being built up but rather for those business activities that have a lead time between the commencement of the activity and the production of assessable income.

The Commissioner must be satisfied there is an objective expectation, based on evidence from independent sources, that your business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period (paragraph 35-55(1)(c) of the ITAA 1997).

Application to your circumstances

In your case, you purchased an operating business. You were aware of the status of the property before purchasing. In the first income year, you made the decision to commence the business activity, acquired the minimum commercial level of business assets to allow the business activity to be carried on and commenced business operations. Initially, you contracted the work and have since started to do the work yourself. From the first income year of operation, you kept 1 tonne of produce that are currently in storage for preparation and sold the excess to local businesses. Therefore, you satisfy the requirement that you are in business.

As your income for non-commercial loss purposes in the 20XX-XX income year is more than $XXX, you do not satisfy the income requirement and you also do not satisfy any of the four tests. Therefore, you are requesting the Commissioner's discretion to offset your business losses against your other income

Commissioner's discretion will be granted when the business activity was affected by circumstances outside your control or due to the nature of the activity, there is a lead time before the business can make a profit. You purchased the business, knowing the condition of the property. The business was capable of producing assessable income soon after acquisition therefore the requirement for lead time has not been met.

Your property was affected by an event. Due to an average increase of XXX mm of rain compared to the average in prior years, you had limited access to apply prevention and control options to the produce. The weather events from September 20XX to April 20XX had a detrimental effect on yield and total costs of production such as input costs increased. The October weather conditions saw an event which led to multiple secondary (more severe) events across the entire growing season.

The rainfall pressure was intense which prevented access to the property which also restricted the prevention and control options from being applied. The event has the most detrimental effect on yield at flowering. Flowering generally occurs from middle of November into December. Whilst flowering, the event has the potential to destroy the forming produce. Yields were very low due to the high pressure of the event across the whole season.

Although the event was not isolated to your business, it did result in a total production low. This event has been outside the averages and therefore, on this occasion, the Commissioner accepts that your business activity was affected by special circumstances outside your control.

Further it is accepted that without the special circumstances you would have made a tax profit or satisfied one of the four tests. Consequently, on this occasion, the Commissioner will exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 in the 20XX-XX income year.