Edited version of private advice

Authorisation Number: 1052065689958

Date of advice: 2 February 2023

Ruling

Subject: Tax losses - non-commercial losses

Question

Will the Commissioner exercise his discretion under paragraph 35-55(1)(c)?

Answer

Yes.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.     Mr X owns a cattle grazing farming primary production business located in X.

2.     The business operates a beef breeding and fattening business.

3.     Mr X runs the farm in partnership with X.

4.     The X Ha farm was purchased in 20XX, the business only operated for X months of the 20XX income year. In those X months, Mr X bought X head of cattle.

5.     The farm currently holds X head of cattle. The herd will be expanded through purchases and natural increase.

6.     Independent guidance estimates the lead time for raising/fattening cattle is 2-3 years.

7.     Capital improvements in the form of fencing and cattle yards are required to carry a "commercial herd".

8.     The farm will have the capacity to hold X head of cattle when fully fenced.

9.     The expected time to fence the property is 18 months.

10.  Fencing has been delayed due to limited availability of staff in the rural community and the scarcity of contractors available being further impacted by COVID-19, which is expected to impact the business operations and the lead time to profitability of the farming operations.

11.  Projections provided by Mr X:

•         a tax loss for both the income year ending 30 June 20XX and 30 June 20XX

•         the first year of producing taxable profits is projected to be 30 June 20XX

12.  Mr X's income exceeded $250,000 for the years ended 30 June 20XX, 20XX, and 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 35-10

Income Tax Assessment Act 1997 35-10(2)

Income Tax Assessment Act 1997 35-10(2E)

Income Tax Assessment Act 1997 35-55(1)(a)

Income Tax Assessment Act 1997 35-55(1)(b)

Income Tax Assessment Act 1997 35-55(1)(c)

Reasons for decision

13.  Division 35 operates to limit the ability to offset non-commercial losses against other assessable income. It also prevents certain pre-business and post-business capital expenditure from being deductible as business related costs under section 40-880.

14.  Under subsection 35-10(2), if deductions for a non-commercial business activity exceeds the assessable income (if any) from the business activity for that year, the excess cannot be deducted in the same income year that they were incurred. This excess will be treated as deductible from the non-commercial business activity's assessable income from the next income year.

15.  If the taxpayer makes losses, they will be deferred and offset against the assessable income of the noncommercial business activity in the next income year. If losses are made in the following income years, the amount of the outstanding losses are added together and deferred to a future year in which the business activity makes profits.

16.  There are situations where the Commissioner can exercise discretion to allow non-commercial losses to be offset against other income for one or more income years (the excluded years). Under subsection 3555(1)(a), this can occur where there is a special circumstance outside the control of the taxpayer that affects the business activity, or where the nature of the business requires a lead time to give rise to a profit.

17.  These lead time discretions are separated into 2 situations. Section 35-55(1)(b) allows discretion where the taxpayer:

•         earns under $250,000, and

•         would have been able to satisfy one of the statutory tests or produce assessable income within a period that is commercially viable for the industry concerned if not for the lead time.

18.  Section 35-55(1)(c) allows discretion where the taxpayer:

•         earns over $250,000,

•         The business activity has started to be carried on,

•         the business activity has not produced a tax profit in the excluded years, and

•         there is an objective expectation that the business activity will make a tax profit within a period that is commercially viable for the industry concerned.

19.  TR 2007/6 ... in discussing and 'objective expectation' states at paras 84-87:

•         The Commissioner needs to be satisfied that there is an objective expectation that the business activity will satisfy a test or produce a tax profit in some future income year falling within a period that is commercially viable for the industry concerned. If the business activity is not expected to satisfy a test or produce a tax profit within this period then the discretion will not be exercised.

•         The objective expectation does not have to be held by, or attributed to, a particular person. The Commissioner need only be satisfied that, based on the available supporting material, an objective expectation exists

•         Whether the required objective expectation exists can be affected by decisions about how a particular activity is operated. For example, the extent of debt finance used (and as a result the level of allowable deductions for interest attributable to the business activity) can affect the time within which the activity can produce a tax profit or satisfy the Profits test.

•         The objective expectation about future performance of the business activity must exist for each particular year and as such may change from year to year.

20.  TR 2007/6 further states, in respect to evidence to support the objective expectation, at para's 103 and 104:

•         For each income year in respect of which the operator of the business seeks the exercise of the discretion, the operator must establish that there is an objective expectation that the activity will satisfy one of the tests or produce a tax profit and that this will occur within a period that is commercially viable for the industry concerned. This expectation must be based on evidence from independent sources, where it is available. This is not limited to just the predictive model type of material but can also include relevant historical evidence of how the industry in question has performed in the recent past.

•         In order to demonstrate that the objective expectation exists, a business operator should produce evidence showing that the business activity will satisfy one of the tests or produce a tax profit, showing the period within which a commercially viable business would do so. Preferably, this evidence will be documented at the time, and the evidence that the business activity will satisfy one of the tests or produce a tax profit within a certain time will be consistent with evidence from independent sources relating to activities of that type. Appropriate independent sources include industry bodies or relevant professional associations, government agencies, or other taxpayers conducting successful comparable businesses.

Application to your circumstances

The excluded years

21.  The discretion is sought in relation to the business activity for the 20XX and 20XX income years. Therefore, references to the excluded years will mean 20XX and 20XX income years.

Income threshold

22.  As Mr X earned over $250,000 for the 20XX and 20XX income years, section 35-55(1)(c) will have application to the circumstances in this case.

The business activity has started to be carried on

23.  Mr X stated that the business started in 20XX.

24.  In the X months remaining of the 20XX income year, Mr X bought X head of cattle.

25.  Over the 20XX income year the projections provided show a series of natural increases and purchases.

26.  The projections also provide a list of expenses incurred by Mr X. The nature of the expenses indicates the running of a farm.

27.  Therefore, the business activity had started to be carried on.

The business activity has not produced a tax profit in the excluded years due to its nature

28.  The business activity started in the final 3 months of the 20XX income year. According to the provided income statement for the income year ending 30 June 20XX, the business activity did not make a profit, and in fact made losses amounting to $X.

29.  The projections provide that there will not be any profits made for the 20XX income year, and that the total expenses will amount to $X.

30.  Broadly, for the type of industry and activity undertaken, a positive cash flow would generally be expected in the second year of operation, although normally a 2-3-year lead time is likely in rearing cattle according to independent sources.

31.  Therefore, there are no profits in the excluded years and nothing that suggests that the business's lack of profit was for a reason other than its nature.

An objective expectation that the business activity will make a tax profit within a period that is commercially viable for the industry concerned

32.  Under section 35-55(1)(c), an objective expectation can be formed based on evidence from independent sources where available.

33.  Mr X's operation has been operating for X year(s) and X month(s) at the time of examination. As outlined in paragraph 30, this is within the expected lead time for a cattle rearing business.

34.  According to the projections provided by Mr X, a tax profit of $X is expected in the 20XX income year, and $X for the 20XX income year.

35.  The activities undertaken by the operations are consistent with a genuine commercial activity and the circumstances resulting in the longer lead time to profitability are not a consequence of the operator's actions or inactions. The financial projections are calculated in a transparent and considered manner and are inclusive of key aspects of bringing a farm to profitability and subsequently running a farm. When viewed in conjunction with typical industry lead times it is expected that a tax profit could be achieved within the timeframes set out in Mr X's projections.

Conclusion

36.  The Commissioner will exercise his discretion under paragraph 35-5(1)(c).