Edited version of private advice

Authorisation Number: 1052137668072

Date of advice: 16 October 2023

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 Mr A (the Taxpayer) to include non-commercial losses from his business activity in the calculation of his taxable income for the income years ended 30 June 20XX to 30 June 20XX (Excluded Years)?

Answer

Yes.

This ruling applies for the following periods:

Income years ended 30 June 20XX and 30 June 20XX

Income years ending 30 June 20XX and 30 June 20XX

Relevant facts and circumstances

1.    The Taxpayer is a sole trader (trading as X), operating a primary production business (the Business).

2.    The Business name was registered in Month 20XX.

3.    As of April 20XX, the Business leases 2 properties, Property 1 and Property 2.

4.    Property 1 is leased to the Taxpayer by Company A. The Taxpayer is the sole director of Company A and the sole shareholder is Company B. The Taxpayer is the sole director and shareholder of Company B.

5.    Property 2 is leased to the Taxpayer by an unrelated entity. The Taxpayer is in discussion with the owner of Property 2 in relation to the purchase of this parcel of land.

6.    The Taxpayer has conducted improvement work on the leased lands, which includes establishing an increased and improved water source for the cattle and fertilisation of the lands to improve pasture growth.

7.    The current leased lands are capable of running XX cows and a calf unit. The Taxpayer intends to lease additional neighbouring land during 20XX.

8.    The Taxpayer purchased cattle in April 20XX.

9.    As at July 20XX the herd number of the Business was made up of XX cows in calf, XX weaner heifers and XX weaner steers.

10.  The Business intends to increase herd numbers by natural growth, retaining heifer calves until a herd of 100-150 breeding cattle has been established.

11.  Once the desired herd number is established, the Business intends to sell one weaner per breeding cow per year.

12.  The Business requires approximately 25 hours of work a week, which increases to approximately 35 hours per week during August and September. The labour for the majority of this work is performed by the Taxpayer, with the assistance of his 2 children.

13.  According to the Profit and Loss projections provided, the Business is not expected to produce a profit until the income year ended 30 June 20XX.

14.  The Taxpayer has advised that the lead time to rear a calf to grow to a saleable size (generally 450 kilograms) takes around 12 to 14 months.

15.  The Taxpayer has projected income based on cattle sold at an average of $4.50 per kilogram.

16.  Between the income years ending 30 June 20XX to 30 June 20XX, the sale of cattle is projected to continue to increase as the herd numbers increase.

17.  Cattle will be sold via the XXXXX Livestock Exchange.

18.  The Taxpayer holds formal qualifications and relevant exposure to agricultural and farming activities.

19.  The Taxpayer did not satisfy the income requirement for the income year ended 30 June 20XX as set out under subsection 35-10(2E) of the ITAA 1997.

Assumptions

1.    The exception in subsection 35-10(4) of the ITAA 1997 does not apply in relation to the Taxpayer in respect of the Excluded Years.

2.    The Taxpayer will not satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 in respect of the Excluded Years.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 82KZM

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 subsection 35-10(1)

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

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

Income Tax Assessment Act 1997 subsection 35-10(4)

Income Tax Assessment Act 1997 section 35-30

Income Tax Assessment Act 1997 section 35-35

Income Tax Assessment Act 1997 section 35-40

Income Tax Assessment Act 1997 section 35-45

Income Tax Assessment Act 1997 section 35-55

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

Income Tax Assessment Act 1997 subparagraph35-55(1)(c)(ii)

Reasons for decision

All subsequent legislative references are to the ITAA 1997.

Summary

The Commissioner will exercise the discretion in paragraph 35-55(1)(c) for the Excluded Years.

Detailed reasoning

Division 35 operates to prevent losses from non-commercial business activities carried on by individuals operating alone or in partnership from being offset against other assessable income.

Subsection 35-10(2) is an integrity measure that has the effect of deferring amounts attributable to the business activity that exceeds its assessable income for the relevant income year as deductions as though the excess amount:

•         was not incurred in that income year; and

•         was an amount attributable to the business activity that is an allowable deduction for the next income year in which the activity is carried on.

Notwithstanding, subsection 35-10(2) will not be triggered if the business activity satisfies any of the conditions set out in subsection 35-10(1). That is:

•         the taxpayer's income for non-commercial loss purposes (as per subsection 35-10(2E)) is less than $250,000 and one of the 4 tests in sections 35-30, 35-35, 35-40 and 35-45 is met (assessable income test; profits test; real property test; and other assets test);

•         the Commissioner has exercised the discretion under section 35-55 for the business activity for the year; or

•         the exception in subsection 35-10(4) applies for the year.

In the context of taxpayers who do not satisfy the income requirement under subsection 35-10(2E) (that is, because their income for non-commercial loss purposes is $250,000 or more) for the most recent income year ending before the application is made, pursuant to paragraph 35-55(1)(c) the Commissioner may, on application, decide that the deferral rule in subsection 35-10(2) does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that:

•         it is because of its nature that the business activity of the taxpayer has not produced, or will not produce, assessable income greater than the deductions attributable to it; and

•         there is an objective expectation that within a period that is commercially viable for the industry concerned, the activity will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsection 35-10(2)).

Paragraph 35-55(1)(c) 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.

In respect of the objective test (referred to in subparagraph 35-55(1)(c)(ii)), the applicant must discharge the onus of proof that the business activity will produce a tax profit within the timeframe customary to the industry in which it operates. For example, an individual may provide independent resources from industry peak bodies in relation to the cattle market throughout Australia.

The Business involves a beef cattle farm and the Taxpayer submits that there is a lead time for rearing weaners (between 12 to 14 months) before they can be sold at optimum weight of 450 kilograms. This is consistent with independent resources regarding the desired sale weight of beef cattle. Additionally, the Taxpayer has stated that the lead time for breeding heifers may take up to 15 months which is ordinarily accepted in the cattle farming industry.

Taking into account various factors such as the number of cattle sold each year, increase in herd numbers, operational expenses, expansion of farmland and inclusion of technology such as artificial insemination to increase the cattle's genetic profile, the Taxpayer has projected a profit to first be made in the income year ending 30 June 20XX with foreshadowed sales increase thereafter.

The lead time between the activity commencing and the production of the assessable income is in keeping with the objective evidence considered in beef cattle rearing cases of Re Applicant v FCT [2011] 85 ATR 612 and Re Hefner v FCT (2013) 95 ATR 130, being 5 to 6 years.

The Taxpayer has established that the Business' inability to produce a profit is due to its inherent characteristics that require lead time before it can be reasonably expected to produce profit and that there is an objective expectation that the Business will start producing a profit within a commercially viable period that is common to other business activities of the same type.

The Commissioner will exercise the discretion under paragraph 35-55(1)(c) for the Taxpayer in respect of the Excluded Years and the Taxpayer will be able to offset the losses from the Business in those years against other assessable income.