Edited version of private advice

Authorisation Number: 1052201603256

Date of advice: 12 January 2024

Ruling

Subject: Non-commercial loss discretion - lead time - greater than $250K

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 activity in your calculation of taxable income for the 20YY-YY to 20YY-YY financial years?

Answer

No

This private ruling applies for the following periods:

1 July 20YY to 30 June 20YY

The scheme commenced after:

1 July 20YY

Relevant facts and circumstances

You do not satisfy the less than $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You carry on a primary production activity. A primary production business was also carried on at this same property for many years. You acquired the property through a deceased estate of a close family member and purchased a number of livestock from the estate.

There is no Business Plan. You are planning to run a number of breeding stock, which will generate income. A Profit and Loss Statement was provided.

You work a number of hours on both farm activities and other employment. You have been improving the farm over a couple of years, so it can run better and increase stock and make profits, so you can reduce your other employment. You have no employees and will use contractors for certain work.

The livestock sale yards are a number of kilometres from the farm gate, you transport livestock yourself or ask your agent for assistance.

You stated that a profit was not made in the ruling period due to:

•                     the nature of building up livestock numbers and improved blood-lines for the herd

•                     the land was in a rundown condition

•                     improvements such as fencing, machinery, pastures and infrastructure needed to be made to the farm to allow for increased carrying capacity.

You received no income in the in the 20YY-YY and 20YY-YY financial years. Your greatest expenses in those financial years were for the immediate write-off of equipment, repairs and maintenance, and fuel and oil. You purchased farm machinery.

You expect the livestock activity to make a tax profit again in the 20YY-YY financial year. You have made a loss each year since taking over the activity.

Relevant legislative provisions

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 paragraph 35-55(1)(c)

Reasons for decision

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 activity in your calculation of taxable income for the 20YY-YY to 20YY-YY financial years?

Summary

Having regard to your full circumstances, it is considered that the commercially viable period for your activity has expired. Therefore, the Commissioner will not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the 20YY-YY to 20YY-YY financial years.

Detailed reasoning

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.

In your situation, you do not satisfy the income requirement and you do not come under any of the exceptions. Your losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

You have requested the Commissioner to exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 for the 20YY-YY to 20YY-YY financial years.

Paragraph 35-55(1)(c) of the ITAA 1997 provides that 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 produce assessable income for an income year greater than the deductions attributable to it for that year.

This discretion 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. The commercially viable period for an activity is measured from the commencement of the business activity itself.

The Commissioner's approach to exercising the discretion under section 35-55 of the ITAA 1997 is outlined in Taxation Ruling TR 2007/6 Income Tax: non-commercial losses: Commissioner's discretion. TR 2007/6 states that the lead time discretion provided by paragraph 35-55(1)(c) of the ITAA 1997 is available for a business activity if there is an initial period from when the activity commenced where the nature of the activity prevents a tax profit from being made.

The lead time discretion is not available once a business activity has made a tax profit. This is because it is then clear that there is nothing inherent in the nature of the business activity that prevents a tax profit from being made. The only exception to this is where a business activity makes a tax profit on a one-off basis during the initial lead time period. For example, a forestry operation may have a lead time of 20 years before harvesting its trees but may make a one-off tax profit in an earlier year due to a thinning operation. In that case, the one-off tax profit would not affect the lead time period.

The inherent characteristics may be present for an initial period from the time your business activity commences. After that initial period has elapsed, which can be several years, the inherent characteristics may cease to be the cause of those business activities being unable to satisfy any of the tests or produce a tax profit.

You carry on a primary production 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, (paragraph 41 of Taxation Ruling 2001/14 Income tax: Division 35 - non-commercial business losses), will not generally reset this commencement date.

An activity that forms part of a taxpayer's overall business will not be treated as a separate business activity for Division 35 purposes unless it is 'capable of standing alone as an autonomous commercial undertaking' (paragraph 38 of TR 2001/14).

In your submissions, you have stated that you commenced a different or new livestock operation in the 2021-22 to 2023-24 financial income years because of the improvements made to livestock activity, namely:

•                     increasing the herd size through breeding and implementing a genetic improvement program to build up your own core breeding herd

•                     improve the land and pastures as they were in a rundown condition

•                     undertake additional Improvements such as fencing, machinery, and infrastructure.

You took over the operations of a primary production activity that had already been operating. There must be sufficient difference between this activity and the one you started to have commenced for it to be regarded as a new activity.

Business expansion

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

Poorly run business

'The acquisition of a poorly run but promising business activity would generally be considered to be within the control of the business operator' (paragraph 58 of TR 2007/6). As such it would not, by itself, constitute the need for additional lead time that had already been afforded to the previous business activity and the commercially viable period had expired, even though the actions of the former operator may have been outside the control of the current operator.

Taxation Ruling TR 2001/14 paragraph 45 outlines the factors to assist in determining if business activities are separate, these factors are not meant to be a checklist and that each factor should be given equal weighting.

Location

It is established that both the previous primary production business and your primary production activities operate at the same location.

Asset used

The new activity has invested in repairing or improving previous assets used such as the pastures, fences and other infrastructure. You are also using some of the same livestock from the original operation with the intention to keep some for breeding.

Type of goods or services produced

These business activities are governed by domestic and world market conditions for livestock produce, required to meet market specific standards and work under the same government and regulatory standards and guidelines.

Both activities are primary production breeding. You are refining the herd to achieve desired production outcomes. The market condition in which those goods are traded are the same.

Inter-dependency

You have had an association with the previous primary production activity for a number of years and you have extensive knowledge of livestock farming on the property, local market and climatic conditions. You have taken over the livestock activity at the existing location. There is interdependency between the farming operations.

Commercial links

The previous primary production activity undertaken has been profitable in past years and supports the present livestock activities, for example supplying livestock for present activity.

Prior to your acquisition of the farm, the same primary production activities had already commenced. Your current activities at the same property are similar to the previous activity operated on the farm, such that it would be considered your activity to be a continuation of the previous activity. This activity does not constitute a new discrete and distinct activity from the activity commenced before that.

The improvements, growth and expansion to your primary production operations, including increasing the herd population and the genetic improvement to the core breeding herd, do not make your activity a distinctly different activity from what was being carried on before and is a natural evolution that occurs across all similar primary production businesses.

A commercially viable lead time has already been afforded to the previous business a number of years ago. The inherent characteristics of livestock farming have ceased to be the cause of those activities being unable to satisfy any of the tests or produce a tax profit, as the commercially viable period for the industry has been surpassed.

The fact that the previous primary production business existed and made tax a tax profit in previous years shows that the initial lead time period required for it to make a tax profit has expired. The tax profits from that business were not one-offs that fall within the exception discussed above.

The Commissioner is unable to exercise the lead time discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include any losses from your livestock activity in your calculation of taxable income for the relevant financial years.