Edited version of private advice

Authorisation Number: 1052215968222

Date of advice: 1 February 2024

Ruling

Subject: Non-commercial losses - special circumstances

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your primary industry business in the calculation of your taxable income for the relevant year?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20YY

Year ending 30 June 20YY

Year ending 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

You commenced your primary production industry activity in a previous financial year. You are building your stock on a gently sloping block in moderately steep country that is suitable for the primary production industry in which you are operating.

You selected 5 stock varieties that are adapted to the climate and growing conditions. You began by raising these 5 varieties of your stock that are known for their marketable produce expecting to be able to sell that produce within the commercially viable period for that industry. You believed that you would make a profit on those sales and that those profits would increase as your stock matured. You also hoped to increase your stock in that period.

You have learnt how to care for, harvest, and market the produce you are hoping to sell through many years of experience in the industry, specifically as a sales manager for a large industry producer and exporter.

Your stock did grow as expected but were inundated in three successive flood events that washed most of your crop away into the floodwaters. The soil of your land remained waterlogged after the flood event and this waterlogged soil engendered fungal disease in the remaining stock. You have photographs showing the floodwaters on your land while the rain was falling and also the runoff through your fields after the rain had stopped. Your land is not on a flood plain and has not previously been known to flood.

The flood events occurred in 3 rain events over a 5-month period. As much rain as the annual rainfall for your location fell over a 48-hour period as a cyclone passed through in the first rain event., with severe impacts to the roads, agricultural areas, and rural townships. Flood waters in local rivers reached record levels in the second event, and further flooding occurred in the third event. This rain was widespread throughout the catchment area you are operating in.

You cleared the dead stock that remained after the floods, removed rubbish from the fields, prepared the ground for restocking, repaired your irrigation system, and started restocking in the relevant year.

Having learnt from your experience growing this stock prior to the flood events you adjusted the selection and proportions of the stock you are raising as you restocked. You commenced restocking with 1,200 units of varieties you knew would do well in your conditions, and are hoping to bring in another 700 units in the appropriate season in the following financial year.

While you will now have no income from your stock for the relevant financial year or the 2 financial years following that you are hoping to sell produce within the commercially viable period for your industry. You have supplied your expected income and expenses for this period and believe you will be able to consistently make a profit from the year following this period.

The Commissioner has previously exercised his discretion under section 35-55(1)(b) of the ITAA 1997 and allowed you to claim your losses from commencement of your activity up until the relevant financial year. This discretion was granted because the crop you are raising take at least 3 years to become productive and your activity would not have been commercially viable until the relevant financial year.

Your annual income from other sources is less than $250,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 paragraph 35-10(1)(a)

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

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

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

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

Reasons for decision

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your primary industry business in the calculation of your taxable income for the relevant years?

Summary

Having considered your circumstances and the relevant factors the Commissioner will exercise his discretion to allow you to claim your losses in the year they occur for the relevant financial year and the following financial years that are within the commercially viable period for your industry.

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));

o   the assessable income test

o   the profits test

o   the real property test

o   the other assets test; or

•         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.

The exception in subsection 35-10(4) of the ITAA 1997 applies to primary production businesses or professional arts businesses when assessable income for the year (except any net capital gain) from other sources not related to the business activity is less than $40,000.

Taxation Ruling TR 2007/6 Income Tax: non-commercial business losses: Commissioner's Discretion sets out the Commissioner's interpretation of the exercise of the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997. The Commissioner may, under this provision of the act, exercise his discretion to allow a business to claim their losses in the year that they occur if they would have met one of the 4 tests or made a profit if it had not been for special circumstances. Special circumstances are circumstances beyond the control of the business activity that would not normally occur in the course of conducting a business activity. Examples of these special circumstances are not limited to natural disasters but include drought, flood, bushfire, or some other natural disaster.

The Commissioner may also exercise his discretion under paragraph 35-55(1)(b) for taxpayers who have commenced business activities which by their nature require a number of years to produce assessable income. This can be applied for those activities for which there is a recognised period before they will produce a profit or pass one of the tests. For this discretion to be exercised there must be an objective expectation that the activity will make a profit within the period recognised as necessary for commercial viability.

The Commissioner has previously exercised his discretion under paragraph 35-55(1)(b) of the ITAA 1997 and allowed you to claim your losses from commencement of your activity up to the relevant financial year. It was considered the activity you are undertaking would require at least 3 years to achieve the expected commercially viable results.

You have now requested the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997 for your activity in the relevant financial year on the basis of special circumstances. The Commissioner may, under this provision of the act, exercise his discretion to allow a business to claim their losses in the year that they occur if that business would have satisfied one of the four tests in Division 35, or made a profit, had the special circumstances not occurred.

In cases where the special circumstances occur within a period that has been recognised as necessary to achieve viability within the industry it is operating in the criteria under which the discretion can be exercised on grounds of special circumstances will not include satisfaction of the 4 tests in Division 35. In these cases there must be evidence that the special circumstances have prevented this business from achieving viability within the period recognised for that industry. The number of years the Commissioner's discretion can be exercised in these circumstances will need to be determined on a case-by-case basis and will depend on evidence that the business in question will consistently satisfy one of the 4 tests or produce a profit within some later time.

You experienced 3 major flood events in the second half of the financial year in which you expected to achieve commercial viability, and these washed away most of your stock, leaving the remaining stock in waterlogged soil which caused fungal disease. The flood events occurred in 3 rain events over a 5-month period. As much rain as the annual rainfall for your location fell over a 48-hour period as a cyclone passed through in the first rain event., with severe impacts to the roads, agricultural areas, and rural townships. Flood waters in local rivers reached record levels in the second event, and further flooding occurred in the third event. This rain was widespread throughout the catchment area you are operating in.

The floods you experienced in that financial year were beyond your control and are within the meaning of the special circumstances listed in paragraph 35-55(1)(a) of the ITAA 1997. These special circumstances prevented you from achieving commercial viability within the period for which the Commissioner's discretion had been granted for your primary production activity.

You have provided evidence that you will make a profit within a commercially viable period with this activity as the new stock you have brought in following the floods reaches maturity and becomes productive. You have also provided evidence that these profits will continue consistently over a number of years. This will be within a period equivalent to the discretion already granted to you to claim your losses in the year they occurred on the grounds of the nature of your activity. In this case the Commissioner will exercise his discretion under paragraph 35-55(1)(a) to allow you to continue to claim losses in the year they occur for the relevant financial year and the following financial years that are within this commercially viable period.