Edited version of private advice

Authorisation Number: 1052227596672

Date of advice: 7 March 2024

Ruling

Subject: Non-commercial losses discretion - special circumstances

Question

Will the Commissioner exercise the discretion in section 35-55 of the Income Tax Assessment Act 1997 to allow you to include any losses from your primary production business activities in the calculation of your taxable income for the 20XX-XX to 20XX-XX income years?

Answer

Yes

This ruling applies for the following periods:

Income year ending 30 June 20XX

Income year ending 30 June 20XX

The scheme commenced on:

1 March 20YY

Relevant facts and circumstances

You and another individual carry on a primary production business as partners in a partnership (the Business).

The Business operates on properties at:

•         Property A, and

•         Property B.

The properties were subject to three major floods over the past three years.

Due to the floods, the costs of feed and fodder increased, the business incurred additional costs repairing and replacing equipment and fences, and the business had to sell stock at a low price. These factors meant that the Net profit from stock sales was low.

You provided a profit and loss statement for the 20XX-XX income year and a projected income statement for the 20XX-XX and 20XX-XX income years.

Relevant legislative provisions

Income Tax Assessment Act 1997

•         Division 35

•         subsection 35-10(2)

•         subsection 35-10(2E)

•         subsection 35-10(4)

•         section 35-30

•         section 35-35

•         section 35-40

•         section 35-45

•         section 35-55

•         subsection 35-55(1)

•         paragraph 35-55(1)(a)

Reasons for decision

Division 35 of the ITAA 1997 applies to losses from non-commercial business activities carried on by individuals, including an individual carrying on business in a partnership). Under the rule in subsection 35-10(2) (the loss deferral rule), a loss made by an individual from a business activity is deferred unless:

the sum of the amounts listed in subsection 35-10(2E) is less than $250,000 (the income requirement) and the business activity satisfies one of the following four tests:

•         the 'assessable income test' (section 35-30), which requires that the assessable income generated from the activity must be at least $20,000

•         the 'profits test' (section 35-35), which requires that the activity has produced a profit in three of the last five income years

•         the 'real property test' (section 35-40), which requires that the reduced cost base value of real property or interests in real property used on a continuing basis to carry out the activity is at least $500,000, and

•         the 'other assets test' (section 35-45), which requires that the reduced cost base of other assets used on a continuing basis to carry on the activity is at least $100,000;

•         the exception in subsection 35-10(4) (the exception) applies to you; or

•         the Commissioner exercises the discretion in subsection 35-55(1).

You have advised that you did not, and will not, satisfy the income requirement or qualify for the exception in either of the 20XX-XX or 20XX-XX income years in respect of your primary production business activities.

Therefore, losses made by you in the 20XX-XX and 20XX-XX income years from your business activities will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997, unless the Commissioner exercises the discretion under section 35-55.

Commissioner's discretion

Under subsection 35-55(1) of the ITAA 1997, the Commissioner may decide that the rule in subsection 35-10(2) does not apply to a business activity if satisfied that applying the rule would be unreasonable. Under paragraph 35-55(1)(a), this discretion may be exercised where, in the relevant years, the business activity was or will be affected by special circumstances outside the control of the operators of the business activity.

Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion provides guidelines on how the discretion in subsection 35-55(1) may be exercised.

Special circumstances

TR 2007/6 explains that 'special circumstances' are circumstances that are sufficiently different to distinguish them from circumstances that occur in the normal course of conducting a business activity (paragraph 13). Special circumstances are those that have materially affected the business activity, causing it to make a loss (paragraph 13A).

Paragraph 35-55(1)(a) of the ITAA 1997 specifically includes drought, flood, bushfire, or some other natural disaster' as relevant special circumstances.

For individuals who do not satisfy the income requirement, the Commissioner's discretion in paragraph 35-55(1)(a) may be exercised for the income years in question where:

•      but for the special circumstances, the business activity would have made a tax profit; and

•      the activity passes at least one of the four tests or, but for the special circumstances, would have passed at least one of the four tests (TR 2007/6, paragraph 13A).

The four tests are used to determine whether a business activity may be treated as commercial in nature for tax law purposes (paragraph 2.17 of the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009).

Many industries, however, have developed, and commonly use, practices to prevent or reduce the effects of certain circumstances, such as pest and disease prevention, fire mitigation, or drought proofing practices. The operators of a business activity failing to adopt commonly used practices to prevent or reduce the effects of these circumstances, for no adequate reason, may indicate that a loss was not outside the operators' control (TR 2007/6, paragraph 14).

The discretion can be exercised in income years after the one in which the special circumstances occurred if the effects of those special circumstances continue to prevent the business activity from satisfying any of the tests in those later income years. However, there may be situations where the special circumstances, because of their continued existence, become the ordinary or usual situation. It would not be appropriate to exercise the discretion once this occurs (TR 2007/6, paragraph 15).

In your circumstances, it is accepted that the floods significantly affected your business activities. Nevertheless, you have satisfied three of the four tests of commerciality set out for the purpose of Division 35 of the ITAA 1997 in respect of the 20XX-XX income year and expect to pass the same tests in respect of the 20XX-XX income year.

'Flood' is specifically identified as 'special circumstance' in paragraph 35-55(1)(a) of the ITAA 1997 for the purpose of the discretion. Although the floods, in your circumstances, occurred in three separate weather events, it is not considered that these weather conditions have become the usual situation or could be expected. They were outside your control. It is considered that, but for the floods, the business activity would have made a tax profit in the 20XX-XX income year and would make a tax profit in the 20XX-XX income year.

Therefore, the Commissioner will exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 for each of the 20XX-XX and 20XX-XX income years and subsection 35-10(2) will not apply to defer any tax losses from your business activity in those years.