Edited version of private advice

Authorisation Number: 1052239548893

Date of advice: 2 May 2024

Ruling

Subject: Non-commercial losses - lead time

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include the loss from your activity in the calculation of your taxable income for the 2022-23 financial year?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2023

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

You previously had a XXXXX business in rural Queensland. In this business you crossed breeds to sell cross XXX.

You purchased a share in property and ran XXX at that location and a breeding program. That property was later sold.

You have been registered as a sole trader previously and used the land you have now as well as another property for your activity. During this period your activity suffered losses.

The main property that your activity is located at, and your main residence is in State A. You also have access to additional land via agistment.

You commenced the activity in late 20XX, when you organised registrations and carried out preparations for the XXX to be on the property.

You have a business plan. You plan to increase the weight of the feedlot XXX and sell within 6 months of purchase for a profit. Your target market is local farmers, breeders and agricultural enthusiasts. You updated this plan to put the feedlot XXX in XX and sell as in XX or as XXX and XX depending on the best market sale price.

The business is XXX farming in two parts:

• breeding XXXX
• fattening XXXX.

You purchased some XXX in the 2022-23 financial year.

The fattening XXX have been chosen for the farm as the XXX have the ability while under stress/stressful conditions to fall pregnant and carry to term and still produce high quality XXX with high-ranking XXXX score. They grow rapidly and have outstanding feed converting ability. Also, they reach slaughter weights at 12 to 15 months and produce lean, yield grade 1 and 2 XXXX that require little or no fat trimming. This breed of XXX is also more suited for the area of the land as they are a hardy breed and can survive in drought conditions. The XXX that are produced from breeding with different XXX breeds tend to yield high return.

The breeding XXX have been chosen to use for XXX as they have a high libido, are fertile and active breeders from an early age. The breed has been designed to have a higher heat tolerance and to be more tick/parasite resistance.

The original purpose of the business is to use the XXXX for XXX breeding with the XXX to be sold at maturity and any female XXX to be used for growing XXX numbers. The other XXX were purchased to hold for a short term to fatten and then sell off. After selling off it is intended to purchase replacement XXX and then sell.

However, due to dry conditions and downturn in the XXX market prices the fattening XXX were not sold off and had been retained. In the 2023-24 financial year some XXX have now been sold.

The non XXXX have been placed with a XXX in hopes to sell at market as XXX and XXX to increase price at market. They are with XXX now.

The XXXX that were purchased are old enough to breed. They have been placed with a XXX and as a result have produced a XXX each within the 2023-24 financial year. All the XXXX will be retained to grow into maturity, both the female and male XXXX. This process will take around 2 years to allow for breeding (females) and weight. The plan is to sell the males once at maturity/weight and use the female XXXX for breeding.

The plan with the natural increase is to account that half of the XXXX produced will be XXX and they will be held until they have reached maturity/weight then sold off. XXXX from the increase will be used to grow the herd via breeding once mature. The XXXX come into maturity at 2 years of age when they can then be sold at market or start breeding as by this time they have reached weight requirements.

Independent expert advice attests to the lead time for each activity being:

• 2 years for XXXX under normal farm conditions to start breeding and breed well into their teen years, and
• 12 to 15 months for the fattening XXXX to reach slaughter weight.

You provided income and expense figures for the 2022-23 to 2030-31 financial years that shows that you will make a profit from the activity in the 2027-28 financial year.

You had a number of depreciation expenses that had temporary full expensing applied to them in the 2022-23 financial year.

You purchased more XXXX in the 2023-24 financial year.

You do not satisfy the $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997 for the 2022-23 financial year.

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

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 business losses are subject to the deferral rule, unless the Commissioner exercises his discretion.

Nature of the business

You have requested the Commissioner to exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 for the 2022-23 financial year.

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. Taxation Ruling TR 2001/14 Income tax: Division 35 - non-commercial business losses provides the Commissioner's view on the operation of the non-commercial business loss provisions. At paragraph 69A of TR 2001/14 it sets out when a business activity is regarded as having commenced for the purpose of this provision:

Broadly, this requires the taxpayer to have:

•         made a decision to commence the business activity;

•         acquired the minimum level of business assets to allow that business activity to be carried on; and

•         actually commenced business operations.

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 initial period finishes at 'the end of the last income year for which it can still be said that an inherent characteristic affects the business activity's ability to satisfy a test' (paragraph 81 of TR 2007/6). There needs to be an objective expectation, based on independent sources, that the business activity will produce a tax profit in a future year within the commercially viable period for the discretion to be exercised (paragraph 16B of TR 2007/6).

For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is not making a tax profit is inherent to the nature of the business and is not peculiar to your situation.

The lead time discretion is not intended to be available where the failure to make a profit or to meet a test is for reasons other than the nature of the business, such as, a consequence of starting out small and needing to build up a client base, or business choices made by an individual (for example, the size and scale of the activity, the hours of operation, and or the level of debt funding) that are not consistent with the ordinary or accepted practice in the industry concerned (paragraph 78 of TR 2007/6).

In your case, you are carrying on two activities: breeding XXXX, and fattening XXXX. You carried on a similar activity for a number of years in the past. You have never made a profit from the activity. You say that you will make a net profit in the 2027-28 financial year. As you purchased XXXX in the 2022-23 financial year, and the XXXX are able to be slaughtered at up to 15 months, or bred from 2 years, and some were at breeding age when you bought them, you would be able to make a profit before the 2027-28 financial year.

In relation to the XXXX that were purchased for fattening, while the dry conditions may have affected the XXXX's potential growth, this breed was picked as they can survive in these conditions. The downturn in the XXXX market is a normal factor in the industry. It was a business decision to retain the XXXX and then impregnate to sell with XXX to increase the profit. This choice has led to growth of the XXX and no sale of the XXXX.

When reviewing the financial information, it can be seen that the majority of the loss in the 2022-23 financial year was not caused through the nature of the business activity resulting from inherent characteristics of the activity.

Conclusion

Having regard to your full circumstances, it is not accepted that it is the nature of the business activity that has prevented you from making a tax profit.

The Commissioner will not exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 for the 2022-23 financial year. You must defer the loss to a future year where you meet a test or make a profit from your business activity.