Edited version of private advice

Authorisation Number: 1052246770470

Date of advice: 2 May 2024

Ruling

Subject: Commissioner discretion - non-commercial losses

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your business activity in your calculation of taxable income for the 2022-23 financial year?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

You satisfy the less than $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You carry on a fruit growing activity on an organic farm.

You commenced the activity in the 20YY-YY financial year.

The orchard is set on a 40 hectare property.

The netted orchard is 20 metres by 24 metres.

There is no local fruit shop or regular grower your area. The next major town is 1 hour away.

It follows organic permaculture principles and contains:

•         20 fruit trees

•         20 dwarf edible trees

•         20 fruit bushes and

•         a 5 metre long fruit field.

The citrus trees already existing outside the orchard are not part of your activity.

Outside the orchard you plan to add an additional 15 fruit trees.

To support the growth of the trees, compost is made from organic food waste from local business.

Existing dams and water tanks excess to current supply will provide irrigation.

You advised you already have skills to grow, prune and manage a successful orchard.

Existing animals on the property include ducks and chickens. These will be used to support organic weed/pest control and provide fertiliser.

You provided a business plan.

Your operational plan is as follows:

•         orchard infrastructure built (completed)

•         planting (completed) and maintenance

•         harvesting and post-harvest handling

•         infrastructure and equipment

•         seasonal planning

Your timeline:

•         Site selection and preparation (year 1).

•         Planting (year 2): plant bare fruit trees either in spring/summer.

•         Initial care and maintenance (years 1-3): during the first few years, the focus is on providing proper care to the young orchard. This includes watering, fertilising, weed control, pest management and pruning to shape the trees and encourage healthy growth.

•         First harvest (years 2-5): depending on the fruit variety and growing conditions, the first significant harvest can occur within 2 to 5 years after planting. However; the yield during the initial years might be relatively low compared to mature orchards.

•         Full productions (years 5-8 and beyond): as the trees mature, they will reach full production capacity, typically around 5 to 8 years after planting. At this stage, the orchard hopefully becomes commercially viable, producing consistent yields of fruit.

You supplied your expenses for the 20YY-YY financial year.

You provided your future operational expenses.

You provided your anticipated revenue over a 6 year period, which shows:

•         year in operation

•         number and type of trees and the amount of produce in kilograms

•         the total number of anticipated kilograms per variety that is expected to be sold

•         the revenue per tree type, and

•         the total revenue.

You plan to sell your produce at local markets nearby. You will use a display table.

The produce will be picked the day before, before being transported in food grade produce crates via your existing vehicle.

The produce will be packaged in strong paper bags.

If there are leftover fruit, they will be stored in the dark, dry sealable shed, which is existing on the property.

The property is owned by you and your spouse.

The activity will be funded through extension of funds on your existing mortgage for the property.

You believe the lead time is 5-8 years for your industry however, you have not provided an independent source for this lead time.

You will not produce at least $20,000 assessable income in any financial year.

You will never satisfy any of the four non-commercial losses tests.

You expect to make a small profit in the year ending 30 June 20YY.

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)(b)

Reasons for decision

Paragraph 35-55(1)(b) of the ITAA 1997 states for those individuals that satisfy the income requirement, but who have commenced to carry on a business activity with a lead time, that Commissioner's discretion may be available, as long as because of its nature, it has not or will not satisfy one of the four non-commercial loss tests; and that there is an objective expectations, based on evidence from independent sources, within an appropriate commercially viable period for the industry concerned, that you will either meet one of the four tests make a profit for the year in question.

In your instance you have advised that you do not expect to ever satisfy a test.

Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion states at paragraphs 10-11:

10. The aim of the Division is to defer losses from business activities which do not satisfy at least one of the four tests. The discretion is not intended to apply where a business activity makes a loss because of factors which can apply to any business and which do not affect the ability of the activity to satisfy one of the four tests.

11. Rather, it is intended to be available for a commercial business activity that has failed, or objectively is expected to fail for a period of time, to satisfy any of the tests in Division 35 for certain reasons outside the control of the operator.

There are no reasons beyond your control as to why you will not satisfy any of the four tests and there are no limiting factors for lead time beyond a reasonable timeframe present in your case.

Paragraph 82 of TR 2007/6 leads to Example 12 at paragraph 161 of this ruling. It states:

However, cases may arise where this initial period has passed, and yet a particular business activity of this type is continuing to not satisfy any of the tests. In this situation it will be appropriate to enquire whether this is the result, not of any inherent characteristic but because of the way in which the operator has chosen to carry on their business activity. (Refer to Example 12 at paragraph 161 of this Ruling.)

Example 12 located at paragraphs 161-166 of TR 2007/6 states:

161. David commenced a yellow fruit growing business in the 2001 income year. For the 2002, 2003 and 2004 income years the Commissioner's discretion was exercised as the requirements of subparagraphs 35-55(1)(b)(i) and 35-55(1)(b)(ii) were satisfied. David's bushes reached full yield by the 2005 income year and for that year and the 2006 income years the business activity made a profit. However, for the 2005 and 2006 income years, the business activity does not satisfy any of the tests in Division 35. In particular, the small scale of the activity means that it is unlikely it will ever satisfy the Assessable income test. David decides to obtain additional finance to cover his business expenses for the next five years and as a result his business activity is expected to make losses for the 2007 to 2010 income years.

162. The exception for primary production business activities does not apply as he had received at least $40,000 of non farm income. This is expected to continue to be the case. As the business activity is unlikely to satisfy a test, the losses from the yellow fruit business activity will be deferred if the Commissioner does not exercise the discretion for the 2007 to 2010 income years.

163. Evidence from the industry body shows that any yellow fruit growing business would not be expected to satisfy one of the four tests before year five as there are inherent characteristics that prevent it from doing so until around the time of full yield.

164. In order for the Commissioner's discretion to be exercised David's business activity must first satisfy the requirement of subparagraph 35-55(1)(b)(i). It must be 'because of its nature' that the activity has not satisfied, or will not satisfy, one of the tests set out in sections 35-30, 35-35, 35-40 or 35-45.

165. David's bushes achieved full yield by the 2005 income year in line with other business activities of this type. Therefore David's business activity's failure to satisfy a test for the 2007 to 2010 income years is not due to any inherent characteristic, but primarily because David has chosen to carry out the activity on a small scale.

166. In this situation the Commissioner's discretion would not be exercised in regard to David's losses from his business activity from the 2007 income year onwards.

In this example, Commissioner's discretion would not be exercised as the client would not satisfy the assessable income test. In addition to this it mentions that tests would not be satisfied because the client has chosen to carry out the activity on a small scale.

With application to your circumstances, you have advised that you expect to make a tax profit in the year ending 30 June 20YY and that the accepted number of years for your activity to become commercially viable is 5-8 years. You started the activity on 1 March 20YY. Though no independent sources were provided to validate your claim of being commercially viable in 5-8 years, your size and scale is well below what would hold your activity as being commercially viable, given that your peak estimated revenue is below $3,000 per annum, before taking into consideration any expenses.

As you have chosen to carry out the activity on a small scale, Commissioner's discretion - lead-time would not be granted.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides indicators for assessing whether a business is being carried on.

Paragraph 13 of TR 97/11 provides:

13. The courts have held that the following indicators are relevant:

•      whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators (see paragraphs 28 to 38);

•      whether the taxpayer has more than just an intention to engage in business (see paragraphs 39 to 46);

•      whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity (see paragraphs 47 to 54);

•      whether there is repetition and regularity of the activity (see paragraphs 55 to 62);

•      whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business (see paragraphs 63 to 67);

•      whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit (see paragraphs 68 to 76);

•      the size, scale and permanency of the activity (see paragraphs 77 to 85); and

•      whether the activity is better described as a hobby, a form of recreation or a sporting activity (see paragraphs 86 to 93).

There are no hard and fast rules for determining whether a taxpayer's activities amount to the carrying on of a business of primary production. The facts of each case must be examined. In Martin at CLR 474; AITR 551 Webb J said:

'The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and, as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.'

Based on the facts provided and with application to TR 97/11 most of the characteristics are lacking to satisfy that you are conducting a significant commercial activity. The size and scale of your activity is smaller than other businesses within the industry. The scale is small; however that is not the deciding factor, with the anticipated yield being beyond that required for your personal needs, though there is no significant commercial return. There is no real purpose or prospect of profit. Your total gross revenue is anticipated at below $3,000 per annum, before factoring in any deductions, or unexpected expenses, yield issues or damage to your crop. The size and scale for this activity, in addition to the limited prospect of profit, would not be considered a business and there is no expected growth. The profit does not appear achievable based on what has been supplied.

Example 7 at paragraphs 53-54 of TR 97/11 states:

53. Fay's friends were avid growers of olive trees and were making a small profit on the sale of olive oil they produced from their olives. Fay decided to grow olive trees on her modest property. She researched the varieties and selected those best for olive oil production. Fay planted 50 olive trees on her property. She knew they were hardy trees which required minimum maintenance. She spent the minimum amount of time necessary to care for the trees. She had spoken to her friends and had calculated that after four years she would be able to make a profit on the production of olive oil from the olives she picked. The trees thrived. In the fifth year after planting, a sizeable crop was produced. Fay employed casual labour to pick the olives, borrowed a friend's trailer and took the olives to be pressed. She sold the barrels of olive oil to friends, work colleagues and members of the public who responded to her newspaper advertisements. She derived a substantial profit in that year, which she was told by her friends in the industry was typical. Was Fay carrying on a business of olive production?

54. Yes. The activities were carried out with a purpose to make a profit, even if no income was made in the first four years of operation. In addition:

•      Fay clearly had a plan to make the activity succeed. She had conducted research by consulting friends in the industry and the local growers association;

•      though the activity was small it was organised. By its nature the activity required minimum maintenance. It was not carried on in an ad hoc manner. Rather, it was carried on in a manner similar to that of other olive producers; and

•      there was repetition and regularity of the activity.

With application to your circumstances, your tree quantity is below that mentioned in the example; however, you are expected to generate a small level of income, whereas in the example, a substantial profit was derived.

The first step of determining if you are entitled to claim non-commercial losses, is to be carrying on a business. As you are not carrying on a business, you are not eligible to claim the losses from your activity, against other income.

At present the activity is better described as a hobby, especially due to the size and scale of the activity.