Edited version of private advice

Authorisation Number: 1052247346825

Date of advice: 2 May 2024

Ruling

Subject: Commissioner's discretion - non-commercial losses

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow the Taxpayer to include non-commercial losses from their business activity in the calculation of their taxable income for the income years ended 30 June 2023 to 30 June 2027 (Excluded Years)?

Answer

Yes.

This ruling applies for the following periods:

Income year ended/ending 30 June 2023 to 30 June 2027

Relevant facts and circumstances

1.    The Taxpayer and Mrs X have established a vineyard, the Business, with the purpose of producing super premium wine for sale.

2.    The vineyard is located in State AA.

3.    The vineyard is planned to consist of X separate blocks, a north block of XX hectares, a south block of XX hectares and an east block of XX hectares.[1]

4.    AConsultant has been engaged by the Taxpayer as viticulture consultant. The Consultant has more than 25 years of experience with small to medium and corporate wine industry businesses across various regions, including the one in which the Business is being carried on. The Consultant has significant experience growing super premium Pinot Noirs and Chardonnays.

5.    Under advice from the Consultant a number of preliminary land preparatory works were undertaken by the Taxpayer and through the use of skilled contractors. Preparatory works included:

•         uplifting pine trees on property boundaries to improve air flow

•         removing stumps on property

•         eradicating weeds and grasses

•         fertilising the soil in line with soil testing results

•         surveying the property via expert surveyor to create the layout of the vineyard

•         installing irrigation to the vineyard, and

•         installing the trellis infrastructure.

6.    In November 20XX, a total of XXX vines consisting of a variety of Pinot Noir and Chardonnay vines were planted on the north and south blocks.

7.    The Consultant has advised that the following yields are expected from the vineyard:

•         Vintage 20XX - 1 tonne per hectare; X.X tonnes total

•         Vintage 20XX - 3 tonnes per hectare; X.X tonnes total

•         Vintage 20XX - 6 tonnes per hectare; XX.X tonnes total.

8.    The Consultant has advised wines from vintages are released for sale 6-12 months post-harvest and that the expected sale price per bottle based on the wine region is expected to be $X.

9.    The Consultant has confirmed that industry standards for winemaking extraction rates after any losses allowed for fining and filtration is XX cases per tonne.

10.  According to the Profit and Loss projections provided, the Business is expected to begin wine sales in the year ended 30 June 20XX and begin producing a profit in the year ended 30 June 20XX.

11.  At full production, expected from the year ended 30 June 20XX onwards, the vineyard is expected to produce ongoing revenue of over $XXX per year, with estimated annual costs of approximately $XX per year, delivering an annual profit of more than $XXX per year.

12.  The wine will be marketed primarily via social media networks using email, Instagram, Facebook and webpage, complemented by selective advertising using other media. Other marketing opportunities such as in person or in industry events or wine club events will be exploited. Orders are expected to be made via email or the website and retail sales will be limited to outlets in the region to increase exposure of the brand.

13.  The Taxpayer and Mrs X have professional backgrounds. They intend to use the skills they developed in their respective fields to provide a platform for knowledge transfer to the wine industry together with the assistance and guidance of the Consultant.

14.  The Taxpayer did not satisfy the income requirement for the income year ended 30 June 20XX as set under subsection 35-10(2E) of the ITAA 1997.

Assumptions

1.    The exception in subsection 35-10(4) of the ITAA 1997 does not apply in relation to the Taxpayer in respect of the Excluded Years.

2.    The Taxpayer will not satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 in respect of the years ended 30 June 2024, 2025, 2026 and 2027.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

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 subsection 35-10(4)

Income Tax Assessment Act 1997 section 35-30

Income Tax Assessment Act 1997 section 35-35

Income Tax Assessment Act 1997 section 35-40

Income Tax Assessment Act 1997 section 35-45

Income Tax Assessment Act 1997 section 35-55

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

Income Tax Assessment Act 1997 subparagraph 35-55(1)(c)(ii)

Reasons for decision

All subsequent legislative references are to the ITAA 1997.

Summary

The Commissioner will exercise the discretion in paragraph 35-55(1)(c) to allow the Taxpayer to include any losses from the Business in the calculation of his taxable income for the Excluded Years.

Detailed reasoning

Division 35 operates to prevent losses from non-commercial business activities carried on by individuals operating alone or in partnership from being offset against other assessable income.

Subsection 35-10(2) is an integrity measure that has the effect of deferring amounts attributable to the business activity that exceeds its assessable income for the relevant income year as deductions as though the excess amount:

•         was not incurred in that income year; and

•         was an amount attributable to the business activity that is an allowable deduction for the next income year in which the activity is carried on.

Notwithstanding, subsection 35-10(2) will not be triggered if the business activity satisfies any of the conditions set out in subsection 35-10(1). That is:

•         the taxpayer's income for non-commercial loss purposes (as per subsection 35-10(2E)) is less than $250,000 and one of the 4 tests in sections 35-30, 35-35, 35-40 and 35-45 is met (assessable income test; profits test; real property test; and other assets test);

•         the Commissioner has exercised the discretion under section 35-55 for the business activity for the year; or

•         the exception in subsection 35-10(4) applies for the year.

In the context of taxpayers who do not satisfy the income requirement under subsection 35-10(2E) (that is, because their income for non-commercial loss purposes is $250,000 or more) for the most recent income year ending before the application is made, pursuant to paragraph 35-55(1)(c) the Commissioner may, on application, decide that the deferral rule in subsection 35-10(2) does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that:

•         it is because of its nature that the business activity of the taxpayer has not produced, or will not produce, assessable income greater than the deductions 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 (apart from the operation of subsection 35-10(2)).

Paragraph 35-55(1)(c) 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.

In respect of the objective test (referred to in subparagraph 35-55(1)(c)(ii)), the applicant must discharge the onus of proof that the business activity will produce a tax profit within the timeframe customary to the industry in which it operates.

The Business involves the establishment of a vineyard for the production and sale of wine. The Taxpayer submits that the lead time required to allow for the vines to establish before the first harvest is 3 years from planting and 5 years from planting before the first profit is expected. This is consistent with both the advice they received from the Consultant and independent resources.

The Taxpayer has established that the Business' inability to produce a profit in the Excluded Years is due to its inherent characteristics that require lead time before it can be reasonably expected to produce profit and that there is an objective expectation that the Business will start producing a profit within a commercially viable period that is common to other business activities of the same type.

The Commissioner will exercise the discretion under paragraph 35-55(1)(c) for the Taxpayer in respect of the Excluded Years and the Taxpayer will be able to offset any losses from the Business in those years against other assessable income.

[1] This application is based solely on the north and south blocks being established (X.X hectares).