Edited version of private advice

Authorisation Number: 1052311541507

Date of advice: 27 September 2024

Ruling

Subject: Commissioner's discretion - non-commercial losses

Question

Will the Commissioner exercise the discretion under section 35-55 of the Income Tax Assessment Act 1997 to allow Person A to include the loss from their activity in the calculation of their taxable income for the 2023-24 financial year?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Person A and Person B operate a primary production business across a number of rural properties.

Person A and Person B have been operating this business for many years.

The business is operated through a family partnership ("the partnership") and employs on average 3-4 staff.

The end of the financial year before the ruling period, the business had over seven thousand cattle on hand being a mixture of breeding cows, heifers and steers for fattening and sale, bulls, and calves.

Over the last seven years the business made the decision to change the type of cattle they bred and sold from general commercial cattle to a more specialised cattle.

It takes several years to begin to sell this specialised cattle, as it takes a year for the cattle to be bred and born, then at least 2-3 years for them to grow large enough to sell.

The change in herd type is done in multiple ways:

•         Selling down the commercial cattle herd to fund the purchase of specialised cattle

•         Purchasing the more expensive full blood specialised breeding stud

•         Over time cross breeding better quality commercial cattle with the full blood specialised cattle

•         Continuing to refine the herd breeding by cross breeding.

Person A and Person B have cut business expenses where needed to cope with the decrease in selling prices, but interest expenses have increased in line with Australian interest rates.

Person A and Person B sold one of their properties in the ruling period to reduce their debt level and reduce costs to their business.

The partnership is expected to make a tax loss in the ruling period.

The partnership typically sells around X head of cattle each financial year.

In the ruling period there was a timing difference in the sale of the cattle. If the partnership had sold Y cattle at an average price of $Z per head before the dramatic drop in prices during the ruling period, they would have had likely produced a tax profit.

The partnership expects to return to profit in the next financial year.

Relevant legislative provisions

Income tax Assessment Act 1997 section 35-55

Income tax Assessment Act 1997 section 35-55(1)(a)

Reasons for decision

Division 35 of the ITAA 1997 operates to prevent certain losses from business activities carried on by individuals operating alone or in partnership from being claimed as a deduction.

Under subsection 35-10(1) of the ITAA 1997, a loss made by an individual from a business activity will not be allowed as a deduction in an income year unless:

• The exception in subsection 35-10(4) of the ITAA 1997 applies;
• You satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 and one of the following four tests:

­   The assessable income test (section 35-30 ITAA 1997)

­   The profits test (section 35-35 ITAA 1997)

­   The real property test (section 35-40 ITAA 1997)

­   The other assets test (section 35-45 ITAA 1997); or

• The Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

There are two discretions available to the Commissioner under section 35-55 of the ITAA 1997: lead time and special circumstances.

The Commissioner's approach to exercising the discretion under subsection 35-55(1) of the ITAA 1997 is outlined in Taxation Ruling TR 2007/6 Income Tax: non-commercial losses: Commissioner's discretion (TR 2007/6).

Special Circumstances

The special circumstances discretion may be exercised for the financial year in question where your business activity is affected by special circumstances outside your control. 'Special circumstances' are those circumstances which are sufficiently unusual or different to distinguish them from the circumstances that occur in the normal course of conducting a business activity.

The following paragraphs have been extracted from TR 2007/6:

12. The Commissioner's discretion in paragraph 35-55(1)(a) may be exercised for the income year(s) in question where the business activity is affected by special circumstances outside the control of the operators of the business activity.

...

13A. For those individuals who do not satisfy the income requirement in subsection 35-10(2E) special circumstances are those which have materially affected the business activity, causing it to make a loss. For these individuals the Commissioner's discretion in paragraph 35-55(1)(a) may be exercised for the income year(s) 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.

14. The special circumstances must be outside the control of the operators of the business activity. Such circumstances are specifically defined to include drought, flood, bushfire or some other natural disaster. In the case of other events, failure for no adequate reason to adopt practices commonly used in an industry to prevent or reduce the effects of special circumstances may point to the special circumstances not being outside the control of the operator.

...

TR 2007/6 goes on to discuss that there is no exhaustive definition of 'special circumstances' in the ITAA 1997 and references the judicial consideration of the term in respect of other legislation.

44. In the case Community Services Health, Minister for v. Chee Keong Thoo (1988) 78 ALR 307; (1988) 8 AAR 245 Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation at ALR 324:

Those discretions are intended to be applied to a great variety of situations. In such a context, the core of the idea of 'special circumstances' is that there is something unusual or different to take the matter out of the ordinary course...

45. In the case Employment, Education, Training Youth Affairs, Department of v. Barrett (1998) 82 FCR 524; (1998) 52 ALD 499; (1998) 27 AAR 291 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed at FCR 530 that:

The word 'special' must be read in context. In normal parlance it signifies that the event or circumstances in question are out of the ordinary or normal course.

46. Tamberlin J went on to say:

The AAT observed in Re Beadle and Director-General of Social Security (1984) 6 ALD 1 at 3 (which was approved by the Full Court in Beadle v. Director of Social Security) (1985) 60 ALR 225):

An expression such as 'special circumstances' is by its very nature incapable of precise or exhaustive definition. The qualifying adjective looks to circumstances that are unusual, uncommon or exceptional. Whether circumstances answer any of these descriptions must depend upon the context in which they occur. For it is the context which allows one to say that the circumstances in one case are markedly different from the usual run of cases. This is not to say that the circumstances must be unique but they must have a particular quality of unusualness that permits them to be described as special.

In the context of Division 35, TR 2007/6 states the following at paragraphs 47-49:

...Subject to paragraphs 48 and 53 of this Ruling, ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances. These fluctuations are expected to occur on a regular or recurrent basis when carrying on a business activity and affect all businesses within a particular industry. (Refer to Example 1 at paragraph 110 of this Ruling). However, substantial unexpected fluctuations of a scale not regularly encountered previously may qualify on a case by case basis.

48. Although not limited to natural disasters, paragraph 35-55(1)(a) refers to 'special circumstances' as including drought, flood, bushfire or some other natural disaster. These events are taken to be special circumstances outside the control of the operators of the business activity.

49. The special circumstances must have affected the business activity. Some indicators of the effects on the business activity that could lead to the exercise of the discretion in regard to the special circumstances limb are:

•         destruction of stock or equipment (refer to Example 2 at paragraph 112 of this Ruling);

•         delays in ploughing, planting, harvesting etc (refer to Example 3 at paragraph 115 of this Ruling);

•         delay in growth of crops (refer to Example 4 at paragraph 118 of this Ruling);

•         inability of operator to perform duties (refer to Example 5 at paragraph 122 of this Ruling); and

•         loss of business opportunities (refer to Example 6 at paragraph 125 of this Ruling).

In summary, ordinary market fluctuations that might reasonably be predicted to affect business activity, affect the industry as a whole, or are regular and recurrent, are unlikely to be special circumstances for the purpose of the Commissioners discretion in paragraph 35-55(1)(a) of the ITAA 1997.

Application to your circumstances

In this case, you have said that the special circumstances exist in the form of a sudden drop in the price per unit of the specialised beef.

Market driven fluctuations in unit sale prices are a normal incident of conducting any business including a primary production business. The sale price fluctuation in the price of the specialised beef is something that will occur on a regular or recurrent basis and will affect the industry segment as a whole in Australia.

For this reason, the Commissioner cannot exercise the discretion under paragraph 35-55(1)(a) to allow the losses from the primary production activity to be deducted in year of the ruling period in the calculation of your taxable income.