Edited version of private advice

Authorisation Number: 1052334728920

Date of advice: 26 November 2024

Ruling

Subject: Commissioner's discretion - non-commercial losses

Question 1

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your sole trader business activity in your calculation of taxable income for the 2023-24 financial year?

Answer 1

No.

This ruling applies for the following period:

30 June 2024

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

You satisfy the income requirement set out in subsection 35-10(2E) of the Income Tax Assessment Act 1997.

You own a livestock farm.

You have a full-time farm manager and two part time employees.

There are trees that are feed to the livestock during dry season. There other feed is made up of the natural vegetation that is specific to the farm's region.

The farm is in an arid area with an average annual rainfall of between 100mm-200mm. To account for the dry season the farm has X strong water sources.

However, during the 20XX-XX rainy season, you had received less than 10mm. Which affected the overall growth of vegetation, which grows during the rainy period till XXX.

According to the Vegetation Condition Index the overall rating for the seasons is between very poor to severe.

A state of emergency was declared by the government in 20XX regarding the drought, which is considered the worst in 100 years.

Due to the drought the natural vegetation was very poor, and the condition of the livestock have deteriorated. Market price decreased due to an oversupply as farmers sold off stock.

You meet the assessable income test.

For the last four years the conditions have ranged between very poor to severe XX times over the XX months of the rainy season.

You have sold off more than half of your livestock between XXX to XXX 20XX which normally would have been a substantial sale but you received significantly less. It is projected that for the 20XX-XX financial year the income will be less as you will retain the livestock you currently own to regrow the herd.

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)(a)

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, none of the exceptions would apply and although you satisfy the income requirement, you do not meet any of the four tests in the years of income under consideration. Your losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

Special Circumstances

'Special circumstances' are those circumstances which are sufficiently different to distinguish them from the circumstances that occur in the normal course of conducting a business activity, including drought, flood, bushfire or some other natural disaster.

For individuals who do not satisfy the income requirement, special circumstances are those which have materially affected their business activity causing it to make a loss, In this context, the Commissioner may exercise this discretion for the financial year(s) in question where, but for the special circumstances the activity would have made a tax profit.

To determine what are 'special circumstances', we need to look at the context in which the phrase is used. Also, it is clear that 'special circumstances' will be something out of the ordinary or unusual. '

The question of what constitutes 'special circumstances' has been judicially considered on many occasions. In the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation:

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...

Later, in the Federal Court Case of Secretary, Department of Employment, Education, Training & Youth Affairs v. Barrett and Another(1998) 82 FCR 524 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed 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.

Tamberlin J then quoted the following passage with approval from the AAT case of Re Beadle and Director-General of Social Security (1984) 1 AAR 362; (1984) 6 ALD 1:

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.

As stated at paragraph 14 of Taxation Ruling TR 2007/6 Income tax: non-commercial business losses:

Commissioner's discretion:

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 disaster4. 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.

At paragraph 47 of TR 2007/6, it states:

...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.

Further, as stated at paragraph 49 of TR 2007/6:

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).

Paragraph 52 of TR 2007/6 states:

The discretion can be exercised in income years after the one in which the special circumstances have occurred if the effects of those special circumstances on a business activity continue such that it cannot satisfy any of the tests or produce a tax profit in those later years. However, there may be situations where the special circumstances in question, because of their continued existence, change, and become the ordinary or usual situation, in which case it would not be appropriate to exercise the discretion after that time.

In your case, because the drought conditions have existed and continued to exist throughout most of your ownership of the property and the operation of your farming activity, the drought conditions are considered normal or a usual situation for your business activity.

Therefore, the continuous drought from mid-2015 until now is not considered to be special circumstances for the Commissioner's discretion under paragraph 35-55(1)(a).

Paragraph 57 of TR 2007/6 provides:

However, if the operators of the business activity fail for no adequate reason to adopt certain practices commonly used in their industry to prevent or reduce the effects of certain circumstances, such as for example pests or diseases, then that may point to the circumstances being within their control.

There is no evidence of any safe-guarding activities to prevent being continually affected by the continuing droughts.

You provided financial reports showing income statements and profit and loss for the 2020, 2021, 2022 and 2023-income years. Each income year resulted in a loss.

Accordingly, the Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the 2023-24 and 2024-25 financial years. Therefore, any loss for that activity cannot be considered in calculating your taxable income for the 2023-24 and 2024-25 financial years and will be carried forward until you meet the conditions to apply the losses against your other income.