Edited version of private advice

Authorisation Number: 1052375952793

Date of advice: 24 March 2025

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 you to include any losses from your business activity in the calculation of your taxable income for the 20XX, 20XX and the 20XX income years?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Property

You purchased a property (the Property) for a specified price. The Property is over 30ha.

The majority of the Property included primary produce of specified varieties. However, approximately 40% is being modified to other varieties of primary produce in a strategic transformation of the property to a specified business.

You entered into a Term Sheet Agreement (the Agreement) with the vendor, Company 1, in the 20XX income year. Company 1 is 100% owned by Company 2 and the vendor specified to the purchaser that the property has been owned by Company 2 and was not operated as an independent commercial produce selling entity but solely as part of their integrated supply chain. As such, there have never been any primary produce sales or documented pathway for profitability from primary produce sales alone.

The Agreement stated "The Purchaser wishes to purchase, from the Vendor and the Vendor wishes to sell to the Purchaser, the land and assets owned by the Vendor and known as Business 1 (Proposed Transaction)."

In addition to the Property. the Agreement included the following assets:

•                     All improvements on the land.

•                     All plant and equipment on site and listed in the attached Schedule.

•                     One (1) truckload of primary prodcue (approximately 24 metric tonnes) to be contracted by Company 2 for three (3) years at approximately $XXX (GST free) per tonne commencing 20XX. The parties will negotiate the terms of a supply contract as part of the Proposed Transaction.

•                     Company 1 Trademark currently does not exist and is available to the Purchaser if so required.

•                     Water licence numbers.

The sale contract for the Property was signed in the 20XX income year.

The date of settlement for the Property was two months after the sale contract was signed.

In the 20XX income year you entered into a short-term transitional supply agreement with Company 2, the previous owners of the Property, to supply a specified number tonnes of primary produce at over $XXX per tonne for three years.

You are currently in negotiations with Company 2 to increase the current supply agreement, and discussions have commenced with several other businesses.

Primary Production Activities

Your primary production activities commenced in late 20XX including various undertakings as these activities were not previously undertaken by Company 2:

•                     Specified measures to assist in better produce distribution and less disease going forward.

•                     Discussions on soil testing to be conducted (which was eventually conducted in May) to confirm soil types and best care programs for the top soil to ensure optimal conditions for high quality produce.

•                     Discussions with external providers and request to reserve specified products accordingly for programs to take place in 20XX.

The Property is operated by you and you have a contractor undertaking works and management. You intend to sell primary produce to various businesses.

The additional costs in the first years of ownership of the business include accessing immediate asset write-off of equipment under $20,000 and costs of modifying produce to more profitable varieties.

Your main clientele are commercial and boutique producers.

Your products/services are advertised via commercial relationships, word of mouth and targeted marketing via the business manager whose role includes marketing and sales.

Prior to purchasing the Property, it was determined that a program would be undertaken as part of a strategic transformation to establish a business focused on supplying premium primary produce to multiple producers. The decision was made to undertake specified activities due to suitability of the Property and increase in profitability as assessed by an industry consultant.

The modification process takes 3-5 years before the target yield will be achieved.

Preparation for the activities began in early 20XX. You expect to make a profit in the 20XX income year.

The qualifications or expertise you possess in respect of your activity are:

•                     Bachelor of Business.

•                     Graduate Diploma in Applied Finance.

The relevant licences, government approvals or planning permits in regard to the Property are:

•                     Take and use licence - water licence.

•                     Licence to operate works - water licence.

•                     Relevant Pipeline Community Water Supply and Access Agreement for water rights.

You spend approximately 12.5 hours per week on this activity.

You engaged a professional in the industry to provide a detailed review of the Property and advise on issues/recommendations. You provided a letter from them stating:

•                     They have personally undertaken a due diligence on the Property and can confirm you have a clear plan in place to make profits from the sale of raw produce.

•                     Currently the vineyard produces a specified variety of produce with an estimated value of over $XXX per tonne.

•                     You have implemented a new management strategy for lower yield in the existing blocks and high quality varietals to achieve a higher specified classification which could see prices increase to $XXX per tonne representing a significant increase in profitability.

•                     This plan includes modifying a portion of the existing Property with more sought-after varieties that command a higher market price.

•                     Based on their professional assessment and industry knowledge, they believe there is a strong objective expectation that the Property will generate a tax profit within the next 5 years.

Business Plan

You provided a business plan. The business plan contained the following sections:

•                     Executive Summary

•                     Market Research and Analysis

•                     Timelines/Milestones

•                     Financial Plan

•                     Risk Analysis and Mitigation

•                     Conclusion.

The below facts below have been extracted from the provided business plan.

•                     The stated Business Objective is to purchase the Property and modify a percentage of the Property to diversify with other high-demand varietals.

•                     The stated Vision is to create an ecologically and commercially sustainable, diversified Property that meets local producers demand for high quality produce locally.

•                     The stated Mission is to be a leading grower locally by offering a diverse portfolio of premium produce while leveraging the region's reputation for high quality produce of a specified variety.

The Key Objectives are:

•                     Acquire the Property and complete the modification project over the next 12-24 months.

•                     Complete extensive capital program of post repairs, irrigation system upgrades, specified activities and working towards certification of sustainable growing.

•                     Establish a diversified product line targeting niche and boutique producers, expanding the customer base.

•                     Generate profitable returns by year 4, with a focus on quality and brand-building.

Financial

You provided profit and loss statements for the 20XX to 20XX income years showing your existing and projected income and expenses and profit or loss.

Business Activities by Previous Owner

You have provided the following explanation of how the prior business activity was different to the current business activity you conduct:

•                     Company 2 operates as a produce manufacturing business, focused on producing, branding, and selling value-added products. This involves the use of their facilities and sourcing produce from multiple sites. Company 2's produce is marketed to consumers, restaurants, large retailers, and export markets.

•                     You operate as a primary production business, focusing exclusively on growing and selling raw produce. The Property does not engage in produce production, processing, or branding. Produce is sold to multiple producers in the local region as agricultural produce.

You provided the "Factors table" below:

Table 1: Factors table

Other

You are currently employed on a full-time basis (38 hours per week).

Your income was more than $250,000 for the 20XX income 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)(a)

Reasons for decision

Under subsection 35-10(2), if the amounts attributable to the business activity for a year of income that otherwise could be deducted, apart from Division 35, exceed the assessable income (if any) from the business activity, the loss is treated as though it:

a)            were not incurred in that income year; and

b)            instead, were an amount attributable to the business activity that is deductible in the next income year in which that business activity is carried on.

The 'income requirement' is set out in subsection 35-10(2E). A person will satisfy the income requirement under subsection 35-10(2E) if their income for non-commercial loss purposes is less than $250,000. If the income requirement is not met, and your activity makes a loss, the Commissioner may exercise discretion to allow the inclusion of the losses.

In your case, you do not satisfy the income requirement as your income for non-commercial loss purposes is above $250,000.

Subsection 35-55(1) states that the Commissioner may, on application, decide that the 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 would be unreasonable to apply that rule because:

...

c)            for an applicant who carries on the business activity who does not satisfy subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made - the business activity has started to be carried on and, for the excluded years:

i.          because of its nature, it has not produced, or will not produce, assessable income greater than the deductions attributable to it; and

ii.          there is an objective expectation, based on evidence from independent sources (where available) 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 subsections 35-10(2) and (2C)).

The operation of Division 35 is considered in Taxation Ruling TR 2001/14 Income tax: Division 35 - non-commercial business losses (TR 2001/14)

Paragraph 38 of TR 2001/14 states

'An activity that forms part of a taxpayer's overall *business will not be a separate '*business activity' for the purposes of Division 35 unless it is capable of standing alone as an autonomous commercial undertaking of some sort (see further paragraphs 40 to 46 on identifying separate and distinct *business activities for the purposes of Division 35).'

Paragraph 45 summarises some factors that may be relevant as to whether a business is made up of separate and distinct business activities and includes the location, assets used, goods or services produced, inter-dependency and commercial links.

Similarly, paragraph 51 of TR 2011/14 provides some characteristics to consider when determining whether business activities are of a similar kind and include:

•                     the location(s) where they are carried on;

•                     the type(s) of goods and/or services provided;

•                     the market(s) conditions in which those goods and/or services are traded;

•                     the type(s) of assets employed in each; and

•                     any other features affecting the manner in which they are conducted.

Lead time - Paragraph 35-55(1)(c)

The meaning of 'because of its nature' is discussed Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion (TR 2007/6). Paragraph 17 states

for the failure to satisfy a test or produce a tax profit (subparagraph 35-55(1)(c)(i)) to be 'because of its nature', the failure must be because of some inherent characteristic that the taxpayer's business activity has in common with other business activities of that type (see Federal Commissioner of Taxation v. Eskandari (Eskandari).

For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is producing a tax loss in a year, is because of something inherent to the nature of the business and not something peculiar to your situation. For example, the discretion will not be available where the failure to make a profit is for reasons other than the nature of the business such as, a consequence of starting out on a small scale, the hours worked or choices made by you.

In Case 1/2013 2013 ATC 1-050; [2013] AATA 3, the Administrative Appeals Tribunal (AAT) determined that a taxpayer who staggered the planting of their vineyard over several years was not eligible for the discretion. The AAT accepted that while it may have been commercially prudent to adopt the staggered approach, it was not sufficient to meet the test outlined in paragraph 35-55(1)(c). The AAT determined that the staggered approach was the taxpayer's choice, and not the result of an inherent characteristic the business activity had in common with other businesses within the industry (in line with Federal Commissioner of Taxation v Eskandari 134 FCR 569).

Further at paragraph 77 of TR 2007/6herefore, the phrase 'because of its nature' refers to inherent characteristics of the type of business activity being conducted by the taxpayer, which are common to any business activity of that type. These inherent characteristics must be the reason why the activity is unable to satisfy any of the tests. The discretion is not intended to be available where the failure to satisfy one of the tests is for other reasons.

Application to your circumstances

Whilst you contend the previous owner of the Property operated a produce manufacturing business whereas you will be focusing on produce growing and selling raw produce, this does not separate the actual activity that was conducted on the Property. While your overall business and the business of the previous owner may differ, the activities on the Property by the previous owner were produce growing activities. These produce growing activities were simply part of their larger business which was conducted over various locations.

You purchased a XXXX with existing varieties of produce along with numerous assets required to conduct produce growing activities on the Property. Your purchase also included the negotiation of a produce supply contract commencing in 20XX.

In your case, the activity conducted on the Property is the same or of a similar kind to the previous owner and not separate or distinct.

As per our view provided in TR 2007/6, the lead time discretion in paragraph 35-55(1)(c) is to provide a safeguard discretion that can be applied to activities that because of the nature require a number of years to become profitable. The inherent characteristics of the activities being common to any business activity of that type. The lead time discretion is therefore not intended to provide a safeguard against the specific business issues such as management decisions on a particular activity.

In this case you have purchased a property with an existing crop and assets and made a decision to implement a new crop management strategy to achieve higher quality produce to increase prices and improve profitability. This has meant that part of existing varieties are being modified.

Our view is that the grafting of new produce varieties to increase prices and improve profitability of a primary production activity becomes part of the management and planning for that activity. Where an ongoing business activity is purchased by a new owner, the 'period that is commercially viable for the industry concerned' as per subparagraph 35-55(1)(c)(ii) is taken from commencement of the activity, not when the activity was purchased by the new owner.

The modification to new produce varieties is not an inherent characteristic that your activity has in common to other similar activities, rather they are specific to your particular circumstances and the result of decisions made by you as to the quantity and variety of produce you would grow.

The lead time period that is common to an activity of the type you are undertaking has now lapsed as the previous business activity conducted on the Property and your current business activity are considered to be the same or of a similar kind.

Therefore, the discretion under paragraph 35-55(1)(c) has not been exercised for your activity for the relevant income year.