Edited version of private advice

Authorisation Number: 5010084015907

Date of advice: 18 July 2022

Ruling

Subject: Commissioner's 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 me to include any losses in relation to my primary production activity in my calculation of taxable income for the relevant income years?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You do not satisfy the less than $250,000 income requirement set out in subsection 35-55(2) of the ITAA 1997.

You and your spouse conduct a business of cattle farming as a partnership in an area that has been drought-declared since 20XX.

The extensive drought conditions have affected carrying capacity which also impacts on sales and the probability of generating a tax profit.

In the 20XX financial year you purchased Block A which has a maximum carrying capacity of XX cattle then in the 20XX financial year you purchased Block B which has a maximum carrying capacity of XX cattle.

You have exposure to both cattle breeding and meat production to diversify and spread risk.

When you sell your cattle, you currently target a XX - XXkg average for the feedlot market.

The intention of both partners is to continue to grow and expand the operation with further land acquisitions being likely in the future.

Your long-term plan is to cease full-time employment and potentially work part-time to focus on the farm operation.

A couple of months after purchasing the property, you realised the paddocks feed had zero value and the land required remediation.

You have provided photographs showing a comparison of the land before and after remediation commenced.

You created an improved pasture rotational upgrading plan involving replanting paddocks on a rotational basis to improve the feed content and quality over a 5-year process.

At this stage one-fifth of the land is unusable as remediation occurs on a rotational basis and carrying capacity will increase once remediation is complete.

Additionally, you grow your own fodder which requires almost one-fifth of land to do so.

The "Livestock calculations" PDF provided contains actual and projected numbers for purchases, natural increase and sales for the years ended/ending 30 June 20XX to 30 June 20XX:

You are seeking the Commissioner's discretion based on lead time for the years ended 30 June 20XX to 30 June 20XX.

Your business' commercially viable period is 3-4 years with an expectation of producing a tax profit in the 20XX income year.

You do or expect to pass the assessable income test in each year except the year ended 30 June 20XX which was the first year of business operations.

Relevant legislative provisions

Division 35 of the Income Tax Assessment Act 1997

Subsection 35-10(2) of the Income Tax Assessment Act 1997

Subsection 35-10(2E) of the Income Tax Assessment Act 1997

Subsection 35-30 of the Income Tax Assessment Act 1997

Subsection 35-55(1) of the Income Tax Assessment Act 1997

Product Ruling PR 2006/92.

Reasons for decision

For the 20XX-XX and later financial years, Division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless:

you meet the income requirement, and you pass one of the four tests

•         the exceptions apply

•         the Commissioner exercises his discretion.

In your situation, you do not satisfy the income requirement (that is, your taxable income, reportable fringe benefits and reportable superannuation contributions but excluding your business losses, exceeds $250,000) and do not come under any of the exceptions. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

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

Lead time

The lead time discretion 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. For example, an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce any income.

For a taxpayer who does not satisfy the income requirement the lead time discretion may be exercised where there is an objective expectation, based on evidence from independent sources that, within a period that is commercially viable for the industry concerned, the activity will produce a tax profit.

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.

For individuals who do not satisfy the income requirement, the business activity must have been materially affected by the special circumstances, causing it to make a loss. In this context, the Commissioner may exercise this discretion for the income year(s) in question where, but for the special circumstances:

•         your 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 one of the four tests.

Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion sets out the Commissioner's interpretation on the exercise of the discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 53 of this ruling:

Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to special circumstances outside the control of the business activity, including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of the paragraph. These events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affected the business activity.

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.

Where special circumstances occur during a business's lead time, the lead time may be extended, and the additional time is allowed under the special circumstances' discretion (paragraph 51 of TR 2007/6). This is demonstrated in Example 11 in TR 2007/6. In that example the taxpayer carried on a fruit growing business that has a lead time of five to six years. During the lead time period, the business suffered a fire which destroyed some of the trees and damaged many of those remaining. The taxpayer had to re-plant 40% of the trees and the development of fruit on another 30% of the trees was set back approximately two years. In this example, the Commissioner considered it appropriate to exercise the special circumstances discretion for an additional two years beyond the lead time period.

Where an operator chooses to carry on the business activities in a manner that does not produce a tax profit within the period that is commercially viable for the industry concerned, paragraph 35-55(1)(c) of the ITAA 1997 may not be satisfied.

TR 2007/6 states that the 'lead time' discretion provided for by paragraph 35-55(1)(c) of the ITAA 1997 is available for a business activity if there is an initial period from when the activity commenced where the nature of the activity prevents a tax profit from being made.

TR 2007/6 does not support any view that the discretion should 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 small and needing to build up a client base, or business choices made by an individual that are not consistent with the ordinary or accepted practice in the industry concerned - such as the hours of operation, location, climate or soil conditions, or the level of debt funding.

It is evident that a significant contributor to the losses of the business is the effects of the drought causing damage to the land (requiring remediation) which affected the carrying capacity and thus extended the lead time required to achieve commercial viability for your business.

The Commissioner will therefore exercise the discretion for the relevant years.