Private ruling: non-commercial losses
Published: February 2012
Ruling period: Year ended 30 June 2010 | Year ended 30 June 2011 | Year ended 30 June 2012 | Year ended 30 June 2013
Date scheme commenced: 1 July 2003

Ruling: Q1: Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include any losses from your primary production business activity in your calculation of taxable income for the 2010-11 to 2012-13 financial years? | A1: 

Relevant facts and circumstances: You do not satisfy the <$250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997. You carry on a primary production business. The activity commenced in the 2003-04 financial year. You are expecting to make a profit in the 2013-14 financial year. You are targeting particular market segments. Commercial production commenced in 2008 and the business has been selling the product since 2009. You opened a shop in the 2010-11 financial year. You now have adequate stocks of high quality product and the most important current goal is to increase sales. The aim is to increase sales and export the product overseas. You have submitted independent which addresses variables that relate to product sourcing, own or contract processing, product mix, destination markets, investment in brand building versus sale of product and market conditions varying with the supply cycle. When taking into account these variables that apply to you the independent evidence concludes that it can take a ten year period to achieve profitability.

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)(c)

Reasons for decision: Summary: For the 2009-10 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. The third arm of the discretion in paragraph 35-55(1)(c) of the ITAA 1997 may be exercised for one or more financial years where: (c) you have failed the income requirement, and 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 greater than the deductions attributable to it for that year. The note to paragraphs b & c states: Note: Paragraphs b & c are 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 income. By asking the Commissioner to consider using his discretion under paragraph 35-55(1)(c) of the ITAA 1997 it is assumed that the activity has not produced or will not produce assessable income greater than the deductions attributable to it. The type of feature contemplated by the phrase 'because of its nature', in the context in which it appears, is that referred to in the note quoted above. That is, that there is an inherent or innate feature of the activity resulting in an inability to produce income in the year of commencement and (in most cases) a number of years thereafter. This is borne out further by paragraph 1.51 of the Explanatory Memorandum for the New Business Tax System (Integrity Measures) Act 2000 , which states: This arm [paragraph 35-55(1)(b)] of the safeguard discretion will ensure that the loss deferral rule in section 35-10 does not adversely impact on taxpayers who have commenced to carry on activities which by their nature require a number of years to produce assessable income. Examples of activities which would fall into this category are forestry, viticulture and certain horticultural activities. The note and the passage cited above do not support any view that the discretion should be exercised for any start-up activity that is yet, for example, to satisfy the assessable income test in section 35-30 of the ITAA 1997, simply because of the small scale on which it was started, or because a client base is being built up. Those sorts of constraints on being able to satisfy that test are far removed from the specific one referred to in the note and the Explanatory Memorandum. The test to determine a commercially viable period is primarily an objective one based on independent sources. This approach was undertaken in the Federal Court case Commissioner of Taxation v. Eskandari (2004) 134 FCR 569 ( Eskandari) where Stone J. said, at 581-582: In some cases it may be a straight forward exercise to identify the industry in which the business activity takes place. Some industries are well-established and the basis for an "objective expectation" can readily be based on a comparison between the tax payer's business and other businesses within that industry, particularly where businesses or business associations with the industry produce material such as annual reports or industry papers… You have asked the Commissioner to exercise his discretion in relation to lead time for the period from the start of the 2009-10 income year to the 2012-13 financial years. Your business commenced in the 2003-04 financial year with the first commercial product available for sale in the 2008-09 financial year. Since them you have increased the capital assets of the business You have provided independent evidence which provides for a ten year period to achieve profitability. However this time period takes into account iconic brand building and expanding your sales abroad. These factors are subjective and based on characteristics specific to your situation and not indicative of the industry as a whole. This independent evidence also states that, excluding these subjective considerations, the first commercial product may be obtained in as little as 3 years. Furthermore, the independent evidence you have provided has taken into account the current oversupply of product and the high value of the Australian dollar. The oversupply of a product is the result of ordinary market fluctuations that affects all businesses within that industry. Reduced product prices as a result of over supply might be reasonably expected to occur when carrying on a business activity and do not extend the commercially viable period. Your forecasts show that you expect the unit price will remain relatively constant in coming years. You expect to return a tax profit in the 2013-14 financial year by significantly increasing the number of sales. However, as noted in Eskandari and in the Exploratory Memorandum, the discretion cannot be granted when a profit has not been made due to the need to build up sales or broaden distribution channels. You have stated that the 2010 product was at optimum levels and that you now have adequate stocks of high quality product. It stands then that the start up period inherent to the nature of your activity is over. In summary, we consider the commercially viable period may reasonably be up to four to five years and you do not expect to make a tax profit until ten years after the commencement of the business. We do not consider that there is anything inherent in the nature of your business activity that prevented you from being able to produce a taxable profit within 4 to 5 years of commencing the business. In conclusion, the requirements of paragraph 35-55(1)(c) of the ITAA 1997 have not been met. Consequently, you are not eligible for the Commissioner's discretion for the 2009-10 to 2012-13 financial years.

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