Private ruling: Non-commercial losses
Published: September 2013
Ruling period: Year ended 30 June 2011 | Year ending 30 June 2012 | Year ending 30 June 2013 | Year ending 30 June 2014 | Year ending 30 June 2015
Date scheme commenced: 1 July 2010

Ruling: Q1: 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 primary production activity in your calculation of taxable income for the 2010-11 and 2014-15 financial years? | A1: No


Relevant legislative provisions: Income Tax Assessment Act 1997 paragraph 35-55(1)(c) | Income Tax Assessment Act 1997 subsection 35-10(2) | Income Tax Assessment Act 1997 subsection 35-10(2E)

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; or · 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 relevant discretion may be exercised for the financial year in question where: · it is in the nature of your business activity that there will be a period before a tax profit can be produced; and · there is an objective expectation your business activity will produce a tax profit within the commercially viable period for your industry. 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. The note under paragraph 35-55(1)(c) states: Paragraphs (b) and (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. The impermissibility of subjective considerations was emphasised in the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 as follows: 2.35 The discretion is not intended to be available in cases 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. Stone J in Commissioner of Taxation v Eskandari (2004) 134 FCR 569 confirmed this view when considering whether the Commissioner's discretion should be exercised in regard to losses incurred in a migration consultancy business. When looking at the type of activities referred to by the note and the EM, Stone J stated at FCA 31: Such activities have an inherent characteristic that cannot be overcome by conducting the business activity in a different way but only by changing the nature of the business. And further at FCA 32: In my view, the phrase 'because of its nature' in s 35-55 indicates that the failure must be a result of some inherent feature that the taxpayer's business activity has in common with business activities of that type. Therefore, 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 make a tax profit. The discretion is not intended to be available where the failure to make a profit is for other reasons. Taxation Ruling TR 2007/6 provides the following example of a situation in which the Commissioner was not able to exercise the discretion. Although the example specifically deals with paragraph 35-55(1)(b) of the ITAA 1997 the inadmissibility of subjective considerations is relevant. Example 9 Andrew started a clock repair business in the 2001 income year. Andrew was new to the region and the industry and had yet to establish his clientele. Andrew had intended to operate his business full time but as his funding was very limited he chose to continue with his part time employment to support himself and only worked on his business activity in his spare time. Andrew's premises are in the back of a small arcade and he only opens for business on weekends while the other shops in the arcade are open every day of the week. The arcade is not in an area that attracts business on weekends. Andrew cannot afford advertising and has so few clients that he is unable to cover his expenses and has made losses each year. Andrew's business has yet to satisfy one of the four tests. Other businesses of this type are able to satisfy a test in the first year of operation. The inability of Andrew's business activity to satisfy any of the four tests is due to his personal business choices as to hours of business, location and advertising, not any inherent characteristics that affect clock repair businesses. Accordingly the requirement of subparagraph 35-55(1)(b)(i) is not met and the Commissioner would not exercise the discretion. In your case, you do not meet the income requirement as your income for the purposes of paragraph 35-55(1)(c) of the ITAA 1997 is more than $250,000 for the 200X financial year. Therefore the Commissioner's discretion is required to claim the losses in the year ending 30 June 20XX. In order to exercise the discretion, the Commissioner must be satisfied that there is an objective expectation, based on evidence from independent sources, that your business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period (paragraph 35-55(1)(c) of the ITAA 1997). We confirm that the discretion is permitted to be applied in circumstances where the activities of the business produce some assessable income, but that which is not greater than the deductions attributable to it provided the taxpayer is within the commercially viable period for the industry concerned and a commercial crop has yet to be produced. You have supplied evidence from an agricultural consultant stating that it is not unexpected for a farming operation of this scale to take five to seven years to achieve commercial viability However the independent evidence you have provided is made in relation to the scale of your business, a subjective factor. The commercially viable period must be taken from the industry as a whole without consideration to the size and scale of the enterprise. You had initially intended to make a profit by the 20YY financial year. However you revised projections and have asked for the Commissioner to exercise his discretion up to and including the 2014-15 financial year. You submit that the primary reason as to why your expectations have changed is because of the introduction of the income requirement and its effect on your ability to fund your operations. Your decision to incur significant capital expenditure in the earlier stages of your activity and your inability to utilise your business losses are not inherent features of your industry but particular to your situation. Your delay in returning a tax profit is primarily due to your personal business choices and whilst we appreciate the changes to the legislation have affected the way you carry out your business, this does not alter the commercially viable period applicable to your activity. To conclude, the introduction of the income requirement does not alter the requirement that a commercially viable period from planting to maturity or one full birth to sale cycle in terms of livestock must be used for the purpose of the Commissioner's discretion. It follows the Commissioner cannot exercise his discretion in your case because the objective commercially viable period has expired.

Relevant facts: You are carrying on a farming activity consisting of livestock, wool and hay sales | At the commencement of the business you expected the activities of the business to make a profit within approximately four to five years, being the year ending 30 June 20XX. This four to five year lead time was based upon initial income and expenditure projections | You purchased this farming equipment for the business on the basis that you would be able to offset this expenditure of the business against your other assessable income. | Had you known of the Treasurer's intention to introduce the income requirement to the non-commercial loss rules it is likely that you would have altered your business plan and continued to use old farming equipment and, where necessary, engage the services of contractors who owned any additional farming equipment, to provide the services | Following the introduction of the income requirement you drafted a revised, income and expenditure projection of the business in an attempt to reduce expenditure as the business was unable to find the activities outlined in the initial plan. | You have provided a letter from an agricultural consultant. | You have asked for the Commissioner to exercise his discretion for the relevant financial years.