Private ruling: Non-commercial losses-Commissioner's discretion
Published: April 2013
Ruling period: Year ending 30 June 2014 | Year ending 30 June 2015
Date scheme commenced: 1 July 2012

Ruling: Q1: 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 primary production activity in your calculation of taxable income for the relevant years of income? | A1: No. | Q2: 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 activity in your calculation of taxable income for the relevant years of income? | A2: No.

Relevant facts and circumstances: The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: · your letter and the application for private ruling, · financial reports for the specific years, · monthly rainfall summary for the specific years, · Prime Minister's media release, flood assistance, · flood assistance notification dated 5 September 2011, · consolidated budget, · original summary of financial predictions for the relevant years of income. · amended summary of financial predictions for the relevant years of income Your first private ruling exercised the Commissioner's discretion for the relevant years of income as you initially estimated a profit to be made in the subsequent year of income. However the initial estimate did not include capital allowances or interest. The revised estimates indicate that a profit would not have been made in any of the relevant years. Your application explains the estimates are based on a benchmarking report and you now expect to make a tax profit in the 20XX year of income. You commenced your primary production activity in 19YY on properties that supported commercially viable primary production activities prior to being acquired by you. You state that the nature of the activity and special circumstance has delayed the profit expected until the 20XX year of income and that the nature of farming requires increasing the scale of business to produce a taxable profit. Also the losses now being incurred in respect of the properties are a result of the water conservation write off and depreciation from the significant improvements made. The special circumstances delaying the projected tax profit include drought, floods and disease. You do not satisfy the income requirement set out in subsection 35-10(2E) of the ITAA 1997

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) | 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 satisfy 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 you do not come under any of the exceptions. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion. | Detailed Reasoning - Special circumstances: The relevant discretion may be exercised for the year of income in question where your business activity is affected by special circumstances outside your control. '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, 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 · the activity passes at least one of the four tests or, but for the special circumstances, would have passed one of the four tests. It is accepted in your case that the drought, floods and disease constitutes special circumstances. However, this in itself is not sufficient for the discretion to be exercised. The Commissioner must also be satisfied that your activity would have made a profit but for the special circumstances. That is, the special circumstances discretion can only be exercised where it can be seen that it was only the special circumstances which caused a loss to be made. You have stated that the tax losses now being incurred in respect of the properties are as a result of the water conservation write off and depreciation from the significant improvements. Therefore had the special circumstances not occurred the business still would have returned a loss. | Detailed Reasoning - Because of its nature: The following has been extracted from paragraphs 77 and 78 of Taxation Ruling TR 2007/6 to provide the meaning of 'because of its nature': 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. The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity and would not result in the requirements of subparagraphs 35-55(1)(b)(i) and (c)(i) being met. You commenced your farming activities in 19XX on the properties that already carried on commercially viable primary production activities prior to you obtaining them. You made significant investments to change the business model to being one of high input/ high output, with the capital input costs initially required to improve pastures, improve water irrigation and increase livestock numbers and quality. Significant improvements have been made to both properties and you have invested considerable funds to re-establish the farm infrastructure on both properties, replace the livestock and re-establish the pastures. Paragraph 79 of TR 2007/6 states: The inherent characteristics may be present for an initial period from the time the business activity commences. After that initial period has elapsed, which can be several years, the inherent characteristics may cease to be the cause of business activities of the type in question being unable to satisfy any of the statutory tests. The tribunal in Applicant 1761 of 2011 and Commissioner of Taxation [2011] AATA 779 stated at paragraph 22 and 24: …do not support a conclusion that it is in the nature of the activity of beef cattle production that it takes more than two decades or anything like that to produce assessable income greater than the deductions attributable to it. There is nothing in the Seer report which would support such a conclusion. Instead, what is revealed by the facts comprising the "scheme" is a series of idiosyncratic, managerial choices made by the Applicant as to how to go about the business activity. That he was able to continue the business activity for all of these years and to make these choices was not, on the evidence, because of the nature of that business activity at all but rather because of his ready access either to funding from his own other resources or from external financiers. These have enabled him to expand his property holdings, to improve his properties and progressively to acquire particular plant and equipment. The Applicant was and remains perfectly entitled to make such choices in conducting his business activity. However, not every managerial reaction to events encountered in the course of a business activity or measure designed to achieve economies of scale is to be regarded as having occurred because of the nature of that activity. Our conclusion is that the criterion specified in s 35-55(1)(c)(i) is not satisfied in respect of any of the excluded years for the business activity conducted by the Applicant. The failure to make a profit since 19XX is not due to the inherent characteristics of a primary production activity rather it is the consequences of your business choices, namely making significant investments to change the business model to being one of high input/ high output, with significant capital input costs. Paragraph 35-55(1)(c) of the ITAA 1997 has two criteria that must each be satisfied. The conclusion that the first criterion has not been met, in that the failure to make a tax profit in your primary production activity is not an inherent characteristic of your primary production activity means that it is not necessary to consider whether the second criterion, regarding the commercially viable period, has been met. However the comments of the Tribunal in Applicant 1761 of 2011 and Commissioner of Taxation [2011] AATA 779 paragraph 27 explains how this period is viewed: …whether, as a matter of objective expectation, the Applicant's business activity will produce the excess of assessable income specified. In so doing, we must act on objective evidence where available. On that evidence, six years is a commercially viable period. But that period runs from when the business activity commences… Your primary production activity commenced in 19XX and prior to that time the properties were carried on as commercially viable activities therefore the commencement of the commercially viable period started prior to the acquisition date of the properties. Furthermore if the commencement of the commercially viable was considered to have started when you acquired the properties, taking another approximately 15 years to produce a profit is not considered to be within the accepted period for your type of primary production. Therefore, the Commissioner will not exercise his discretion under paragraph 35-55(1)(a) or 35-55(1)(c) of the ITAA 1997 for the years in question.