Private ruling: Commissioner's discretion for lead time and special circumstances
Date of advice: 19 September 2017
Published: February 2018
Ruling period: Year ended 30 June 2016 to 30 June 2018
Date scheme commenced: 1 July 2015

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 stock breeding business activity in your calculation of taxable income for the 2016-17 and 2017-18 financial years? | 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 crop business activity in your calculation of taxable income for the 2015-16 to 2017-18 financial years? | A2: No | Q3: If the answer to Question 2 is no, will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 to allow you to include any losses from your business activity in your calculation of taxable income for the 2015-16 to 2017-18 financial years? | A3: No

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 two activities in a partnership. The business activities are primarily concerned with trees and breeding stock. You commenced the tree activity in the 20XX-XX financial year. The land was established in 20XX. X acres were fertilised and strip grazed. X trees were planted in 20XX and 20XX. Initially the soil was degraded and was in need of substantial improvement. You undertook soil tests and soil improvements in July 20XX, February 20XX, January 20XX, April 20XX, November 20XX and May 20XX. The method that you used was an organic approach. This method is notably slower than other commonly used methods in the industry. You have advised that the soil has experienced issues since the initial improvement. You have provided independent evidence that shows the maximum allowable lead time for the trees is X years. It is expected that it will be at least a further five years before the trees are producing enough product to market commercially. You also submit that your activity has been continuously affected by pests in the area which have been damaging the trees since they were planted. You advise that these issues have been large factors in why it has taken additional time to produce assessable income from the trees. You have only recently started to install tree protection measures to alleviate the pest problem. You would also like to install a fence to keep the pests out; however the installation of the fence will be a large expense for the business. You may also have to install bird netting to protect the trees from further damage. You commenced the stock farming activity in the 20XX-XX financial year. You will purchase X head of stock in the 20XX-XX financial year to start your breeding business. You chose this number of stock to start with to keep costs down and to reduce the work hours involved in running the activity for yourself and your partner. You undertook research into breeds and determined which breed is the most suitable for your size and conditions. The gestation period of the breed of stock chosen is between X and X days. The expected holding time for the young stock is between X and X weeks. The stock breeding activity is expected to make a profit in the 20XX-XX financial 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) and | 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 the discretion. In your situation, you do not satisfy the income requirement and you do not come under any of the exceptions. | Detailed Reasoning - Stock breeding: The relevant discretion may be exercised for the income 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. This discretion is intended to cover a business activity where there is an inherent period of time between the commencement of the activity and the production of assessable income greater than the deductions attributable to it. For example: forestry, viticulture and certain horticultural activities. The note following paragraph 35-55(1)(c) of the ITAA 1997 does not support any view that the discretion should be exercised for any start-up activity that is yet to produce assessable income greater than the deductions attributable to it simply because of the small scale on which it was started. In your case you commenced your business operations in the 20XX-XX financial year. You will start the activity with X head of stock which will be purchased in the 20XX-XX financial year. A business decision was made to start your activity small to keep costs down and reduce the work hours for the partners. Therefore, the Commissioner cannot exercise the ‘lead time’ discretion in paragraph 35-55(1)(c) of the ITAA 1997 with respect to the 20XX-XX and 20XX-XX financial years. | Detailed Reasoning - Lead time: The relevant discretion may be exercised for the income 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. Taxation Ruling TR2007/6 states that the ‘lead time’ discretion provided for 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 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. In your case, your trees were planted in 20XX and 20XX. The maximum lead time allowable for your trees is X years. The lead time on your activity expires in the 20XX-XX financial year and it would be expected that your activity would produce a profit in the 20XX-XX financial year. You have advised that the activity struggled with the quality of the soil, which has delayed the production of earning assessable income from the trees. When you purchased the property, the soil was compacted down and required extensive work to develop the land for the trees. Even though the soil quality was low, the trees were still planted. The soil quality is an individual circumstance affecting your particular business activity rather than an inherent characteristic that affects all businesses in the industry. The soil quality does not alter the requirement that a commercially viable period of maximum five years must be used for the purpose of the Commissioner’s discretion. Accordingly, the Commissioner cannot exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 for the 20XX-XX to 20XX-XX financial years as the objective commercially viable period of X years will have expired before your business will produce a tax profit within the commercially viable period for your industry. | Detailed Reasoning - Special circumstances: Where your business activity is affected by special circumstances outside of your control, the Commissioner may exercise his discretion. The special circumstances must be outside the control of the operators of the business activity. Such circumstances are specifically defined to include drought, flood, bushfire or some other natural disaster. In the case of other events, failure for no adequate reason to adopt practices commonly used in an industry to prevent or reduce the effects of special circumstances may point to the special circumstances not being outside the control of the operator. In your case, you have only recently started to implement strategies to reduce the affects the pests are having on your trees. The question that must also be addressed is whether the situation described is considered special circumstances. It is not accepted that these circumstances constitute special circumstances in the way this term is used in the legislation. We believe these occurrences to be standard risks of carrying out a business in your industry and are not unusual or out of the ordinary. Therefore, the Commissioner cannot exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the 20XX-XX to 20XX-XX financial years.