Private ruling: Commissioner's discretion for non-commercial losses
Date of advice: 20 July 2017
Published: November 2017
Ruling period: Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017
Date scheme commenced: 1 July 2013

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 business activity in your calculation of taxable income for the 2013-14, 2014-15, 2015-16 and 2016-17 financial years? | A1: No

Relevant facts and circumstances: Your income for non-commercial loss purposes was more than $250,000 in the 2013-14, 2014-15 and 2015-16 financial years and is expected to be more than $250,000 in the 2016-17 financial year. Property You purchased a property approximately 15 years ago to run livestock. At the time of purchase, the entire property was extremely run down and dilapidated. You have undertaken the following improvements with the aim of having a sustainable and viable business ● Work done to all paddocks to improve the quality of the pastures to enable the property to carry a greater number of livestock and also improve the average kilo weight of the livestock. ● Shed and stock yard repairs. ● Fence replacements ● Improvements to the dams and bore on the property to provide a more sustainable and constant water supply for the livestock. ● More than 500 trees have been planted. As the bulk of the improvements have been made to the property, the sub-contract labour hire costs have been significantly reduced in the 2015-16 financial year. In 2014 the sub-contract labour hire costs represented more than 50% of total costs. In 2015 the subcontract labour hire costs represented more than 50% of total costs. Livestock Numbers You have provided information regarding the number of opening stock, natural increase and closing stock of the livestock on the property. You have advised that the natural increase numbers should be close to opening stock numbers. This did not occur in the years from 2010-11 to 2015-16 and was extremely low in the 2015-16 year. In the 2015-16 year, you sold off substantial stock to generate income as livestock prices were very high. In the years from 2010-11 to 2015-16 , the older females were sold before they had offspring and therefore the natural increase numbers were low. This was considered to be a better economic outcome at the time. You have advised that in 2016-17 and 2017-18 this will not be the case as the pasture quality is excellent , there is abundant bore and dam water, and livestock prices are extremely strong. You have advised that currently all of the herd are in calf. It is envisaged that all of the herd will produce offspring. All offspring will be sold and additional pregnant animals will be purchased. Therefore, the herd size will increase to the optimal level. These animals will produce offspring which will be sold. The herd will then be maintained at this level to ensure the carrying capacity of the property is not compromised. Based on current prices, revenue will be derived. This income will be earned in the 2017-18 financial year and will also mean that the business will produce a profit in that year. Similar revenues are expected to be earned in future financial years assuming livestock prices remain relatively stable. Drought You have advised that bad drought periods (annual rainfall less than 600mls) occurred in the 2002 and 2006 years. You have advised that moderate drought periods (annual rainfall less than 700mls) occurred in the 2003, 2004, 2009 and 2014 years. You have also advised that the timing of the rainfall is also important. Poor rainfall during Autumn and Winter months impacts on the quality growing of pasture in Spring. Rainfall in the 2016 and 2017 years has been very good which will flow through in the 2017 and 2018 operating results. Drought impact You have provided the following information in relation to how the drought has impacted on your property. Drought Impact 2013-14 In reviewing the 2013-14 year, the rainfall received over the months of July, August and September, 2012 is relevant in terms of the natural increase of the herd. The rainfall for that period was in the order of 60mls which was very low. This meant that the livestock in the herd were not in the best condition in terms of their weight and overall health prior to mating in October. As a result the natural increase for the year was a poor result. You reluctantly sold some livestock at very depressed prices. This produced two poor outcomes, one being poor sales revenue and the other being a significant reduction in the size of the herd. The significant cost increases in this year was the reduction of the gross profit margin and agricultural supplies, including fertilizer. A much higher number of livestock was sold in this year when compared to other years, but at much reduced prices per head. Drought Impact 2014-15 In reviewing the 2014-15 year, the rainfall received over the months of July, August and September 2013 is relevant in terms of the natural increase of the herd. The rainfall for that period was in the order of 75mls which was again very poor. This meant that the livestock in the herd were not in the best condition in terms of their weight and overall health prior to mating in October. As a result, the natural increase for the year was a better result than 2013-14 but was still considered to be only a reasonable result. You decided to sell approximately 50% less livestock in this year compared to 2013-14. This generated similar revenue to 2013-14 and allowed you to get the herd number back to the optimal level. Drought Impact 2015-16 In reviewing the 2015-16 year, the rainfall received over the months of July, August and September 2014 is relevant in terms of the natural increase of the herd. The rainfall for that period was in the order of 225mls which was good. Whilst the livestock were in good condition in terms of their weight and overall health prior to mating, for some unexplained reason the natural increase for the year was small. In order to maintain the herd, you purchased further livestock. You also sold some livestock at very good prices and was able to keep the herd number at only 10% less than the optimal target. Ultimately, the loss for the year was very significantly reduced in comparison to previous years and is an indication of the business about to achieve its aim of being profitable in the long term. Drought Impact 2016-17 In reviewing the 201617 year, the rainfall received over the months of July, August and September 2015 is relevant in terms of the natural increase of the herd. The rainfall for that period was in the order of 250mls which was good again. The livestock were in good condition and as a result the natural increase for this year is high. This is well up on previous years. Some livestock have been sold at excellent prices and the herd is back at the optimal level. Financial Information You provided profit and loss statements for the 2013-14, 2014-15 and 2015-16 financial years which showed that the business was in a net loss position in each year. Interim financial figures are not available for the 2016-17 financial year, but you have advised that the operating result will be a small profit. You have provided a detailed projection for the 2017-18 financial year which shows that the business will be in a net profit position.

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

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. The relevant discretion may be exercised for the financial year 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 constitutes special circumstances. The rainfall data from the Bureau of Meteorology website confirms that there were drought periods in the area of the property. The information confirms bad drought periods occurred in the 2002 and 2006 years. The figures also confirm moderate drought periods occurred in the 2003, 2004, 2009 and 2014 years. 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. The following considerations lead us to believe that had the special circumstances not occurred the business still would have returned a loss. You provided some general information about how your expenses and income were affected by the drought and the details of improvements made to the property. You advised that you have repaired the hay shed and fully secured the stock yards. You further advised that you have conducted an extensive replacement program of the fences on the property as they were in a poor condition when you purchased the property. You also provided information that most of the dams on the property have been dredged in order to increase their holding volume. You also re-drilled the bore to provide a more sustainable and constant water supply for the livestock. You have reduced the sub-contract labour hire costs in the 2015-16 financial year. As the bulk of improvements have now been made to the property, these costs will continue to reduce in future financial years. You have advised that the optimum herd size for the property which will produce sufficient offspring to be sold. You anticipate that at the carrying capacity will enable you to generate revenue for the 2017-18 financial year onwards, assuming livestock prices remain relatively stable. You have provided figures for livestock numbers which show that you only held the optimal number of livestock for one year in the 2014-15 year, and still suffered a net loss. Your business operation made net losses for the 2013-14, 2014-15 and the 2015-16 financial years. Obviously the drought conditions have contributed to the losses incurred in these years but this is not sufficient for the Commissioner to be able to exercise the special circumstances discretion. He must be satisfied that you would have made a profit but for the drought. Your farm has been in operation since 2002. It has never made a profit. Your losses for the 2013-14, 2014-15, 2015-16 financial years are sizeable. It is not disputed that the drought has affected your business and contributed to the extent of the losses. However, you have not demonstrated that your farm would have made a profit in the 2013-14, 2014-15, 2015-16, 2016-17 financial years but for the drought. Therefore, the Commissioner is not able to exercise the special circumstances discretion for these years. Therefore, the Commissioner is unable to exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the years in question.