Private ruling: Non-commercial losses
Published: October 2014
Ruling period: Year ended 30 June 2014 | Year ending 30 June 2015 | Year ending 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2013

Ruling: Q1: Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your business activity in the calculation of your taxable income for the 2013-14 financial year to the 2017-18 financial year? | A1: No.

Relevant facts and circumstances: You meet the income requirement of Division 35 of the ITAA 1997. Several years ago you bought a property in partnership with established trees. Last season you produced product from the trees. Your independent source states the trees would be productive in nine years.

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)(b)

Reasons for decision: Summary: Taking into consideration all the information that has been provided the Commissioner will not exercise the discretion under paragraph 35-55(1)(b) because the activity does not meet the following requirements: (i) because of its nature, it has not satisfied, or will not satisfy, one of the tests set out in section 35-30, 35-35, 35-40 or 35-45 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 either meet one of those tests or will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C). The year a test is passed is outside the commercially viable period. Therefore, the Commissioner will not exercise the discretion available in accordance with paragraph 35-55(1)(b) of the ITAA 1997 for the 2013-14 financial year to the 2017-18 financial year. | Detailed Reasoning - Detailed reasoning: For the 2009-10 and later income years, Division 35 of the Income Tax Assessment Act 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 • the Commissioner exercises the discretion. In your situation, none of the exceptions would apply and although you satisfy the income requirement, you do not meet any of the four tests in the year of income under consideration. Your losses are therefore subject to the deferral rule, unless the Commissioner exercises the discretion. The relevant discretion may be exercised for the income year in question where: • it is in the nature of the business activity that there will be a period of time before it can be expected to pass one of the four tests • there is an objective expectation your business activity will produce a tax profit or meet one of the four tests within a 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. 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. Paragraph 17 of Taxation Ruling TR 2007/6 deals with the exercise of the Commissioner's discretion under this subparagraph and the meaning of 'because of its nature' For the failure to satisfy one of the four tests to be 'because of its nature', the failure must be because of some inherent characteristic that the taxpayer's business activity has in common with other business activities of that type (see Federal Commissioner of Taxation v. Eskandari ). | Detailed Reasoning - 'because of its nature': Paragraphs 77 and 78 of Taxation Ruling TR 2007/6, which discusses non-commercial business losses and the Commissioner's discretion, relevantly state: 77. 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 satisfy any of the tests. The discretion is not intended to be available where the failure to satisfy one of the tests is for other reasons. 78. 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. For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is producing a loss is inherent to the nature of the business and is not peculiar to your situation. Where an operator chooses to carry on the business activities in a manner that does not pass a test within the period that is commercially viable for the industry concerned, paragraph 35-55(1)(b) of the ITAA 1997 may not be satisfied. As an example, in the case of Scott v. Commissioner of Taxation [2006] AATA 542 ( Scott's Case ) , the court upheld the Commissioner's decision in not applying the discretion. Mr Scott initially planted olive trees in 1997 and 1998. He then planted further trees in July 2000. No income was produced in the subsequent four years. The Commissioner contended that the losses fell outside the commercially viable period for that industry, which was determined on an objective basis. In relation to the commercially viable period, Mr Scott argued that there were other circumstances which should be taken into account when determining this time frame. On this issue, the court expressed the following view: It seems to me that if it were permissible to take into account subjective considerations of each individual grower, there might be an almost infinitely variable period which could be described as the commercially viable period…The fact that a grower elects not to plant sufficient trees at the outset to ensure the business is commercially viable is a decision for that individual grower. Such a grower could not expect the Commissioner to exercise his discretion under s 35-55 in his or her favour because, to do so, would effectively render nugatory the rule dealing with losses from non-commercial business activities. The Note to paragraph 35-55(1)(c) of the ITAA 1997 states that the particular 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. You have trees from ages three through to ten years old. In Scott's Case the court found that; ' The fact that a grower elects not to plant sufficient trees at the outset to ensure the business is commercially viable is a decision for that individual grower'. In your circumstances your trees had been planted at various times before you purchased the property, there were sufficient trees to produce product in the 2013-14 financial year. The commercially viable period does not commence from the date you purchased the property. It commences from when the trees were first planted and in your grove some were planted approximately three to ten years prior to you purchasing the property. As described in Scott's Case the staggered planting of trees over several years does not extend the lead time available to pass one of the tests of Division 35 of the ITAA 1997. Although you purchased the property many years after the first planting of trees, the inherent characteristics of the trees do not change. The lead time to be productive is still measured from the time of the first planting. Therefore the Commissioner is not satisfied that you have commenced a new business activity when you purchased the property. The activity commenced when the first trees were planted. You have stated that the commercially viable period for the industry is nine years. Therefore, the commercially viable period has now lapsed.