Private ruling: Commissioner's discretion - non-commercial losses
Date of advice: 23 June 2022
Published: October 2022
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

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 financial year? | A1: No.

Relevant facts and circumstances: You operate a primary production business. The business is operated by you with the use of contractors as required. The long-term plan is to improve the property and build breeders to increase future profitability. Most operators in the area have de-stocked due to the drought conditions. The state Government published their drought declarations via website, the archives show your region was drought declared. During the relevant income tax year, you did not experience a significant reduction of revenue. However, the drought affected your decisions regarding keeping livestock and to sell based on the costs directly related to the drought. Your profit and loss statement for the income tax year report your livestock sales increased during the relevant financial year Your total profit (prior to deducting business expenses) also increased in the income tax year. Your holding of livestock increased during the year. During the income tax year, you incurred significant costs to drill new bores, construct and fix dams, install new water tanks, improve pastures and purchase fodder. You incurred expenses to improve and maintain property infrastructure to increase future profitability and maintain stock levels. You have pastured land and had been trying to grow your own fodder. However, you contend the drought has impacted the growth of the fodder causing it not to grow. You had to purchase fodder externally and tried improvements, such as irrigation to improve the land. The depreciation (small items) included the purchase of assets and construction work. The total sum of assets purchased in the income year and depreciated in full. Prior to operating the primary production business as a sole trader, you were involved in a partnership. The partnership ceased, having had profits for several years previously. Previously five out of the six financial years have resulted in an overall loss. Your non-farm income is from a non-primary production business. Due to Covid19 pandemic conditions there were unprecedented profits resulting in you failing to meet the $250,000 income requirement threshold. Covid19 had significantly increased the non-primary production sales during the financial year. The profits from the non-primary production business were used to keep the primary production business operational during the past years of drought.

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

Reasons for decision: Summary: For the 2009-10 and later income 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. Section 35-10 of the ITAA 1997 provides that an income requirement must be met (along with certain other tests), in order to include losses from a business activity in your taxable income calculation. If the income requirement is not met, the Commissioner may exercise his discretion to allow the inclusion of the losses. | Detailed Reasoning - Special circumstances: 'Special circumstances' are those circumstances which are sufficiently different or unusual, out of the ordinary 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 (refer to Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion, paragraphs 47 to 53). The special circumstances, outside your control, are considered if they prevented you (the taxpayer) from passing one of the four tests or from making a tax profit. This would not include ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity (TR 2007/6 paragraph 47). A taxpayer will satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 if their income for non-commercial loss purposes is less than $250,000. In your case, you do not satisfy the income requirement for the financial year as your income for non-commercial loss purposes was above $250,000. The Commissioner does not have a discretion where the special circumstances affect the $250,000 income requirement. For individuals who do not satisfy the income requirement, the business activity must have been materially affected by 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 (Taxation Ruling TR 2007/6 paragraph 41D). In your case, you stated that the loss was incurred due to drought conditions, which have impacted on profit making abilities for several years. The profits from the other business activity have been used to keep the farm operational during the drought. If not for these profits the farm would not remain operational. | Detailed Reasoning - Revenue from livestock sales: Your profit and loss statement shows the farm's turnover increased during the income year. The turnover more than doubled compared to the reported turnover of the prior income year. The increase in revenue during the income year does not reflect circumstances that indicate the turnover was impacted by drought. You have advised the drought has affected your decisions concerning your livestock. You've needed to decide how much livestock to purchase, keep and to sell based on the costs directly related to the drought. During the relevant year the number of your livestock increased. This reflects the business decisions you made during the year. The special circumstances provided do not warrant the losses to be offset against other income as a profit was only made once previously. In addition, you advised there has not been a significant reduction of revenue directly related to the drought. The figures from the farm profit and loss statement show that the livestock sales had more than doubled and total profit tripled. The circumstances outlined can be compared to those in Example 7A at paragraph 129A of TR 2007/6. Focusing on paragraph 129E, if the business had not made a profit in recent times, and was not reasonably expected to do so in the future, just by satisfying one of the tests, would not indicate that it was unreasonable for losses to be deferred. This would apply where you were impacted by special circumstances to some extent, but not to the extent a profit would be made without the special circumstances. | Detailed Reasoning - Temporary full expensing - depreciation and other expenses: A taxpayer has a choice whether to apply the temporary full expensing provisions in relation to the purchase of their assets for their business (refer to Law Companion Ruling LCR 2021/3 Temporary full expensing, paragraphs 86-88). Alternatively, they may choose to instead apply the general depreciation rules in Division 40 of the ITAA 1997 (LCR 2021/3 paragraphs 150, 154 and 155). For example, during the income tax year you acquired an asset. Normally, the effective life for the asset is several years (refer to Taxation Ruling TR 2020/3); and section 40-102 of ITAA 1997 provides a capped life for the asset. However, you have chosen to apply the temporary full expensing provisions to claim the cost of the asset in full. Paragraph 13A of TR 2007/6 describes how the Commissioner's discretion may be exercised for the income year(s) in question where: • but for the special circumstances, the business activity would have made a tax profit; and • the activity passes at least one of the four tests or, but for the special circumstances, would have passed at least one of the four tests. Paragraph 14 of this ruling states that the special circumstances must be outside the control of the operators of the business activity. For the income year, you incurred such expenses as depreciation, repairs and maintenance and plant hire to improve and maintain the property and farming operations. You incurred increased fodder costs to feed your livestock but this cost is relatively small compared to the other costs. The losses described in your application have not resulted from drought or circumstances beyond your control. These expenses have contributed to the loss in the income tax year. The expenditure reflects business decisions you have made to improve the farm and maintain its operation. You have chosen to claim the favourable tax provisions offered in the income tax year. Choosing to apply the temporary full expensing provisions to your income tax year does not constitute special circumstances to allow the exercising of the Commissioner's discretion. In conclusion, the Commissioner does not consider it to be unreasonable for the non-commercial rules to apply and will not exercise the discretion to allow you to include any loss from the farming activity in the calculation of the taxable income for the financial year. The loss from the business will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997.