Private ruling: Non-commercial losses and the Commissioner’s discretion for special circumstances.
Date of advice: 9 January 2019
Published: April 2019
Ruling period: Year ended 30 June 20XX | Year ended 30 June 20XX | Year ending 30 June 20XX | Year ending 30 June 20XX | Year ending 30 June 20XX | Year ending 30 June 20XX | Year ending 30 June 20XX
Date scheme commenced: XX/XX/20XX

Ruling: Q1: Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the Income Tax Assessment Act (ITAA 1997) to allow you to include any losses from your primary production business activity in your calculation of taxable income for the income years ruled on? | A1: 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 a primary production business activity which commenced in 20XX. You submit that your business was affected by special circumstances in the 20XX-XX to 20XX-XX income years. You have submitted the following evidence to substantiate your claim: ● Bureau of Meteorology report on the Millennium Drought which peaked from 20XX to 20XX. You submit that the special circumstances impacted on the profitability of your business in the following ways: ● During this period the region experienced the lowest decile of rainfall on record. ● With very limited rainfall there was no run-off during this time and hence the irrigation dam failed to collect water. ● During the first seven years of business there was no irrigation water and only limited rainfall. ● The first few years are critical in establishing the growth of the trees and as there was limited water available the trees failed to thrive during this time. ● The trees grew very slowly and failed to produce a commercial crop. ● The first limited commercial crop was not achieved until the winter of 20XX as a result of rainfall in 20XX. During the drought you implemented practices such as extensive mulching to assist the tree growth and as a result less than 2% of the trees were lost. You have advised that since the Millennium Drought the rainfall in the region has fluctuated. You have not provided any evidence which indicates that the region was in drought from 20XX onwards, only that the region has experienced fluctuating rainfall. Up to the 20XX-XX income year, the business had yet to make a tax profit. You have projected that from the 20XX-XX income year onwards, the business will make a profit in every second year and a loss in the alternate years as you anticipate that your trees will have significant alternate year bearing tendencies. You have provided a reference that states that the phenomenon of alternate bearing can be mitigated by summer pruning and sophisticated irrigation. You have previously received a favourable private ruling for the Commissioner’s discretion for lead time for the 20XX-XX to 20XX-XX income years. For that private ruling application, you projected that your farming business would make a tax profit in the 20XX-XX income 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)

Reasons for decision: Summary: For the 20XX-XX 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. There are two discretions available to the Commissioner under section 35-55 of the ITAA 1997 being, lead time and special circumstances. | Detailed Reasoning - Lead time: The lead time discretion is intended to cover a business activity that has a lead time between the commencement of the activity and the production of any 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 any income. For a taxpayer who does not satisfy the income requirement the lead time discretion may be exercised where there is an objective expectation, based on evidence from independent sources that, within a period that is commercially viable for the industry concerned, the activity will produce a tax profit. | Detailed Reasoning - Special circumstances: The special circumstances 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 unusual or 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; and ● 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 sets out the Commissioner’s interpretation on the exercise of the discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 53 of this ruling: Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to special circumstances outside the control of the business activity, including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of the paragraph. These events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affected the business activity. Ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances. These fluctuations are expected to occur on a regular or recurrent basis when carrying on a business activity and affect all businesses within a particular industry. Where special circumstances occur during a business’s lead time, the lead time may be extended and the additional time is allowed under the special circumstances discretion (paragraph 51 of TR 2007/6). This is demonstrated in Example 11 in TR 2007/6. In that example the taxpayer carried on a fruit growing business that has a lead time of five to six years. During the lead time period, the business suffered a fire which destroyed some of the trees and damaged many of those remaining. The taxpayer had to re-plant 40% of the trees and the development of fruit on another 30% of the trees was set back approximately two years. In this example, the Commissioner considered it appropriate to exercise the special circumstances discretion for an additional two years beyond the lead time period. | Detailed Reasoning - Your case: You carry on a farming business. The Commissioner accepts a lead time of approximately six years for your type of farming activity. Your business commenced in 20XX. For your previous private ruling application, you projected that your business would make a tax profit in the 20XX-XX income year. On that basis, the Commissioner exercised the lead time discretion for the 20XX-XX to 20XX-XX income years. However, as at the 20XX-XX income year, your business had yet to make a tax profit. You have stated that your business activities were affected by drought in the 20XX-XX to 20XX-XX income years which impacted the growth of the trees going forward. Drought is considered special circumstances for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. We accept that for the period from the 20XX-XX to 20XX-XX income years your region was drought affected. As the drought occurred during the lead time period, as per paragraph 51 and Example 11 in TR 2007/6 the lead time may be extended and the additional time allowed under the special circumstances discretion if it is considered appropriate to do so. Generally, as in Example 11 of TR 2007/6 the extra time allowed would be an additional portion of the lead time period. It is considered the maximum further time that could be allowed is an additional full lead time period. This may be appropriate where the special circumstances caused the entire enterprise to be started from scratch with all the trees having to be replanted. In your case, although the growth of your trees was severely impacted by the drought you lost less than 2% of them. However, even if you had lost all your trees and had to replant all of them in 20XX after the drought ended, the maximum additional time the Commissioner could allow is a further six years. You have advised that the region received irregular rainfall from 20XX onwards, where some years the region received less than the average rainfall amount and other years the region received greater than the average rainfall amount. These variations would be considered to be part of normal weather fluctuations and, while the rainfall levels during this period were outside your control, they are not considered to be special circumstances. Also, the alternate bearing characteristics of the trees is not a special circumstance. It is a characteristic that affects all farmers in your industry and therefore is not unusual or different; rather it is a normal part of conducting a farming business in your industry. It has been more than six years (that is, an additional full lead time period) since the special circumstances that impacted your business (being the Millenium Drought) ended. However, your business has still yet to demonstrate that it has made a tax profit. Also, you have advised that your business will make losses in alternate years up to at least the 20XX-XX income year which will be almost 20 years after the Millenium Drought ended. Therefore, the Commissioner cannot accept that it is only the Millenium Drought which causes your business to make losses. Consequently, the Commissioner is unable to exercise the special circumstances discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the years in question.