Private ruling: Commissioners discretion for non-commercial losses
Date of advice: 25 June 2018
Published: September 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2016

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 primary production business activity in your calculation of taxable income for the 2016-17 financial year? | 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 commenced your business over 40 years ago. The business is primarily concerned with farming. Your business has made profit in previous financial years. You leased your property out for approximately 10 years whereby you leased the property to a third party. You paid all the relevant expenses associated with the property and received a share of the profits. You ceased the lease arrangement, and when you took over the farming operations you incurred expenses to complete repairs on the property. You incurred a loss as a result of the repair expenditure. You expect to return a profit in the 2017-18 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)(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 meet the income requirement and you pass one of the four tests ● the exceptions apply ● 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 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 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. ● there is an objective expectation your business activity will produce a tax profit within the commercially viable period for your industry. Having regard to your full circumstances, it is not accepted that it is in the nature of the business activity that has prevented you from making a profit. Taxation Ruling TR 2007/6 states that the ‘lead time’ discretion provided for by 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. The ‘lead time’ discretion is not available once a business activity has made a tax profit. This is because it is then clear that there is nothing inherent in the nature of the business activity that prevents a tax profit from being made. The only exception to this is where a business activity makes a tax profit on a one-off basis during the initial ‘lead time’ period. For example, a forestry operation may have a lead time of 20 years before harvesting its trees but may make a one-off tax profit in an earlier year due to a thinning operation. In that case, the one-off tax profit would not affect the lead time period. In your case it is apparent that your business did not have an initial period where a tax profit could not be made due to the nature of the business activity. The fact that your primary production business made several tax profits in its earliest years shows that there was no initial ‘lead time’ period required for it to make a tax profit. The tax profits that your business made were not one-offs that fall within the exception discussed above. Also, where an operator chooses to carry on the business activities in a manner that does not produce a tax profit within the period that is commercially viable for the industry concerned, paragraph 35-55(1)(c) of the ITAA 1997 may not be satisfied. 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 needing to build up a client base, or 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. It appears that a significant contributor to the losses of the business in the 2016-17 financial year is the significant expenditure you made to make repairs to the property. This expenditure was incurred following a period where you had entered into a share farming arrangement (for approximately 10 years where you leased the property to a third party), and once you took over the property following the share farming arrangement you determined that these repairs were required. Whilst we acknowledge the need for these repairs, the additional expenditure you incurred is an individual circumstance affecting your particular business activity rather than an inherent characteristic that affects all businesses in the industry. As such, the discretion cannot be exercised on the basis that additional expenditure and repairs were required. Therefore, for the reasons stated above, the Commissioner is unable to exercise the ‘lead time’ discretion in paragraph 35-55(1)(c) of the ITAA 1997 with respect to the 2016-17 financial year.