Private ruling: Non-commercial losses
Published: April 2012

Ruling: 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 activity in your calculation of taxable income for the 2009-10 to 2012-13 financial years? | Answer: No | 1 July 2006

Relevant facts and circumstances: You do not satisfy the income requirement set out in subsection 35-10(2E) of the ITAA 1997. You operate a primary production business trading in livestock. You commenced business in the 2006-07 financial year. You expect to make a tax profit in the 2013-14 financial year. You acquired the property in a run down state, had suffered decades of asset decay and required significant infrastructure investment. Existing fences were in a state of disrepair and required replacement. You implemented a land improvement policy focusing on three major areas: soil quality, water conservation and protection from outside elements. Land and infrastructure improvements were performed in a phased approach over an extended period to allow the cost of improvements to be spread over several years as finances permitted You have provided evidence as to the commercially viable period of 5-8 years for your industry. 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 satisfy the income requirement and you pass one of the four tests · the exceptions apply · the Commissioner exercises his 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 years of income under consideration. Your 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 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. The phrase 'objection expectation' was discussed in the Administrative Appeals Tribunal case of Scott v. Commissioner of Taxation [2006] AATA 542; VS2005/31-33, where it was said: …in determining a commercially viable period, the test is primarily an objective one based on independent sources. According to the Commissioner, this approach was taken by the Federal Court in Commissioner of Taxation v Eskandari (2004) 134 FCR 569 where Stone J said, at 581-582: In some cases it may be a straight forward exercise to identify the industry in which the business activity takes place. Some industries are well-established and the basis for an ''objective expectation'' can readily be based on a comparison between the tax payer's business and other businesses within that industry, particularly where businesses or business associations within the industry produce material such as annual reports or industry papers ... Despite what Stone J said, Mr Scott contended that there were other circumstances which had to be taken into account when determining the commercially viable period expressed in the Olives Australia document. However, according to the Commissioner, this is impermissible because, as the Federal Court held in Eskandari , in most cases only objective material will be considered. It is only where, because of the nature of the industry, there is very little or no objective evidence that recourse may be had to the circumstances of the tax payer. That is not the case in the olive industry, which has been established for centuries. I agree with that submission. 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. Further, in the case of Scott , additional plantings made at a later time were not permitted to be included in the commercially viable period, as follows: 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 sole reliance on objection evidence and the impermissibility of subjective considerations was further emphasised in the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 as follows: 2.30 The taxpayer is required to establish objectively that the business is commercial in nature and will become profitable in a commercially viable timeframe. Objective evidence from independent sources can include evidence from an individual or organisation experienced in the relevant industry, such as industry or regulatory bodies, tertiary institutions, industry specialists, professional associations, government agencies or other independent entities with a similar successful business activity. Evidence from independent sources can also include evidence from business advisers (such as business plans), financiers and banks. 2.34 For taxpayers that do not meet the income requirement, the Commissioner may exercise a discretion after an application by a taxpayer, where the Commissioner is satisfied that - based on evidence from independent sources - the business will produce assessable income greater than available deductions, in a timeframe that is considered commercially viable for the industry concerned. 2.35 The discretion is not intended to be available in cases 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. Further, the Explanatory Memorandum provides the following relevant example: Tracey carries on a business of primary production from breeding and selling cattle. Their profit projections indicate that they do not expect to make a tax profit for six years. Independent evidence provided by Tracey indicates the lead time period begins from the commencement of the activity and includes the time taken to raise the females to a breeding age, allowing for the gestation period of those animals to finish, and finishes when the progeny have reached a saleable age. On the evidence provided, the period for a typical business activity of breeding and selling cattle to become commercially viable is no greater than three years. Therefore, Tracey will not be able to produce a tax profit within a period that is commercially viable for the industry concerned and the Commissioner will not be able to exercise the discretion to allow the losses. In your case, you purchased a property in a run down state and have chosen to carry out improvements over an extended period to allow the cost of improvements to be spread over several years. You intend to make a tax profit in the 2013-14 financial year, seven years after commencing business The run down state and neglect of the property by the previous owner, your decision to carry out infrastructure and land improvements using a phased over an extended period time and your method of financing are subjective and impermissible considerations, as affirmed in the cases of Eskandari and Stone. These features cannot be used as determinative factors in this private ruling. You have provided evidence from various sources which provides for time period of 5-8 years to achieve profitability. However this time period takes into account the sub-optimal condition of the property when purchased and your methods of financing. These factors are subjective and based on characteristics specific to your situation and not indicative of the industry as a whole. As per the example provided in the Explanatory Memorandum, the Commissioner considers the commercially viable period of an activity such as yours to be 3 years. Your activity has produced significant income since the 2008-09 financial year as shown in the budgets you have provided. It stands then that that the start up period inherent to the nature of your activity is over. To conclude, your purchase of the property in a neglected state does not alter the requirement that a commercially viable period of 3 years must be used for the purpose of the Commissioner's discretion. It follows the Commissioner cannot exercise his discretion in your case because the objective commercially viable period of has expired.

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