Private ruling: Non-commercial losses – Commissioner’s discretion
Date of advice: 15 November 2018
Published: February 2019
Ruling period: Financial year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

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 business activity in your calculation of taxable income? | 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 for the relevant financial year. Your business activity is rearing/selling beef cattle of a particular breed. You initially purchased a number of weaners arriving in mid-20XX and a further number arriving later in 20XX. There are several studs around the relevant state that could supply large quantities of the particular breed of cattle. You purchased weaner heifers to build your herd. You purchased a property in May 20XX with only a portion secured originally. You have a staggered purchase plan over a number of years in place to achieve commercial herd numbers. You are increasing your herd size through a mixture of natural increase and purchase of new heifers. Your current herd size is X head on X acres of land. You are currently allowing simultaneous use of your property through a long term agistment agreement. Your depreciable assets are a tractor and shed. You assess that your business activity will make a tax profit in the 20XX-XX 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: It is considered that the length of time your cattle breeding activity will require to make a tax profit is not simply a result of the nature of the activity. Rather your individual circumstances, that is, your choice to adopt a staggered approach gradually increasing your herd size, has substantially affected the period that will elapse before a tax profit is made. Another business in the same industry could make a tax profit in a substantially shorter time frame if it did not adopt a staggered purchasing approach. You have not shown that your business will produce a tax profit within the commercially viable period for the industry concerned. Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997 in relation to your cattle breeding activity for the 20XX-XX financial year. Consequently, any losses from your activity in this financial year are required to be deferred. | Detailed Reasoning - Detailed reasoning: From the 2009-10 financial year subsection 35-10(2E) of the ITAA 1997 was introduced to include an income requirement for the purposes of the non-commercial loss provisions. Consequently, if the income requirement is not met, the taxpayer must defer their business loss unless the Commissioner exercises discretion or they meet the exception. The income requirement under subsection 35-10(2E) of the ITAA 1997 is satisfied if the total of your: ● taxable income ● reportable fringe benefits ● reportable superannuation payments ● total net investment losses but ● excluding the losses from your business activity is less than $250,000. In your case, you do not meet the income requirement. Therefore, your losses from your cattle breeding activity for the 20XX-XX financial year must be deferred unless discretion is exercised. The discretion that is relevant in your circumstances is provided by paragraph 35- 55(1)(c) of the ITAA 1997. For the Commissioner to exercise this 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. That is, the reason why the business is making a loss must be due to the inherent features of the industry rather than the way the business is carried on. In order for the Commissioner to exercise this discretion, it must also be established, that there is an objective expectation, based on evidence from independent sources (where available), that your business activity will produce a tax profit within a commercially viable period for the industry concerned. 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. Taxation Ruling TR 2007/6 sets out guidelines on how the Commissioner’s discretion under paragraph 35-55(1)(c) of the ITAA 1997 may be exercised. The following has been extracted from TR 2007/6: 73A. Because the tests are not automatically relevant if the income requirement is not met, the first factor in paragraph 35-55(1)(c) considers whether it is 'because of its nature' that the activity has not produced, or will not produce, a tax profit. 76. And further at FCA 32: In my view, the phrase 'because of its nature' in s 35-55 indicates that the failure must be a result of some inherent feature that the taxpayer's business activity has in common with business activities of that type. 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. As an example, in Case 1/2013 2013 ATC 1-050; [2013] AATA 3 ( Case 1/2013 ), the AAT found that a taxpayer who staggered the planting of their vineyard over several years, so that the operation would not reach full production for approximately ten years, was not entitled to the discretion in section 35-55 of the ITAA 1997. The AAT accepted that it may be commercially prudent to approach the development of the vineyard in a gradual way, but that is not the test outlined in paragraph 35-55(1)(c) of the ITAA 1997. The AAT said it was required to look at whether the failure to produce sufficient assessable income during a given year of income was a result of some inherent feature that the taxpayer's business activity has in common with business activities of that type, in line with FC of T v Eskandari 2004 ATV 4042 . The following paragraphs from Case 1/2013 are relevant: 15. Can it be said the business, “because of its nature… will not produce… assessable income greater than the deductions attributable to it’ during the 9 year period contended for by the taxpayer? The answer to that was clear enough from Mr Greaves’ evidence – in particular, from his answer to a question from Ms Ford about whether it was possible to have the vineyard up and running within 5 years. He said it was. I accept he thought it was commercially prudent to approach the development in a more gradual way, and he may well be right. But that is not the test. I am required to look at whether the failure to produce sufficient assessable income during a given year of income was a “result of some inherent feature that the taxpayer’s business activity has in common with activities of that type”. See Federal Commissioner of Taxation v Eskandari 134 FCR 569 at [32] per Stone J. 16. Vines can be planted and become productive within 5 years. The applicant has chosen to take a more gradual approach. No one quibbles with the wisdom of her decision, and I am told it is common practice in the industry. But she is unable to satisfy the first leg of the test in paragraph 35-55(1)(c). In those circumstances, it would not be reasonable to exercise the discretion in her favour. | Detailed Reasoning - Application to your circumstances: It is acknowledged that you have your reasons for purchasing weaner cattle and adopting a staggered approach to your activity. However, the Commissioner considers that another business carrying on a cattle breeding activity could be commercially viable in a shorter time frame if it did not adopt a staggered approach to herd size. The losses that you have incurred are not the result of an inherent characteristic of your activity; rather, they arise from the choices you have made in how your activity was carried out and as such the Commissioner will not exercise the discretion. Whilst we appreciate your situation, there is no other discretion available to the Commissioner in Division 35 of the ITAA 1997 that would allow you to claim your losses.