Private ruling: non-commercial losses
Published: December 2011
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2001

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 primary production business activity in your calculation of taxable income for the 2010-11 financial year? | A1:  | Q2: Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include any losses from your primary production business activity in your calculation of taxable income for the 2010-11 financial year? | A2: 

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. 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 primarily devoted towards mixed cropping and livestock farming. The current farm was purchased in blocks over a number of years. The information you have provided from the consulting firm attests to a five year lead time for a property such as yours to reach commercial viability. You submit that the original block was in a very run down state when purchased. The property was infested with weeds, fences in disrepair and the pasture that existed had been significantly damaged by over grazing. You implemented a perennial pasture establishment plan involving a cropping process over a number of years to reduce weed infestation and improve soil, followed by planting of perennial pasture. This perennial pasture would then be available for full grazing of livestock. You submit that poor weather conditions including drought affected your ability to reach profitability. You have submitted information to show that your property suffered from drought and below average rainfall for a number of years. You submit that your initial perennial pasture establishment plan had met with only partial success due in part to management but predominantly due to seasonal failures. You conducted a review of your business after a number of years of operations. You concluded that the underlying principle of farm improvement was still to occur, as a staged approach with new management and a new farm advisor. You have chosen to increase your stocking rate by retaining an increased number of breeding stock rather than buying new breeding stock.

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) Income Tax Assessment Act 1997 paragraph 35-55(1)(c)

Reasons for decision: Summary: Section 35-1 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 discretion to allow the inclusion of the losses. You satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 if your income for non-commercial loss purposes is less than $250,000. In your case, you do not satisfy the income requirement as your income for non-commercial loss purposes is above $250,000 in the 2010-11 financial year. | Detailed Reasoning - Special circumstances (first limb): The Commissioner's discretion in paragraph 35-55(1)(a) may be exercised for the financial year where the business activity is affected by special circumstances outside the control of the operators of the business activity. Special circumstances are those circumstances which are sufficiently different to distinguish them from the circumstances that occur in the normal course of conducting a business activity. For those individuals who do not satisfy the income requirement, special circumstances are generally those which have materially affected the business activity, causing it to make a loss. Special circumstances can include things like droughts and floods (Taxation Ruling TR 2007/6). | Detailed Reasoning - Nature of the activity (second limb): The Commissioner's discretion in paragraph 35-55(1)(c) may be exercised for the financial year where there is an objective expectation, based on evidence from independent sources, that your business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period. For the Commissioner to exercise the 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. The phrase 'objective 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 objective 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. | Detailed Reasoning - Interaction between the limbs: As stated above, ordinarily the operation of the first limb is confined to those situations in which the business activity has been affected by special circumstances outside the control of the operators of that activity where, had these circumstances not existed; the activity would have made a tax profit. However, the first limb may also apply to a business activity affected by such circumstances during a time when 'because of its nature' it is not able to produce a tax profit, but this time is still 'within [the] period that is commercially viable for the industry concerned'. In such a case, the enquiry is not whether the activity would have produced a tax profit had the special circumstances not existed (paragraphs 35 55(1)(b) and (c) already recognise that there are reasons outside the control of the operators of the activity why this would not have occurred, regardless of the existence of the special circumstances). In such cases the appropriate enquiry will be whether or not the special circumstances have meant that there is no longer an objective expectation that within the period that is commercially viable for the industry concerned the activity will produce a tax profit. Where the special circumstances are the sole reason why the activity can no longer objectively be expected to produce a tax profit within the period that is commercially viable for the industry concerned, but the activity is now expected to consistently produce a profit at some later time, the discretion may be exercised. In your case, you have provided evidence which attests to a commercially viable period of five years for your activity. You expect to make a tax profit outside the commercially viable period. Since commencing operations you have since bought further properties over a number of years and have applied significant resources towards improving the property. It is accepted that it is in the nature of your business activity to require a lead time before it produces a tax profit. However, there must also be an objective expectation this lead time is within a period which is commercially viable for this industry. For the purposes of addressing this point, subjective considerations, such as the condition of property at purchase, the state of repair and lack of perennial pasture are not relevant. Your decision to increase breeding stock by retaining stock rather than through purchase has also impacted on the length of time required before your farm activity will make a profit. Like the ongoing improvements to the property these are individual business decisions affecting your activity rather than an inherent characteristic of the industry. It is accepted that the drought years may be regarded as special circumstances beyond your control, for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. However, the information you have provided does not point to a reasonable expectation that the business activity would have produced a tax profit within the commercially viable period had it not been for the adverse climatic conditions. This is based upon the fact that, as submitted by you, you purchased a property in very poor condition that needed significant improvements unrelated to weather conditions, which you carried out by a staged approach. Even if the commercially viable period for your farming enterprise is extended to account for the setbacks of below average rainfall and drought conditions, your expectations of a tax profit are well outside the commercially viable period. It follows that the Commissioner cannot exercise his discretion in your case. The reason your activities have continued to make a loss is peculiar to your situation and is not inherent to the nature of the business or as a result of special circumstances.

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