Private ruling: Non-commercial losses
Published: December 2014
Ruling period: Income year ended 30 June 2009 | Income year ended 30 June 2010 | Income year ended 30 June 2011 | Income year ended 30 June 2012 | Income year ended 30 June 2013 | Income year ended 30 June 2014
Date scheme commenced: 1 July 200X

Ruling: Q1: Will the holding costs of the land be attributable to your business activity of agistment for the purpose of Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: If the answer to question 1 is yes, can the holding costs be included in the cost base of the sale of the land in accordance with Subdivision 110-25 of the ITAA 1997? | A2: No

Relevant facts and circumstances: You own a property where you conduct primary production activities. On the property were a number of paddocks used in your primary production activities and two dwellings. One of the dwellings was rented out from time to time. While the second was lived in by an employee that worked weekend shifts on the property free of charge. You have never lived in either of the dwellings. You acquired the property in 20xx. You had a business plan when you acquired the property. The purpose of acquiring the property was to carry on primary production activities; the property has continued to be used for that purpose and no other while you have owned it. You were involved in overseeing the day to day running of the property which took about 2 hours a day. You employed 2 staff members on a permanent basis to undertake activities on the property on a daily basis. One of the staff members worked 5 days a week and was paid on a weekly basis while the other worked 2 to 4 days a week and was paid by the hour. You had income from other sources during the period of 1 July 20xx to 30 June 20xx which exceeded the income test. In most years, the primary production activity expenses exceeded the primary production activity income, resulting in a loss. However in the 20xx, 20xx and 20xx income year the primary production activities were profitable. From 1 July 20xx to 30 June 20xx, you have self-assessed that the NCL rules have applied to prevent the tax losses from the primary production activity being used against other income. The property was sold in the 20xx financial year to a party not interested in continuing the business and accordingly was sold as vacant possession with no amount allocated for goodwill. All primary production activity had ceased on the property when it was sold. You were issued a ruling on the x which provided that the Commissioner considered: • you were carrying on a business in a partnership • your losses were subject to deferral under Division 35 • the capital gain from the sale of your agistment property was not assessable income from that business.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 35-10(2) | Income Tax Assessment Act 1997 section 110-25(4) | Income Tax Assessment Act 1997 section 110-45(1B)

Reasons for decision: Detailed Reasoning - CGT cost base: The cost base of a CGT asset consists of five elements and subsection 110-25(4) of the ITAA 1997 provides that the third element is the cost of owing the CGT asset. These costs include interest on money borrowed to acquire the asset (including any money borrowed to refinance money borrowed to acquire the asset). Subsection 110-45(1B) of the ITAA 1997 states that expenditure does not form part of the second or third element of the cost base of a CGT asset to the extent that you 'have deducted' or 'can deduct it'. This provision ensures that second and third elements of the cost base that are deductible do not form part of the cost base. The principle underlying the CGT cost base rules is that an item of eligible expenditure can be either deductible for income tax purposes, or included in the CGT cost base of an underlying asset, but not both. | Detailed Reasoning - Non-commercial loss provisions: The non-commercial loss rules set out in Division 35 of the ITAA 1997 are intended to limit the extent to which non-commercial losses in an income year can be used to reduce the tax paid on other assessable income brought to account in that year. The rules are an integrity measure that was introduced to simplify and introduce certainty into the law as it relates to the treatment of allowable deductions attributed to certain business activities. In broad terms, Division 35 operates to prevent the losses of certain business activities of a taxpayer from being deducted against other assessable income of that taxpayer unless certain exceptions apply. For those business activities to which it applies, subsection 35-10(2) of the ITAA 1997 relevantly provides: If the amounts attributable to the *business activity for that income year that you could otherwise deduct under this Act for that year exceed your assessable income (if any) from the business activity, or your share of it, this Act applies to you as if the excess: (a) were not incurred in that income year, and (b) were an amount attributable to the activity that you can deduct from assessable income from the activity for the next income year in which the activity is carried on. The result is that the excess deductions are not taken into account in calculating your taxable income under section 4-15 of the ITAA 1997 for that income year. However, they are an amount that you can deduct from the assessable income of the business activity in a subsequent income year in which the activity is carried on. | Detailed Reasoning - Deductions attributable to a business activity: The Commissioner's view on the application of the Division 35 of the ITAA 1997 is contained in Taxation Ruling TR 2011/14. It discusses what deductions are 'attributable' to a particular business activity at paragraph [12] and [57]: 12. In determining how Division 35 applies to the relevant *business activity it is necessary therefore to identify both the allowable deductions 'attributable' to the *business activity and the assessable income 'from' that activity. Note that the amounts to be 'attributed' to the *business activity in this regard include all the amounts for the activity that otherwise could be deducted; not just those deductible under section 8-1, for example, any deductible under Division 40. 57. The 'amounts attributable to the *business activity' that an individual taxpayer can otherwise deduct are, for the purposes of applying the loss deferral rule in subsection 35-10(2), all those amounts otherwise deductible under any provision of the ITAA 1997, to the extent that they relate to the carrying on of the particular *business activity in the income year in question. The relevant assessable income from the *business activity is that income which is *derived directly from, and has its source or origin in the *business activity for the income year in question (see paragraphs 91 to 92C and Example 5 at paragraphs 134 to 136 of this Ruling). In your circumstances that holding expenses of the property are deductible under section 8-1 of the ITAA 1997 by virtue of the income producing activity you carry on in the property. It follows where the income producing activity satisfies the definition of a business under section 995-1 the deductions will be attributable to that business for the purpose of Division 35. The Commissioner does not consider that there is any inconsistency in ruling that the regular recurrent expenses associated with holding a property used in a business are 'attributable' to that business, while the proceeds from the subsequently sale of that property will not be assessable income 'from' that business. We do not consider that the sale of the land was an activity or process of your agistment business. By its very nature the sale of the property can only proceed after the termination of the business activity. | Detailed Reasoning - Interaction between section 110-45(1B) and Division 35: One of the conditions for the operation of subsection 35-10(2) of the ITAA 1997 is that there are amounts attributable to the business activity for the income year that you can 'otherwise deduct' for that year and which exceed your assessable income (if any) from the activity. It is only the excess of the otherwise deductible amounts that are affected by Division 35. It follows that: 1. if there is no assessable income from the business activity in the income year the excess will comprise the sum of all the amounts attributable to that activity that are otherwise deductible in that income year. Subsection 35-10(2) specifically provides that this excess can be deducted from assessable income from the business activity for the next income year in which the activity is carried on; and, 2. if there is assessable income from the business activity in the income year the excess only comprises the sum of amounts attributable to the business activity that are otherwise deductible in that year which exceed the amount of that income. The otherwise deductible amounts equal to the amount of assessable income are not excess for the purposes of Division 35; those amounts will have been deducted. Accordingly, the conditions for the operation of subsection 110-45(1B) of the ITAA 1997 are satisfied in respect of the expenditure because you have either deducted it, or can deduct it as provided by paragraph 35-10(2)(b). The Commissioner does not consider that the likelihood of the business being carried on in the future is relevant. Furthermore, if it was intended that costs subject to the operation of Division 35 of the ITAA 1997 can be carved out and included in the cost base of a CGT asset, there is a procedural difficulty with the interaction of subsections 35-10(2) and 110-45(1B). If the business activity has itself ever generated assessable income there isn't a tracing rule within Division 35 to determine which items of individual expenditure have been deducted and which haven't. This is explained in the following paragraphs from Taxation Ruling TR 2013/6: 53. Moreover, there is no rule which applies to specify how much of any of the individual items of expenditure underpinning the affected deductions might relate to the 'non-excess', that is, relate to the total of the deductions which are able to be taken into account under section 4-15 of the ITAA 1997 for the relevant year. 54. The loss deferral rule in subsection 35-10(2) of the ITAA 1997 blends all of the otherwise deductible amounts attributable to the business activity together in a way where they lose their identity and connection with the expenditure on which their initial deductibility was based. The operation of the rule is analogous to that of former section 80 of the ITAA 1936 concerning the composition of a carried forward loss, considered by the High Court in Ravenshoe Tin Dredging Ltd v. FC of T . Like former section 80 of the ITAA 1936, subsection 35-10(2) creates a special deduction arising from the operation of the ITAA 1997, which is not itself made up of 'actual expenditures' (refer Barwick CJ at CLR 91). Without a tracing rule it would be impracticable to apply the income tax law to allow eligible individual items of expenditure incurred in conducting non-commercial activities to be carved out and included as third element expenditure in the cost base of a CGT asset. The contrary argument might be that in the case of a taxpayer that has never derived assessable income from the business activity such tracing isn't necessary. However, it would be contrary to the object of Division 35 of the ITAA 1997 to apply the law to allow costs included in quarantined losses from non-commercial business activities to be carved out and included as third element of the cost base of a CGT asset where the business activity didn't generate assessable income. And it would be egregious to allow this treatment yet deny it (because of the inability to trace individual items of expenditure) where the activity did generate such income. In addition, if costs included in quarantined losses from non-commercial business activities were allowed to be included as third element of the cost base of a CGT there isn't a rule to reduce the quarantined losses amount. This could allow the taxpayer to claim a deduction for the costs against assessable income from the business activity in a later income year after they have already included the same amount in the cost base of a CGT asset that has been subject to a CGT event. This result would be contrary to the scheme of the income tax legislation to treat an item of expenditure as deductible or as an amount which can be included in the cost base of an underlying asset, but not both.