Private ruling: Non-commercial losses
Date of advice: 20 October 2020
Published: December 2020
Ruling period: Year ended 30 June 20XX | Year ended 30 June 20XX | Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

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 productionbusiness activity in your calculation of taxable income for the 20XX to 20XX financial years? | A1: No

Relevant facts and circumstances: You do not satisfy the less than $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997 in the financial year ended 20XX. You anticipate exceeding this income requirement in the 20XX year as well. You commenced business operations in late 20XX as part of a partnership. You carry on a business at Location 1. This is known as "Farm 1". In the period 20XX to 20YY the partnership initiated significant improvements on Farm 1. This included machinery, stock and farm improvements including drought proofing stock water. This farm was also expanded to cover YYY hectares. In mid-20ZZ the partnership acquired another farm located at Location 2. This is known as "Farm 2". This is a farm of XXX hectares. In the period 20XX to 20YY the partnership initiated significant improvements including pasture renovation and actions to expand the farming enterprise. Farms 1 and 2 became intensely drought affected in the 20XX, 20XX and 20XX financial years. The partnership anticipates that it will be recovering from drought in the 20XX financial year. You have provided evidence that these farms were drought affected using charts produced by the local Department of Primary Industries which demonstrate a significant reduction in average rainfall in the region of both farms. The extensive drought conditions affected profitability in the 20XX financial year and are expected to adversely affect the 20XX and 20XX financial year results as well. You state in your application that these adverse effects flow mainly from - · Significant depreciation claims for prior capital expenditure. · Significant increases in the cost of fodder and seed/pasture costs. · Increases in interest costs as debt that would otherwise have been retired being increased as loans were extended as drought affected farm operations. · Revenue falls due to lower livestock numbers as well as reduced sales revenue. The partnership made extensive efforts to adapt to the drought conditions by - · Gradually changing to emphasise animal production to reduce farm labour costs as well as lower chemical and other input costs. · Attempting to drought proof the business by - - installing bores to water animals, - building up fodder reserves, - planting drought tolerant pasture species, - buying another farm in a better rainfall location, - progressively reducing stocking rates, · Placing Farm 1 on the market to dispose of the least productive farmland, retire debt and eliminate interest costs for the partnership. To assist with drought proofing the farms you installed the following assets - · Bore hole and pump · Hay making equipment · Hay shed · Farm vehicles · Irrigation pump and supply water · New tractor · Pasture renovation Current indications are that the drought broke in early 20XX however, you anticipate additional costs to recover from the drought. Many input costs have increased, and you anticipate lower sales of stock in the 20XX and 20XX financial years. Despite these increased costs, you project a tax profit in the 20XX financial year . You seek a ruling to allow deduction of farm losses generated by the partnership against other taxable income. You argue that, but for the effects of the drought, the business would have generated a profit in the 20XX financial year and have provided a detailed profit and loss to support this argument.

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 20XX-XX 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, or · 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 you 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 financial year in question where your business activity is affected by special circumstances outside your control. '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, including drought, flood, bushfire or some other natural disaster. For individuals who do not satisfy the income requirement, the business activity must have been materially affected by the special circumstances, causing it to make a loss. In this context, the Commissioner may exercise this discretion for the income year(s) in question where, but for the special circumstances: · your business activity would have made a tax profit · the activity passes at least one of the four tests or, but for the special circumstances, would have passed one of the four tests. Taxation Ruling TR 2007/6 sets out the Commissioner's interpretation of the exercise of the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 53 of this ruling: Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to special circumstances outside the control of the business activity, including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of the paragraph. These events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affected the business activity. In application to your case you have requested that the Commissioner exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 in the 20XX, 20XX and 20XX financial years. It is accepted in your case that the drought affecting your businessconstitutes special circumstances. However, this in itself is not sufficient for the discretion to be exercised. The Commissioner must also be satisfied that your activity would have made a profit but for the special circumstances. That is, the special circumstances discretion can only be exercised where it can be seen that it was only the special circumstances which caused a loss to be made. The following considerations lead us to believe that, had the special circumstances not occurred, the business still would have returned a loss: · Partnership returns for recent years show a consistent pattern of business losses. · These business losses have been increasing in the period before the drought. · There is no evidence that a business profit could have been expected irrespective of the most recent drought. Further, it is also the case that some part of the assets purchased during the drought will support drought-proofing your farms. However, other major items such as hay making equipment, a hay shed, farm vehicles and a new tractor appear to be normal or routine farm equipment which could be bought at any time and which it could be argued have little to do with drought-proofing. Such items might best be described as general improvements to the property. Separating the expenses into two categories - those that are obviously water related or helpful for drought assistance and other expenses - gives the following. The water related expense makes up 28% of the expenses. One could argue that the other expenses might reasonably have been deferred until the end of the drought to improve profitability, if that was practical at the time. Therefore, the Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the years in question.