Private ruling: Non-commercial losses and the Commissioner’s discretion
Date of advice: 9 May 2018
Published: July 2018
Ruling period: Year ending 30 June 20XX | Year ending 30 June 20XX | Year ending 30 June 20XX | Year ending 30 June 20XX
Date scheme commenced: 10 February 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 primary production business activity in your calculation of taxable income? | 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. You carry on a primary production business. You purchased a property that contained established horticulture activities. At the time of purchase, the property was not profitable due to being in a run-down state and lack of water supply to the property. The established horticulture activities had been infested with a fungal trunk disease which would require extra work to bring them back to full potential. The fungal trunk disease is a wide spread issue. You advise you will be undertaking numerous re-development improvements such as increasing the bearing land, improving the water supply infrastructure and improving the quality of the produce. You have provided a letter from an independent source. You have incurred expenses in relation to the initial improvements and the profit and loss projections provided outline the additional expenditure required to increase the quality and number of horticulture planted. Ongoing costs will be incurred to undertake the further improvements required. You advise the business will be profitable in the XXXX-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: 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. Your losses are therefore subject to the deferral rule, unless the Commissioner exercises his discretion. You have requested the Commissioner to exercise discretion for ‘lead time’ for the 20XX-XX to 20XX-XX financial years so that you are not required to defer any losses from your primary production business activity under the non-commercial loss provisions. Under paragraph 35-55(1)(c) of the ITAA 1997, the Commissioner’s discretion can be exercised where: ● the business activity has started to be carried on but because of its nature it has not produced, or will not produce, assessable income greater than the deduction attributable to it. ● there is an objective expectation that within a period that is commercially viable for the industry concerned the activity will meet one of the tests or produce assessable income for an income year greater than the deductions attributable to it for that year. It should be noted that the periods discussed above are measured from the commencement of the business activity itself: Applicant 1761 of 2011 v. Commissioner of Taxation [2011] AATA 779 at [27]. Your subsequent involvement in the business activity at some point after its commencement, or changes to an aspect of that business activity which do not constitute a new discrete and distinct business activity (see Taxation Ruling TR 2001/14), will not generally ‘reset’ this commencement date. 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. You must be able to show that the reason your business activity will produce a loss is inherent to the nature of the business and is not particular to your situation. In your case, the commencement of the business activity itself was when the original horticulture were planted. Your purchase of the property and future improvement plans does not constitute a new discrete and distinct business activity from when the activity commenced. You have advised your business activity will be profitable in the XXXX-XX financial year which is sometime after the original activity commenced. While you have provided independent evidence that your plans for re-development should return the activity to profit by the XXXX-XX financial year, there is no evidence that that commercial viable period for your business activity is XX years. There is nothing inherent in the nature of your business activity which would prevent it from producing assessable income greater than the deductions attributable to it for XX years. Therefore the Commissioner is unable to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include any losses from your business in your calculation of taxable income. | Detailed Reasoning - Special circumstances: We have also considered the Commissioner’s discretion available under paragraph 35-55(1)(a) of the ITAA 1997 which 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 those which have materially affected the business activity, causing it to make a loss. Taxation Ruling TR 2007/6 sets out the Commissioner’s interpretation on the exercise of the 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. Ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances. These fluctuations are expected to occur on a regular or recurrent basis when carrying on a business activity and affect all businesses within a particular industry. When purchased, the property was in a run-down state with a significant amount of the horticulture suffering from a fungal trunk disease. It is accepted that a fungal trunk disease could constitute ‘special circumstances’ for the purposes of paragraph 35-55(1)(a) of the ITAA 1997 however these conditions were not outside your control as you were aware of the fungal trunk disease when purchasing the property. Therefore, the Commissioner would be unable to exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(a) of the ITAA 1997 either.