Private ruling: Non-commercial losses
Date of advice: 13 September 2017
Published: January 2018
Ruling period: Year ended 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020
Date scheme commenced: 1 June 2017

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 for the income years ended 30 June 2017, 30 June 2018, 30 June 2019 and 30 June 2020? | A1: Yes

Relevant facts and circumstances: You are in the course of carrying a business by producing truffles. The farming operation commenced on 1 June 2017 and will be conducted by you as a sole trader. Prior to planting your new products, you removed all of the previous income producing plants as they were no longer profitable. You incurred start-up costs in preparation for the planting of truffle-inoculated trees. You already have the necessary capital equipment from your previous income producing activity. Your activity is of sufficient scale to be able to produce a profit as set out in your business plan you have provided, showing potential production and income and expenses. Truffles are graded into quality classes: Extra, First, A, B and C. The price of French black truffles depends on the class of truffle and market being sold into. B and C class truffles will be used for the production of truffle oil. In the cash flow statement you provided, you expect to be at neither a loss nor profit in the worst possible scenario in the 2020-2021 income year as you have used the minimum sale price for truffles and maximum annual cultivation costs. Hence, you expect positive annual cash flows from the 2020-2021 income year and onwards. Your other income for non-commercial losses purposes is less than $250,000 in the 2016-2017 income 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: For the 2009-10 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 subsection 35-10(2E) of the ITAA 1997 for that year and one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 is met, or ● the 'Exception' in subsection 35-10(4) of the ITAA 1997 applies, or ● the Commissioner exercises the discretion in section 35-55 of the ITAA 1997. Section 35-1 of the ITAA 1997 provides that an income requirement must be met (along with certain tests) in order to include losses from a business activity in your taxable income calculation. Where the income requirement is not met, the Commissioner may exercise discretion to allow the inclusion of the losses. Subsequently, the Commissioner will not allow discretion if one of the following four tests is satisfied: a) assessable income test (section 35-30) b) profits test (section 35-35) c) real property test (section 35-40) d) other assets test (section 35-45) Exceptions in subsection 35-10(4) states that subsection 35-10(2), 35-10(2A) or 35-10(2B) does not apply to a business activity for an income year if: a) the activity is a primary production business, or a professional arts business; and b) your assessable income for that year (except any net capital gain) from other sources that do not relate to that activity is less than $40,000. 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 do not come under any of the exceptions. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion. Your primary production activity will only be potentially subject to these provisions if it is carried on as a business. The Commissioner is satisfied that your activity is carried on as a business. The relevant discretion may be exercised for the income year in question where: ● it is in the nature of the business activity that there will be a period of time before it can be expected to pass one of the four tests ● there is an objective expectation your business activity will produce a tax profit or meet one of the four tests within a commercially viable period for your industry. The Commissioner may, on application, decide that the rule in subsection 35-10(2) does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply that rule because: a) for an applicant who carries on the business activity who does not satisfy subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made - the business activity has started to be carried on and, for the excluded years: I. because of its nature, it has not produced, or will not produce, assessable income greater than the deductions attributable to it; and II. there is an objective expectation, based on evidence from independent sources (where available) that, within a period that is commercially viable for the industry concerned, the activity will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C)). The Note to paragraph 35-55(1)(c) of the ITAA 1997 states that the particular paragraph is intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. The note includes an example of an activity involving the planting of hardwood trees for harvest where many years would pass before the activity could reasonably be expected to produce income. Paragraphs 77 and 78 of Taxation Ruling TR 2007/6, which discusses non-commercial business losses and the Commissioner's discretion, state: 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. 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. Having regard to your full circumstances, it is accepted that it is in the nature of the business activity that has prevented one of the four tests being passed. It is also accepted that you will pass one of the four tests or make a tax profit within the commercially viable period for your industry in the 2020-2021 income year. Consequently the Commissioner will exercise his discretion in the 2016-2017 to 2019-2020 financial years.