Private ruling: non-commercial losses - Commissioner's discretion
Date of advice: 3 July 2015
Published: July 2015
Ruling period: Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018
Date scheme commenced: 1 July 2014

Ruling: Q1: Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to offset the losses from your business activity against your other income in the years ended 30 June 2015 to 30 June 2018? | A1: No.

Relevant facts and circumstances: You purchased a property in 20XX and commenced mixed farming activities. You are taking a staggered approach to planting your crops. You satisfy the <$250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997. Your income from other sources (excluding net capital gains) that do not relate to your farming activity will be more than $40,000. You expect to satisfy one of the tests set out in Division 35 of the ITAA 1997 in the year ended 30 June 2019.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 35 | Income Tax Assessment Act 1997 subsection 35-10(2) | Income Tax Assessment Act 1997 section 35-35 | Income Tax Assessment Act 1997 paragraph 35-55(1)(b)

Reasons for decision: Summary: Under Division 35 of the ITAA 1997, a loss made by an individual from a non-commercial business activity cannot be offset against other assessable income in the financial year in which it arises unless certain conditions are met. Losses that cannot be offset in a particular year of income, because of the loss deferral rule in subsection 35-10(2) of the ITAA 1997, can be applied to the extent of future profits from the business activity, or are deferred until one of the tests is passed, a discretion is exercised, or the exception applies. Where the individual satisfies the income requirement in subsection 35-10(2E) of the ITAA 1997, a loss made from a non-commercial business activity cannot be offset against assessable income from other sources unless: • the exception in subsection 35-10(4) of the ITAA 1997 applies • one of the four tests set out in Division 35 of the ITAA 1997 is met, or • the Commissioner exercises a discretion in section 35-55 of the ITAA 1997. Your business is a primary production activity; however, your income from other sources is more than $40,000. Therefore, the exception contained in subsection 35-10(4) of the ITAA 1997 does not apply. The four tests set out in Division 35 of the ITAA 1997 are contained in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) and 35-45 (other assets test) of the ITAA 1997. Your farming activity will not satisfy any of these four tests in the years ended 30 June 2015 to 30 June 2018. You have requested that the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997. The Commissioner may exercise this discretion where he considers that applying the loss deferral rule would be unreasonable because: (i) the business activity, because of its nature , has not satisfied, or will not satisfy, one of the four tests set out in Division 35 of the ITAA 1997, 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 either satisfy one of the four tests or will produce a tax profit. The discretion in paragraph 35-55(1)(b) of the ITAA 1997 is intended to cover a business activity that has a lead time between the commencement of the activity and the production of assessable income. For example, 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. For the failure to satisfy one of the four tests set out in Division 35 of the ITAA 1997 to be because of its nature , the failure must be because of some inherent characteristic that your activity has in common with other business activities of the same type. Therefore, for the Commissioner to exercise this discretion you must be able to show that the reason your business activity will not satisfy one of the four tests set out in Division 35 of the ITAA 1997 is inherent to the nature of the business and is not peculiar to your situation. That is, the reason why your business cannot satisfy one of the four tests must be due to the inherent features of the industry rather than the way your business is carried on. The discretion is not intended to apply where a business activity makes a loss because of factors which can apply to any business and which do not affect the ability of the activity to satisfy one of the four tests. For example, the discretion is not exercised for any start-up activity that is yet to satisfy, for example, the $20,000 assessable income test or profits test, simply because of the small scale on which it is started, or because a client base is still being established. The phrase because of its nature has been considered by the courts in a number of cases, including Case 1/2013 [2013] AATA 3; 2013 ATC 1-050; 87 ATR 355 ( Case 1/2013) . In that case, the AAT held that a taxpayer whose vineyard did not reach full production for approximately 10 years was not entitled to the exercise of the lead time discretion in paragraph 35-55(1)(c) of the ITAA 1997 allowing losses from non-commercial businesses to be offset against other income. The AAT found that, although the taxpayer provided convincing reasons why she chose to take a staggered approach, the vineyard could be planted and reach peak production within five years, rather than eight or nine years. The following paragraphs from Case 1/2013 are relevant: 15. Can it be said the business, 'because of its nature… will not produce… assessable income greater than the deductions attributable to it' during the 9 year period contended for by the taxpayer? The answer to that was clear enough from Mr Greaves' evidence - in particular, from his answer to a question from Ms Ford about whether it was possible to have the vineyard up and running within 5 years. He said it was. I accept he thought it was commercially prudent to approach the development in a more gradual way, and he may well be right. But that is not the test. I am required to look at whether the failure to produce sufficient assessable income during a given year of income was a "result of some inherent feature that the taxpayer's business activity has in common with activities of that type". See Federal Commissioner of Taxation v Eskandari 134 FCR 569 at [32] per Stone J. 16. Vines can be planted and become productive within 5 years. The applicant has chosen to take a more gradual approach. No one quibbles with the wisdom of her decision, and I am told it is common practice in the industry. But she is unable to satisfy the first leg of the test in paragraph 35-55(1)(c). In those circumstances, it would not be reasonable to exercise the discretion in her favour. While it is accepted that your cropping activities have a lead time between their commencement and the production of assessable income, it is not due to the nature of these activities that you will not satisfy one of the four tests set out in Division 35 of the ITAA 1997. Rather, the reasons your activity will not satisfy one of the four tests is due to the relatively small scale of your operations together with decisions you have made about how you run your business. That is, you have decided to stagger the planting of your crops. Your circumstances are considered similar to those of the taxpayer in Case 1/2013 . It is acknowledged that you have your reasons for adopting this staggered approach to your mixed farming activity; however, it is considered that another business carrying on the same activities could satisfy one of the four tests in a substantially shorter time frame if it did so on a larger scale or did not adopt a staggered approach to planting. As the activity has not failed the test in Division 35 of the ITAA 1997 because of its nature , it is not necessary to consider whether you will satisfy the second limb of paragraph 35-55(1)(b) of the ITAA 1997 about the expectation that the activity will either satisfy one of the four tests, or will produce a tax profit, within a period that is commercially viable for the industry concerned. For the reasons provided above, and consistent with the decision in Case 1/2013 , the Commissioner will not exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to offset the losses from your business activity against your other income in the relevant years.