Commissioner's discretion- Special Circumstances - expectation of taxation profit not decisive

Is a reasonable expectation of a taxation profit a decisive factor for the Commissioner in deciding whether or not to exercise his discretion under paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to special circumstances?

No, a reasonable expectation that a business activity would make a taxation profit, but for a special circumstance, is not a decisive factor for the purposes of exercising the discretion under paragraph 35-55(1)(a) of the ITAA 1997.

An individual taxpayer commenced a horticultural business activity ('the activity') during the income year ended 30 June 2001.

Unseasonably high winds significantly affected the taxpayer's crop in this income year. The taxpayer provided projections, based on supporting evidence, indicating that if the activity had not been affected by the unseasonably high winds, it was expected to make a taxation profit, that is, assessable income was expected to exceed allowable deductions for the year.

However, the activity was not expected to pass any of the tests in Division 35 of the ITAA 1997 for the year ended 30 June 2001, even if these high winds had not occurred.

Taxation Ruling TR 2001/14 provides an overview of the application of Division 35 of the ITAA 1997. Specifically, paragraph 6 states: "6. Division 35 was introduced into the ITAA 1997 via the New Business Tax System (Integrity Measures) Act 2000. It applies from 1 July 2000 to each and every income year in which an individual taxpayer carries on a relevant *business activity. The main operative provision in the Division is section 35-10. The major rule in section 35-10 is that unless in each year: (a) the individual's *business activity meets one of the four tests; (b) the individual comes within the Exception; or (c) the individual is covered by an exercise of the Commissioner's discretion in relation to that *business activity, a loss from the *business activity will not be deductible in the income year in which it arose."

The four tests in Division 35 of the ITAA 1997 are: (a) the Assessable income test in section 35-30 of the ITAA 1997; (b) the Profits test in section 35-35 of the ITAA 1997; (c) the Real property test in section 35-40 of the ITAA 1997; and (d) the Other assets test in section 35-45 of the ITAA 1997.

Section 35-55 of the ITAA 1997 provides that the Commissioner can decide that section 35-10 of the ITAA 1997 not apply where he is satisfied that it is unreasonable for it to apply.

Paragraph 35-55(1)(a) of the ITAA 1997 provides that the Commissioner can exercise the first arm of this discretion where certain special circumstances apply. Special circumstances in this context are those circumstances outside the control of the operators of the business activity, including those such as drought, flood, bushfire or some other natural disaster, that have materially affected that activity.

The loss made from the activity in the income year ended 30 June 2001 will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997, unless the Commissioner exercises his discretion under paragraph 35-55(1)(a) of the ITAA 1997. A note to this paragraph provides guidance on how this arm of the discretion is intended to be applied, and states: 'Note : This paragraph is intended to provide for a case where a business activity would have satisfied one of the tests if it were not for the special circumstances.'

Therefore, it is intended that the Commissioner only exercise this arm of the discretion under paragraph 35-55(1)(a) of the ITAA 1997 if one of the tests would have been satisfied but for the special circumstances.

This is not the case in this matter. The Commissioner accepts that the taxpayer's business activity was affected by circumstances that were unusual and outside their control, and that in the absence of those circumstances it was probable that a taxation profit would have been made from the activity for the income year in question. However, as the activities would not have satisfied one of the tests in Division 35 of the ITAA 1997 the reasonable expectation that the activity would have made a taxation profit, but for the special circumstance, is not a decisive factor for the purposes of paragraph 35-55(1)(a) of the ITAA 1997.

What is decisive is that the circumstances in question did not stop the activity meeting any one of the four tests in Division 35. Therefore, the Commissioner decides under paragraph 35-55(1)(a) that it is not unreasonable that the rule in section 35-10 of the ITAA 1997 apply.