Issue
Can there be an objective expectation of profit in a future year, for an individual carrying on a business activity which ceases during the income year, for the purposes of exercising the Commissioner's discretion under paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
No. There cannot be an objective expectation of profit in a future year, for an individual carrying on a business activity which ceases during the income year, for the purposes of exercising the Commissioner's discretion under paragraph 35-55(1)(b) of the ITAA 1997.
Facts
An individual taxpayer started a fish-breeding activity in several dams, on a small acreage in 1998. Breeding stock was collected from river systems and some fish were produced. Independent evidence, with profit projections for the activity were provided to support a lead time of three years.
The activity which produced taxation losses since its commencement was abandoned in January 2001.
The taxpayer applied for a Private ruling seeking the exercise of the Commissioner's discretion under paragraph 35-55(1)(b) of the ITAA 1997 for the income year ended 30 June 2001.
Reasons for Decision
Division 35 of the ITAA 1997 will apply to defer a non-commercial business loss from a business activity carried on by a taxpayer who is an individual, unless: • their business activity satisfies one of the four tests in Division 35 • the Commissioner has exercised the discretion in section 35-55 for the activity, or • the individual comes within the Exception to Division 35, contained in subsection 35-10(4).
As the activity has commenced, and is carried on by an individual taxpayer as a business in the 2000-01 income year, the loss made from the activity will be potentially subject to Division 35 of the ITAA 1997.
The activity has not satisfied any of the four tests under Division 35 of the ITAA 1997 for several years, and neither will the Exception to the Division in subsection 35-10(4) of the ITAA 1997 apply. The loss made from the activity for the 2000-01 income year will therefore be subject to the loss deferral rule in subsection 35-10(2), unless the Commissioner decides under paragraph 35-55(1)(b) of the ITAA 1997 that it would be unreasonable for this to occur.
The discretion in paragraph 35-55(1)(b) of the ITAA 1997 is only able to be exercised where: (i) the business activity has started to be carried on (ii) because of its nature it has not satisfied, or will not satisfy, one of the tests set out in Division 35 of the ITAA 1997, and (iii) there is an objective expectation based on independent evidence, where available, that the business activity will either meet one of the tests, or produce a taxation profit, within a period that is commercially viable for the industry concerned.
Therefore, the discretion is intended to be exercised for the income years from when the business activity first commenced until it could be expected to satisfy one of the four tests or make a taxation profit. This period must be within the commercially viable period for the industry concerned.
When considering whether to exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 for a particular year, the Commissioner must be satisfied that there is an objective expectation of the activity meeting a test or producing a taxation profit within a period that is commercially viable for the industry concerned. This expectation may change from year to year, and therefore, the exercise of the discretion for an income year is dependant on this expectation existing for that year.
It is accepted that it is in the nature of fish breeding that there will be a lead time before a profit can be expected or one of the tests passed. The time it takes for fish to breed and mature is an innate or inherent feature of a fish breeding activity. The taxpayer has provided information, supported by independent evidence that demonstrates there is an objective expectation that the fish breeding industry generally meets the Assessable income test and produces a taxation profit within three years from the time of commencing.
However, in this case, as the business activity ceased during the 2000-01 income year, there can no longer be any objective expectation of the activity satisfying a test, or producing a profit within a period that is commercially viable for the fish breeding industry, that is, in any future year.
The Commissioner, therefore is not satisfied that the requirements of paragraph 35-55(1)(b) of the ITAA 1997 have been met for this income year, and accordingly he cannot exercise the discretion. Therefore, the loss deferral rule will apply for the 2000-01 income year and the taxpayer will not be able to include the loss from this business activity in their calculation of taxable income for the 2000-01 income year.