A recent AAT decision (AAT Case [2011] AATA 779) has affirmed how difficult it is for those with an adjusted taxable income of over $250,000 to utilise business losses.

In this case, a taxpayer who carried on a loss-making beef cattle business which incorporated 2,000 hectares of land and 1,200 head of cattle was unsuccessful in overturning a ruling issued by the Commissioner in which he refused to exercise his discretion to allow the taxpayer to apply his business losses against his other income.

Based on the evidence presented, the Tribunal held that the taxpayer did not satisfy s.35-55(1)(c)(i), as it said the nature of beef cattle production does not take more than 2 decades to produce assessable income greater than deductions. The Tribunal also held that the taxpayer did not meet the criterion in s 35-55(1)(c)(ii), as it found 6 years to be a commercially viable period on objective evidence.

For those of you not familiar with the non-commercial loss provisions, as from 1 July 2009, an individual with an adjusted taxable income of over $250,000 have their business losses quarantined for utilisation against future profits of that business activity only. This is regardless of the fact that the business may have satisfied the existing commerciality tests which include:

1. Assessable Income Test: Annual income exceeding $20,000
2. Real Property Test: The value of real property used in the business exceeds $500,000
3. Other Assets Test: The value of other assets used in the business exceeds $100,000
4. Profits Test: The activity must have produced a profit in 3 of the last 4 years.

Adjusted taxable income includes an individuals:
 - taxable income;
 - reportable (salary sacrifice) super contributions;
 - reportable fringe benefit amounts; and
 - total net investment losses

While a high income individual may be prevented from looking to one of the four tests because they fail to meet the income requirement, there is a further avenue for relief in the form of an ATO discretion to allow the utilisation of tax losses, if there is an objective expectation, based on evidence from independent sources (where available), that the business will produce taxable income in a timeframe that is considered commercially viable for the industry concerned.

This is to be contrasted with the ATO's discretion that applies for individuals that meet the income requirement. In exercising that discretion, the ATO need only satisfy that the business will satisfy one of the four tests within a commercially viable time frame.

Disappointingly, the ATO will not recognise valid commercial reasons for a long yield time where they depart from the industry norm as evidenced in the following example:

Joe earns in excess of $250,000 and has a substantial rural property. The property has a family residence and sheds and apart from one area of the property where a few goats are kept, is otherwise developed with nut trees.
As Joe's income is higher than $250,000, Joe applies to the ATO seeking the exercise of the discretion in paragraph 35-55(1)(c) to allow him to access his losses.
In support of his application, Joe provides a letter from the secretary of the Nut Tree Growers Association that states that yields from that number and type of trees would ordinarily be sufficient to allow Joe to make a profit within about six years. This is the industry norm for growers of that type of nut tree. However, because the soil on the property is not very fertile and the site does not get a lot of sun, Joe accepts that the lead time for his particular not-growing activity will be nine years not six years. Joe otherwise manages his nut tree orchards in accordance with industry management practices.
Having examined the case, the ATO concludes that, despite the large number of trees on the property and the fact the business is being conducted in accordance with industry management practices, the discretion should not be exercised in Joe's favour. This is because the lead time for this activity to become profitable is greater than the industry norm.