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Taxation assignment date 12/1/2014
The information that you have provided will be dissected into the establishment of carrying on a business and Div 35 deducting business losses against other income and the avenues that may be useful in ascertaining what actions are needed to receive the deductions.
To firstly establish that you are “carrying on a business” the Master Tax Guide sec 16 – 015 explains the most important factors in determining whether a business is being carried on. The four factors are profitability, size, effort and business records. To prove profitability the most relevant case law is Smith v. Anderson(1880) – “anything which occupies the time and attention and labour of a man for the purpose of profit is business” (Federal Commissioner of Taxation, 4 June 1997). You said “sensing a business opportunity he …consulted with Government departments … and developed a business plan” this is seeking a business opportunity, thus seeking profit. Also the time spent planting and maintaining the trees and cattle is giving attention and labour for purpose of business profit. Based on this evidence and case law the key factor of profitability, although no profits it suggest you believe it will produce profit, is in favour of carrying on a business.
To determine if size will affect the commissioners opinion that this is carrying on a business the relevant case law from Thomas v FCT (1972) is applicable - Also “The larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business of primary production. However, this is not always the case. The size or scale of the activity is not a determinative test, and a person may carry on a business though in a small way (Thomasat ATC 4099; ATR 171)” (Federal Commissioner of Taxation, 4 June 1997). The size of the cattle grazing activity is small but the way that it was conducted in business like manor is evident through the business plan developed and significant capital investment to start the trees and cattle operation. Also the operations are dealing in “items typically dealt with commercially” (MTG 16 – 015).
Business records are essential to commercial business and although you have not divulged any such information, you have the recordings of sale of cattle and the overall enterprise loss for taxation purposes. These if there be any paper work or electronic recordings of sales or how you calculated your overall loss would be in favor of identifying business records. Relevant to systematic approach to business the relevant case law is applicable in John v F.C. of T. (1989) – “Whether a person is a trader (ie. in the business of trading) is a question of fact … if trading has not commenced or if there is no discernible trading pattern, the question of intention or purpose may be relevant in the sense that if there is an absence of intention or purpose to engage in trade regularly, routinely or systematically the person may well not be a trader …" (http://www.gf.com.au/829_226.htm)
Based on the case law and the evidence of systematic calculation of income and overall losses it would appear to be in favor of evidence supporting the carrying on of a business. Also the effort described in achieving these in your operations suggest significant effort & if critically observed significantly invested into the operations that it would be in favor of commissioner accepting that you are carrying on a business.
Note: Adjusted Taxable income is family income assistance for dependants it includes: taxable income, reportable super contributions, total net investment loss (from shares, rights, options & rental properties), adjusted fringe benefits etc (MTG, 2013)
Secondly the losses from a business cannot be offset against income unless the adjustable taxable income is less than $250,000 and one of the tests is passed. Division 35 “deferral of losses from non commercial business activities” prevents losses of a business to be offset against other assessable income in that year. It sets out a n income requirement and series of tests to determine whether a business activity is treated as being a business. (Stephen Barkoczy, 2013). The four tests include:
- “annual assessable income of activity is at least $20,000; or
- value of real property (land & buildings) used in connection with business are at least $500,000; or
- value of other assets (excluding cars) used in connection with the business are at least $100,000; or
- activity resulted in taxable income in at least 3 of the last 5 years (including current year)” (Text book, 2013)
From the information provided the business does not pass any of these tests and accordingly results include:
- Assessable income from the sale of cattle is $15,400 (not passed)
- Farm land and buildings are worth ($660,000 -$166,000 exclude residence) = $494,000 (not passed)
- Farm plant and equipment is valued at( $155,000 -$65,000 exclude 4WD)= $90,000 (not passed)
- Only purchased land on 30 June 2012 (not passed)
To pass test 1 the sale of cattle exceeding $4,600 would make the loss allowable to be offset. To pass test 2 the purchase of $6,000 in land & buildings is needed to pass. To pass test 3 the purchase of $10,000 in plant and equipment excluding cars is needed to pass the test. From these results a favorable sale of cattle is significantly smaller amount. The sale of cattle to neighboring properties or family and friends with the intention to purchase back would yield the results to pass the test.
Div 35-45(2) “ the assets counted for this test(Value of other assets) and their values for this test”(MTG, 2013) include trading stock stipulated as: sec 70-10(1) Live stock and Anything produced, manufactured, or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business (MTG, 2013)… does not include CGT assets sec 108. Trees used to produce oil are not CGT assets
If these have been overlooked in your calculation of income and losses then on revision there is a possibility of passing the “Value of other assets test” by making the difference of $10,000 with the added value of trading stock including value of cattle and trees on hand.
Thirdly the Federal Commissioner of Taxation can exercise his discretion to allow the loss offset from the business. Sec 35 – 55 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 if the commissioner is satisfied that it would be unreasonable to apply that rule (Stephen Barkoczy, 2013).
Upon meeting the income requirement and not passing any of the business tests of which there are four, you can ask the commissioner to allow the offset from the business loss if:
- “your business would have passed one of the tests except for special circumstances outside your control, or
you have just started your business and, because of its nature, there is a lead time before:
- it passes one of the tests, or
- you can expect a profit” (ATO, 2013).
The application to the commissioner must have evidence that the business lead time is common in this industry and because of the nature of the business you did not make a profit for the current year. This may include “industry articles, statistics, analyses, scientific research or other papers on the relevant industry that support“ (ATO, 2013) your claim and are they from independent sources qualified with the skills and experience with the primary production industry. Based on the information provided, the nature of the olive oil industry because of natural lead time with the growth of the plants, this is common with plantations within farming and primary production businesses and would be in favor upon application to the Federal Commissioner of Taxation.
The exempt activities provisions in sec 35 -10(4) can be exempt if “primary production business” and “your assessable income for that year from other sources that do not relate to that activity is less than $40,000. The teaching income is $41,000 and is greater than $40,000 thus negating this provision. (MTG, 2013) (Stephen Barkoczy, 2013).
On possibility that you are not able to claim then Deferring a non-commercial loss in the current year deferring will give you time to meet the requirements.” and may be able to offset it in a future year, either by passing one of the tests or making a profit in the business” (ATO, 2013).
The rules explain that if current year losses are not able to be offset then it is accumulated for a future year it does pass. This accumulated deferred loss is offset by a year where the business makes a profit but does not meet any of the tests; example 1000 profit will be deducted from the 3000 in deferred losses leaving a deferred loss of 2000 for next year. Once the business passes 1 of the 4 tests it will used the current losses and the deferred losses; example is the business makes a loss of $4,000 andhe meets 1 of 4 deferred commercial loss tests, then adding deferred and current of $6,000 will be offset against his other income. So the money losses incurred in current year can be claimed upon meeting one of the business tests.
According to the information provided it would seem that the most favorable course of action is to pass the Div 35 tests or seek reduction of assessable income by $1,000 to come under the exempt activities provision in sec 35 – 10(4). The revision of assets held by the primary production with the inclusion of Trees and remaining cattle may provide enough value to pass the “other assets test”.
Answers to conclusion
- Div 35-45(2) recalculating the “other assets test” adding livestock & trees to other assets test to meet 10,000 needed to pass.
- Write to FCT discretion for a business with lead time, with the relevant documentation and evidence.
- Defer the losses for a future year when the operation meets the requirements
Try to reduce his Teaching income with deductions by $1,000 to come under the exempt activities rule
- Look for deductions: work related, self education related, Donations or Gifts, Cost of managing tax affairs.
- Making an agreement of payment to taxation specialist of $1,000 in order to reduce income by $29,000
Engage in Earnings management to increase gross income or meet the other assets test
- Purchase of inventory to hit the “other Assets test”. The purchase of livestock or machinery
- Sale of large inventory, a tractor, to neighbors with intention to purchase back at a later date or lease back.
To advise you on taxation in regards to carrying on a business of primary production first the Federal Commissioner of Taxation will need to establish the carrying on of a business then that you are of primary production business for taxation purposes. I have explained the reasoning the FCT may have in regards to these matters.
Turning into full time farmer as a result of the loss of your job as a teacher and the sale of your Newcastle house demonstrates a greater permanency and dependency on cattle farming as a profitable enterprise. The key indicator that is a business includes his full time work on farming operation, the taxpayer has genuine in that activities will be profitable (Stephen Barkoczy, 2013). Also it suggests regularity and repetition of activities which is an indicator (Stephen Barkoczy, 2013). There are two cases that clarify the importance of these indicators. Smith v. Anderson(1880) - It would appear that a business is being carried on. Jessell MR said that: “... anything which occupies the time and attention and labour of a man for the purpose of profit is business” (Federal Commissioner of Taxation, 4 June 1997). Based on the court case it illustrates a favourable position in determining if James is carrying on a business.
The result of gaining cash from selling the Newcastle house and redundancy payments you purchased more land, farm equipment and more cattle, this is a significant capital investment into cattle farming and displays the existence of a business plan or intention to seek profits. As a favorable indicator of carrying on a business the importance is put on the size and scale of the activities (Stephen Barkoczy, 2013). The Thomas v FCT ( 1972) case clarifies the importance of this indicator. Thomas v FCT (1972) - “The larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business of primary production. However, this is not always the case. The size or scale of the activity is not a determinative test, and a person may carry on a business though in a small way. Based on this case it suggests a favourable indicator that you are carrying on a business.
The actions in going to Cattle farmers and Department of primary industries for business plan & expert advice are evidence of Researching the market and development of business plan. This is an indicator that he is seeking the same characteristics of ordinary trade in line of business (Stephen Barkoczy, 2013) and further an indicator of the activities being systematic and in a business like manor (Stephen Barkoczy, 2013). The John v F.C. of T. (1989) case clarifies the importance of the latter indicator. John v F.C. of T. (1989) – the court explains that for the intention or purpose may be relevant in the sense that if there is ….intention or purpose to engage in trade regularly, routinely or systematically the person may well ...be carrying on a business.” Based on this court case you would be in favor of carrying on a business systematically and in ordinary business manor.
The result of obtaining a loan from parents in order to purchase more land is evidence of commitment to the farming operation. It also is an indicator according to the Master Tax Guide which states “Indicator of a significant capital investment”( MTG, 16-015). This would strengthen the case for carrying on a business, As in Smith v Anderson (1880) the attention you are giving towards the operation in form of financing would benefit the resulting argument in your favor of carrying on a business.
Also the attendance at the cattle market strengthens your argument for carrying on a business. The Master Tax Guide holds that it is an indicator “Market research and Business plan development for future” (MTG, 16-015). In the FCT v Walker (1985)case – Walker a taxpayer who began with only one Angora goat was held to be in the business of goat breeding, conducting his activities in a “businesslike” way, business even though the venture was small. Accordingly in acting as the other cattle farmers in the area, you are conducting your activities in a business like way, which adds to the cause to be determined as carrying on a business as a primary producer.
The activity of calculating improvements to business by purchasing 20 more hectares and trying to double your herd size in cattle shows a long term commitment to seek profit and increase capital in the farming operation. It is an indicator of the activities being systematic and in a business like manor (Stephen Barkoczy, 2013). This can be confirmed with case law from FCT v Walker (1985)– Walker a taxpayer who began with only one Angora goat was held to be in the business of goat breeding, conducting his activities in a “businesslike” way, business even though the venture was small. Based on the case and your actions both suggest business like way. Cases Smith v. Anderson(1880) and Daff v FCT (1998) add favorable cases to support your argument – Mr Daff was an unsuccessful over 14 years in making a profit, he is experienced and competent in farming and has devoted much of his efforts towards developing and operating the property. The fact that a taxpayer is experienced and competent in farming and has a genuine belief that the property will generate profits will indicate that a primary production business is being carried on. The actions taken throughout July 2012 to June 2013 suggest a not only that you have researched and obtained experience prior but add to the argument pertaining to carrying on a business and determining that you are in fact in the primary production in regards to taxation law.
Based on the facts that you have provided and the relevant case law the Federal Commissioner of Taxation would within reasonable circumstances be in favor of firstly you carrying on a business and being categorized as primary production for taxation purposes.