CARRAZZO CONSULTING UPDATE:
A ‘SPECIAL CIRCUMSTANCES’ TAX UPDATE
It would be obvious to many of you that the tax rules relating to our industry that have caused the writer the most grief over the past few years has been the “Non-Commercial Loss” (NCL) rules.
Under updated NCL rules, where an individual (alone or in partnership) has “adjusted taxable income” greater than $250,000, the only way that person can claim the loss immediately is if they apply to the ATO for a private ruling. One of the two grounds available is where “Special Circumstances” caused the loss, defined in ATO jargon as:
“Where the business was (or will be) affected by special circumstances beyond the control of the operators of the business (e.g., a fire, flood, drought, diseases affecting livestock or crops (e.g. EI), a pest plague or a hailstorm.”
In the past few years where ATO revenue has been diminishing, high earning industry players have found it increasingly difficult to have their losses deducted when applying under the grounds available, but more so under the “Special Circumstances” ground.
Ground breaking AAT decision re “Special Circumstances”
However, a recent NSW AAT decision (AATA 620) has given the writer a little more hope that the ATO will take note of the principles raised in this case and not be so strict in its application of the “Special Circumstances” requirement and the laws surrounding it.
To my knowledge, this is the first case that has found in favour of a person claiming “Special Circumstances” as the grounds for being able to claim losses under the NCL rules. Needless to say, a welcome and long overdue decision!
Though this case does not strictly relate to the horse breeding industry, it does relate to another primary production activity of Olive growing. In general terms, the “special circumstances” that stopped this person, a Doctor Bentivoglio (“Dr B”), from generating a profit could also apply to many horse breeders, being:
- Bug infestation;
- Prolonged drought and dry conditions;
- Hail storms;
- Hot weather;
- Fire; and
- The serious illness of a “key” person, Dr B’s wife.
Below I will comment on this case and highlight how this favourable decision to Dr B could be of help to the breeding industry.
Dr B carried on a business activity of olive growing and olive oil production since 1 July 1997.
Dr B’s business activity was affected by olive lace bug infestations for many years (with direct physical effects being experienced up until the 2008/09 income year), and other special circumstances outside Dr B’s control (see below).
For the 2009/10 to 2013/14 income years Dr B made losses from his business activity. In each of these years, the Dr B’s business activity would have produced a tax profit if the special circumstances had not happened.
In May 2012, the Dr B applied for an ATO private ruling seeking approval for the immediately claiming of his losses in the relevant years.
The ATO refused allow the private ruling and after an unsuccessful objection to the ATO, Dr B went to the Administrative Appeals Tribunal (“AAT”) to appeal the ATO decision.
Dr B wins at the AAT – most of his “special circumstances” accepted
In a win for common sense, the AAT ruled in favour of Dr B and his losses relating to the 2009/10 to 2012/13 years were allowed to be claimed and not subject to deferral under the NCL rules.
The AAT found that the losses incurred from the 2009/10 to 2012/13 years (inclusive) were attributable to the special circumstances and it was unreasonable not to allow the losses for those years. This was because the olive lace bug infestation, along with the other special circumstances outside the Dr B’s control, had put the Dr B’s business four years behind where it should have been. The losses incurred for the 2013/14 year did not meet the NCL criteria and were not allowed.
The AAT noted that even accepting that special circumstances are defined as “circumstances that are unusual, uncommon, or out of the ordinary”, in this case it posed the long overdue question: by reference to what? Is it by reference to the circumstances of other businesses generally, other businesses in different locations, other businesses carrying on similar activities? Or is it by reference to the activities of this particular olive business, in years other than the years in question? The AAT noted that it may vary, depending on the particular circumstances being considered.
This was a welcome departure from the general ATO policy of considering “special circumstances” only by reference to what occurs reasonably commonly in Australia, not what may be a “special circumstance” to the business in question.
Below I note what the AAT concluded re the issues raised by Dr B that, in its opinion, were “special circumstances”.
Issue 1 - Olive lace bug infestation
The point the Dr B made is that, for his particular business activity, a lace bug infestation is a special circumstance because, although it might be experienced by other participants — even by many other participants — in the olive industry, his organic certification restricted the way he could respond to the problem . The AAT agreed that lace bug infestation is a special circumstance.
The ATO’s contention that insect pests can never be a special circumstance because the primary industry will have to deal with insect pests at some point in time was rejected because “….to take the entirety of primary industry activity in Australia as reference point for the consideration of special circumstances – a brush that is plainly too broad”.
Issue 2 – Drought
Drought was accepted as a special circumstance even though it occurs reasonably frequently in Australia and for extended periods. It was no less special for spanning multiple years or for impacting multiple parties.
Issue 3 - Prolonged drought and dry conditions; other weather events
The AAT accepted the following events as constituting special circumstances that affected the business activity and were outside Dr B's control:
• The drought experienced in the 2007 and 2009 years;
• An extraordinarily hot weather event experienced in November 2009;
• Spot fires from lightning strikes in February 2007 and November 2009,
and resulting smoke that inhibited pollination; and
• A hailstorm in January 2011.
Issue 4 - Illness of a “key” person, Dr B's wife
The ATO had submitted that illness is not a special circumstance unless the person is a “key” person such that the illness affected the operation of the business.
The facts showed that the Dr B's wife was a highly qualified member of the team and an experienced oil maker and blender, thus the AAT concluded that her illness, which was of course outside the Dr B's control, is a special circumstance that affected the business activity in the 2010 income year (when the diagnosis of her illness was made and she underwent surgery) and the 2011 and 2012 income years (when she was recuperating). It was possible that there was some residual impact during the 2013 income year.
Issue 5 - Extraordinary challenges facing the olive oil industry
The following “challenges” claimed by Dr B as being extraordinary were not special circumstances because they were examples of the standard types of challenges faced by the olive oil industry and also other industries that are in the business of importing products:
The impact on oil pricing of low grade olive oil being sold in Australia;
- The GFC;
- The devaluing of oil for short term gain;
- The high Australian dollar adversely impacting exporting opportunities; and
- The low pricing on world markets.
Lessons for the breeding industry out of this case?
- As noted above, a “special circumstance” can still be argued by reference to the impact on your business even though it is common to many other breeders or primary industry, e.g. mare abortions, foals dying etc. The AAT noted that “..the answer may vary depending on the particular circumstances being considered”;
- Contrary to many ATO decisions in this area and its public rulings, fact sheets etc, the AAT commented that it is not within the NCL laws that “special circumstances” will only be accepted if they prevented a tax profit from being made. It was noted as a relevant consideration, but not mandatory;
- Per Issue 4 above, the loss or illness of “key” personnel in your breeding business, say a stud manager, vet, pedigree consultant etc could be reasonably argued as a “special circumstance”;
- Per Issue 5 above, it would be difficult to argue that a slump in sales prices, economic downturn etc would be considered a “special circumstance” by the ATO; and
- Droughts, fires, equine viruses, extreme weather, bug infestations etc could be argued as “special circumstances” affecting the development of sales horses and the general welfare of other breeding stock. And furthermore, as noted above, it is not imperative that these prevented a tax profit from being derived.
You are welcome to contact Paul Carrazzo if you wish him to clarify or expand upon any of the matters raised in this release.
Any reader intending to apply the information in this article to practical circumstances should independently verify their interpretation and the information’s applicability to their particular circumstances with an accountant specialising in this area.
PAUL CARRAZZO CPA
CARRAZZO CONSULTING CPAs
339 WILLIAM STREET
WEST MELBOURNE VIC 3003
TEL: (03) 9982 1000
FAX: (03) 9329 8355
MOB: 0417 549 347
Web Site: www.carrazzo.com.au