The Taxpayer and Commissioner of Taxation

[2013] AATA 3

[2013] AATA 3

Division	TAXATION APPEALS DIVISION
File Number	2011/2706
Re	The Taxpayer
APPLICANT
And	Commissioner of Taxation
RESPONDENT

DECISION

Tribunal	Senior Member Bernard J McCabe
Date	8 January 2013
Place	Brisbane

The objection decision is affirmed.

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Senior Member Bernard J McCabe

CATCHWORDS

TAXATION – Private rulings – Objection decision – Capital intensive business – ‘Business like’ activity – Objective to make profit – offsetting non-commercial losses – Whether the discretion should be exercised in the taxpayer’s favour – Objection decision affirmed.

LEGISLATION

Income Tax Assessment Act 1997 (Cth) ss 35-55.

REASONS FOR DECISION

Senior Member Bernard J McCabe

8 January 2013 

1. Many professional people dream of owning a vineyard. For some, it is a lifestyle choice; others regard it as a hobby. But many (presumably most) professional people who buy or establish vineyards are doing so with the objective of making a profit. As it happens, grape-growers and wine producers have struggled to make money. There has been a glut of grapes produced in Australia and overseas for several years. That has contributed to falling wine prices, especially at the lower end of the market. It is a difficult business at the moment.

2. The taxpayer in this case has decided to establish a vineyard in the Margaret River region of Western Australia. She is undertaking the venture in partnership with another person, but that is irrelevant for present purposes. She purchased a property and developed a business plan in consultation with appropriate experts. There is no doubt she is embarking on the venture with a view to a profit. She has seen an opportunity to produce premium grapes: apparently the price for premium grapes is holding up relatively well, and may actually be increasing. But this is a capital-intensive business. Vines have to be planted (after being sourced from appropriate stocks) and the land has to be improved in various ways.

3. The taxpayer proposes staggering the planting of her vineyard over several years. She does not want to plant the whole vineyard at once. That makes perfect commercial sense: she can husband her capital more effectively if the vines she plants first start to produce an income after 3 years. That income will help offset the cost of the further development of the vineyard. She will also have the opportunity to carefully select and adjust the sort of vines she plants. On her approach, the vineyard operation will not reach full production for approximately ten years.

4. The taxpayer wants to offset the losses she makes from the venture over the extended period against her other income. That is a problem. Division 35 of the Income Tax Assessment Act 1997 establishes rules preventin a taxpayer from offsetting losses from non-commercial businesses against other income. There are exceptions to the rules. The Commissioner has the discretion in s 35-55 to allow the losses to be offset where he (or the Tribunal, upon review) is satisfied as to certain matters. A taxpayer can apply to the Commissioner for a private ruling that the discretion be exercised in his or her favour. That is what the taxpayer did here. Her request for a private ruling explained why the Commissioner should exercise his discretion under s 35-55 to permit her to offset the losses she will incur in the income tax years ended 30 June 2010 through 2018. (There was also an objection taken to the taxpayer’s income tax assessment in the 2009 financial year, but I understand that aspect of the application is not being pursued, so I will not deal with it further.)

5. The Commissioner declined to make the ruling sought by the taxpayer. I have now been asked to consider whether the discretion in s 35-55(1)(c) to exempt the taxpayer from the usual rule quaranting losses from non-commercial businesses should be exercised in the taxpayer’s favour.

6. The Commissioner does not suggest there is a material difference between the scheme identified in the ruling and the evidence presented at the hearing. It follows there is no difficulty in dealing with the objection.

   THE EVIDENCE

7. The facts are uncontroversial. The taxpayer’s vineyard is located in prime grape-growing country in the Margaret River. It was purchased for close to $1 million in 2008. The previous owner grew some grapes but much of the land was cleared. The property is approximately 20 ha in size. 

8. The taxpayer plans to grow premium grapes of different varieties. To that end, she proposes establishing 12 blocks within the property. Each block will be planted with a particular variety of grape, but the planting would be staggered over until 2014. The taxpayer started with the small existing vineyard, which became the first two blocks in 2009; additional blocks have since been planted. In the meantime, the taxpayer proposed:

   ·Sinking a new bore;

   ·Expanding the existing dam;

   ·Establishing irrigation head works;

   ·Erecting or replacing trellises.

9. I was provided with evidence about grape growing in the Margaret River region. The vineyards in Margaret River do not produce a large percentage of the total Australian “crush” but the region is well-known for producing high-quality grapes – albeit at generally higher costs than other regions where yields are typically higher: exhibit one at p 301. In recent years, some of the marginal vineyards have produced inferior quality fruit in an attempt to compete with larger producers at lower price points. Some of those producers are going out of business in the face of a world-wide glut of grapes and wine. Mr Greaves, an expert valuer called by the taxpayer, said the industry was “in crisis”.

10. So why would one establish a vineyard? Mr Greaves said the market for premium wine and grapes was showing more life. He was optimistic a recovery in that sector of the market might be underway. He suggested a staggered program of plantings would give a producer in the taxpayer’s position the opportunity to gradually increase production to match the rate of recovery in the market. Mr Greaves also referred to:

    ·the opportunity to manage one’s capital expenditure if one staggered plantings; and

    ·The potential difficulty in obtaining suitable cuttings for the vines. Mr Greaves said two of the nurseries in the Margaret River that supplied cuttings had closed. He admitted he was not aware of nurseries in other areas but suggested state quarantine laws and local conditions might be an obstacle to importing vines from other areas.

11. Mr Greaves said staggering was common. 63% of the vineyards established in the region over the last decade adopted the practice – although it was acknowledged few if any new vineyards had been established recently.

12. I was provided with an analysis of a budget and business case prepared by Mr Greaves’s firm for the taxpayer. It is clear the taxpayer has gone about this venture in a business-like way. There was also evidence to this end from AHA Viticulture, another consultant. With staggered planting and assuming the vineyard produces high quality fruit, Mr Greaves estimated the property would be in full production (and would be making income in excess of deductions) by the 30 June 2018 year of income. He opined (Exhibit 1 at p 304):

    It is my opinion that a commercially viable period for the industry at this time, taking into account the factors outlined in my report such as the current market conditions and the practice of staggering, is 8 to 9 years.

13. Mr Greaves also gave evidence – which appears to be widely accepted – that vines take around 5 years to mature. They start producing fruit after 3-4 years but they do not reach their peak until 5 years after planting. Ms Ford, for the Commissioner, asked Mr Greaves whether it was possible to plant the entire vineyard in the course of a year. I did not understand there to be any obstacle to that occurring other than access to capital. Which is not to say it is a good idea to move that quickly: I was provided with convincing business reasons why it would make sense to take the more gradual approach contended for by the applicant. But it was agreed the vineyard could be completely planted and reach peak production within 5 years rather than 8 or 9 years.

    THE LEGISLATION

14. Section 35-55(1)(c) provides:

    (1) 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 (the excluded years ) if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

    …

    (c)  for an applicant who carries on the business activity who does not satisfy subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made--the business activity has started to be carried on and, for the excluded years:

    (i)  because of its nature, it has not produced, or will not produce, assessable income greater than the deductions attributable to it; and

    (ii)  there is an objective expectation, based on evidence from independent sources (where available) that, within a period that is commercially viable for the industry concerned, the activity will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C)).

15. Can it be said the business ‘because of its nature…will not produce… assessable income greater than the deductions attributable to it” during the 9 year period contended for by the taxpayer? The answer to that was clear enough from Mr Greaves’s evidence – in particular, from his answer to a question from Ms Ford about whether it was possible to have the vineyard up and running within 5 years. He said it was. I accept he thought it was commercially prudent to approach the development in a more gradual way, and he may well be right. But that is not the test. I am required to look at whether the failure to produce sufficient assessable income during a given year of income was “a result of some inherent feature that the taxpayer’s business activity has in common with business activities of that type”: see Federal Commissioner of Taxation v Eskandari 134 FCR 569 at [32] per Stone J.

16. Vines can be planted and become productive within 5 years. The applicant has chosen to take a more gradual approach. No one quibbles with the wisdom of her decision, and I am told it is a common practice in the industry. But she is unable to satisfy the first leg of the test in s 35-55(1)(c). In those circumstances, it would not be reasonable to exercise the discretion in her favour.

    CONCLUSION

17. The objection decision is affirmed.

I certify that the preceding 17 (seventeen) paragraphs are a true copy of the reasons for the decision herein of Senior Member Bernard J McCabe.

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Associate

Dated 8 January 2013

Date of hearing	3 December 2012
Counsel for the Applicant	Mr S Fisher
Solicitors for the Applicant	Merthyr Law
Counsel for the Respondent	Ms E Ford
Solicitors for the Respondent	ATO Legal Services