Plan or perish!
Whether carrying on a small business of primary production?
Paul Kenny
School of Commerce
Research Paper Series: 99-2
ISSN 1441-3906
In light of the recent focus of the Australian Taxation Office on the deductibility of
losses claimed by small scale primary producers, it is essential that taxation advisers
provide their clients with appropriate advice prior to their commencement of primary
production activities, so as to minimise the risks involved in claiming primary
production losses. This paper examines the relevant case law and the Australian
Taxation Office’s current approach having regard to two practical scenarios.
Whether carrying on a primary production business?
Conveniently the Courts have provided a framework of criteria which needs to be
considered in determining whether a taxpayer is carrying on a business. Perhaps the
criteria are best summed up in the frequently quoted joint judgement of Bowen C.J.
and Franki J. in Ferguson v FCT1, which states :
There are many elements to be considered. The nature of the activities,
particularly whether they have the purpose of profit-making may be important.
However, an immediate purpose of profit-making in a particular income year
does not appear to be essential. Certainly it may be held a person is carrying
on business notwithstanding his profit is small or even where he is making a
loss. Repetition and regularity of the activities is also important. However,
every business has to begin and even isolated activities may in the
circumstances be held to be the commencement of carrying on business.
Again, organisation of activities in a business like manner, the keeping of
books, records and the use of system may all serve to indicate that a business
is being carried on. The fact that, concurrently with the activities in question,
the taxpayer carries on the practice of a profession or another business, does
not preclude a finding that his additional activities constitute the carrying on
of a business. The volume of his operations and the amount of capital
employed by him may be significant. However, if what he is doing is more
properly described as the pursuit of a hobby or recreation or an addiction to a
sport, he will not be held to be carrying on a business even though his
operations are fairly substantial.
Often these criteria will be in conflict, for example an activity conducted on a small
scale may indicate insufficient business character whilst other relevant criteria may
1
79 ATC 4261 at 4265
2
well outweigh that factor, such as a profit making purpose and a business like
approach. As found in Martin v FCT 2, the test is ‘eventually based on the large or
general impression gained’, the relevant factors must be weighed up, no one factor is
decisive.
For example, in Ferguson v FCT3 the taxpayer was considered to carry on a business
even though the activity only involved five cows which were to be built up into a herd
for full time breeding. The Full Federal Court found that the activities were
commercial in nature, regular and recurrent and that an immediate purpose of profit
making in a particular income year is not essential.
In Walker v FCT4 the taxpayer was carrying on a business that consisted of one
female Angora goat. The goat was purchased with the intention of establishing a
small stud and selling the offspring. However the goat and offspring died and
consequently these activities ceased. The Supreme Court of Queensland established
that the taxpayer was carrying on a business, as the activities were commercial in
nature, regular and recurrent and had a profit making purpose which offset its small
scale.
The Australian Taxation Office’s approach
Whilst it would appear that the system of self assessment provides taxpayers with the
opportunity to claim primary production losses without any immediate substantiation,
it is clear that the Australian Taxation Office has highlighted this as a risk area, stating
in a media release5 :
Over the last year, the ATO has been examining certain cases where people
have claimed losses from primary production activities. A number of cases
were identified where the losses were not allowable as the taxpayers were not
carrying on a genuine primary production business. As a result of the initial
phase of the project, there have been tax savings of over $10 million.
We have been concentrating on those people who earn their main income from
a salary and claim primary production losses’ Mr Carmody said. ‘Of the
initial sample of 39,000 people, 1,000 are no longer claiming a loss, 3,000 are
now including a profit and we are in the process of making adjustments to
those losses claimed by a significant portion of the balance. Of those people
subject to examination, which normally includes an inspection of their
property, around 75% have been found not to be in business of primary
production.’ Mr Carmody stressed that genuine primary producers have
nothing to fear from the ongoing project.
The Australian Taxation Office uses statistical and internal computer assisted analysis
to identify a patch of taxpayers who broadly would meet the definition of a doubtful
primary producer. Criteria such as the amount and pattern of losses, industry code,
significant other income, and postcode were used to refine the database to a
2
90 ATC 171 at 174
79 ATC 4261
4
83 ATC 4168
5
Australian Taxation Office Media release of 29 May 1995
3
3
manageable level. Each potential case is reviewed, and if still considered doubtful, a
primary production questionnaire is sent out. If upon reply the issue is still not free
from doubt, a visit to the property is arranged to inspect the primary production
operations. Also an Australian Valuation Officer may be utilised to confirm whether
a genuine business is being carried on . The Australian Taxation Office would then
consider the information collected, identify the key issues, and review the case in
relation to well established indicators of business. 6
Taxation Ruling TR 97/11 largely follows the relevant factors set out in Ferguson,
stating7 :

whether the activity has a significant commercial purpose or character;
this indicator comprises many aspects of the other indicators

whether the taxpayer has more than just an intention to engage in business

whether the taxpayer has a purpose of profit as well as a prospect of profit
from the activity

whether there is repetition and regularity of the activity

whether the activity is of the same kind and carried on in a similar manner
to that of the ordinary trade in that line of business

whether the activity is planned, organised and carried on in a businesslike
manner such that it is directed at making a profit

the size, scale and permanency of the activity

whether the activity is better described as a hobby, a form of recreation or
a sporting activity
In particular TR 97/11 attaches a special importance to profit motive and business
viability, stating8 :
Subject to all the circumstances of a case, where an overall profit motive
appears absent and the activity does not look like it will ever produce a profit,
it is unlikely that the activity will amount to a business.
Now this paper will apply these principles to the facts of the following two scenarios.
Background to scenarios
Mr Jones is professionally employed in the city and on 1 January 1997 he purchased a
small parcel of land financed by way of a bank loan on normal commercial terms.
Australian Taxation Office, ‘Doubtful Primary Producers’ South Australian Tax Agents Forum,
Waymouth Australian Taxation Office, 24 November 1995
7
TR 97/11 at para.13
8
Id at para.17
6
4
Although Mr Jones has had no previous agricultural experience prior to purchasing
the property, he has always had a keen interest in the land. It is his earnest belief that
he is in business as a farmer, which he expresses regularly in his discussions with the
Australian Taxation Officer.
Primary production losses have been claimed in relation to the activities undertaken
on the property, for both the 1997 and 1998 years.
1998 Primary production details:
Livestock account
Number
Sales
0
Closing stock
4
Deaths
1
Loss on trading account
Opening stock
Purchases
Loss calculation
Agistment
Cattle
Less
Feed
Depreciation
Motor vehicle
Property holding costs
Other expenses
Interest expense
Loss claimed
0
5
$
0
300
100
0
400
600
(100)
711
555
4,468
944
911
7,874
14,963
Land Valuation Office and Department of Primary Industry information reveals that
the property is capable of carrying around 30 cattle.
Scenario One
Mr Jones bought the property as a retirement nest egg. He has no immediate intention
of residing there, but may do so upon retirement. Indeed, his commitments in the city
would prevent him from doing this. He has no written business plan or cash flow
projections, but in his words, he is seeking "to maximise the returns from the property
to make it pay it's way". With this in mind, his intention at the time of purchase was
to buy steer calves for fattening. He believed he would be able to turn-off 30 steers
per year for $230 each providing an income of $6,900. However, financial constraints
would prevent him from operating at this level for the next couple of years.
In February 1997 he agreed to allow a neighbour to agist cattle on the property for
$600 per annum. The terms of the informal agreement were that he would have the
option to terminate the arrangement or reduce the area available for lease, as his
primary production activities increased. In March 1997 he purchased five poddy
calves from a nearby dairy for $400. The cost of weaner formula amounted to $508.
5
One calf died within a month of purchase.
Mr Jones did not anticipate the amount of time commitment needed to wean the
calves, and arranged for the neighbour to finish the process in return for free
agistment next year. In future he intends buying weaned steers.
Whether a business is being conducted?
The major use of the property to date has been by the neighbour for agistment. This
does not constitute a business from Mr Jones’ point of view because it is merely rent
received for the enjoyment of the land by another. With respect to the cattle
operations the small scale indicates a lack of commercial flavour. The cattle will not
be used as the step towards a larger herd that would be the case with breeders.
The activities have resulted in a substantial loss given the relatively high level of
expenses required to maintain the small herd. To date Mr Jones has incurred marginal
costs per head of $180, being that of purchase and weaning. He has anticipated a sale
price of $230 per head, thereby implying a gross margin of $50 per head. He could
therefore expect to gross $1,500 per year, even with his optimistic estimation of the
property's capacity. This would not even cover the property's holding costs.
Note that this calculation does not account for the costs of maintaining pastures or
providing supplementary feed in summer. Lack of resources at this stage and the
amount of travelling required as reflected in the claim for motor vehicle expenses are
preventing the property from becoming viable. His purpose is "to maximise the
returns from the property to make it pay it's way" the scale of operations 9 and lack of
business plan10 provide no basis for showing how the activities will eventually be
profitable. He has stated his belief that the property will operate at a capacity of 30
sales per year but has only the resources to turn off four head.
The cattle operation has not been carried on in a manner characteristic of ordinary
trade. Such trade would typically display some of the following characteristics to
ensure economic viability, that is greater time and resources spent on cattle and
property maintenance, acquiring cows in a breeding operation and residing near the
primary production activities.
The activities lacked repetition and regularity11 as a result of the limited time spent on
the property. Also, an examination of the activities and records showed limited
organisation of his activities in a businesslike manner and use of system. He had no
prior experience in primary production activities. Although there is no evidence that
suggests that the activity is a hobby or lifestyle choice rather than a business.
Thus, the activities would be better described as being preparatory in nature.
Obtaining a small income in order to defray some of the costs of the property whilst
waiting for some time in the future where proper commercial activities may be
undertaken when finances allow. Accordingly, the Australian Taxation Office may
well argue that Mr Jones was not conducting a business of primary production in the
9
an important factor per Ferguson v. FCT 79 ATC 4261 at 4265
important per TR 97/11 at para.17
11
an important factor per Ferguson v. FCT 79 ATC 4261 at 4265
10
6
year ended 30 June 1998.
Scenario Two
Mr Jones lives on the property and has started to build improvements to increase the
size of the herd to 60 breeders. He is adamant that his main motive in purchasing the
property was to pursue a business of primary production. He intends for the property
to provide him with an income to live off. He has prepared cash flow projections to
support his contention that the property can become viable. This is on the basis that
he will be establishing a firewood plantation of 10 hectares, run in conjunction with a
cattle enterprise.
Mr Jones’ cattle venture will be based on selling 60 head of cattle per year. Although
the property will only currently support 30 head, he has commenced a number of
improvements. Firstly, he has improved the pastures, and installed irrigation to
supplement the area's high rainfall. Also, he has a breeding and purchasing program
to build up the herd to 60 cattle, and then turn off once a year.
He anticipates gross sales of $25,000 per annum when a herd size of 60 is attained.
All costings appear reasonable on the basis of information supplied from the
Department of Primary Industries. He intends to retire in five years and from his
superannuation pay out and extinguish the debt on the property. He therefore
anticipates the property will be viable in five years when the herd is up to 60 cattle.
He has planted 200 trees in grid formation with the aim of having 10 hectares of trees
planted for firewood. His projections show that the firewood will gross $4,000 per
annum within seven years. This is based on a price delivered to a firewood merchant
located in the Hills, as he believes the additional cost and time of delivering the wood
directly to customers would outweigh the higher price that would be expected.
He has made enquiries with the wood yard and is of the opinion that they will readily
accept the wood. He anticipates the cost per annum of harvesting the wood with his
own labour and delivering it to the wood yard to be $1,000.
Whether a business is being conducted?
Mr Jones had no prior experience in primary production activities and the small scale
of the cattle and forestry operations indicates a lack of commercial flavour. Although,
there is no evidence that suggests that the activity is a hobby or lifestyle choice rather
than a business. The cattle, being breeders will be used as the step towards a larger
herd. Also a ten hectare plantation of trees is planned, and the cattle and forestry
operation has been carried on in a manner characteristic of ordinary trade. The
activities displayed repetition and regularity through his time spent on the property.
Also, examination of the activities and records showed organisation of his activities in
a businesslike manner and use of system.
His purpose is "to maximise the returns from the property to make it pay it's way".
He has provided realistic business plans and profit forecasts showing how the
property will become profitable in five years time. He has and will introduce
sufficient resources to enable the property to become viable supported by plans to
7
build up the herd and the plantation of trees. Thus, in the year ended 30 June 1998,
Mr Jones was conducting a business of primary production.
Conclusion
Given that the Australian Taxation Office has highlighted that new small primary
producers are an area of risk, taxation practitioners will need to carefully advise
taxpayers and point out all the risks associated with claiming losses. The importance
of planning prior to the commencement of a business can not be over estimated. If
the activity is a genuine business proposition supported by business plans, industry
and expert information and sufficient resources so as to support a viable activity there
will be little doubt about the deductibility of such losses.