Non-commercial losses: Commissioner's discretion

Lead time

Where you can demonstrate that your business activity is commercially viable but, because of its nature, there is a lead time between the commencement of the activity and you satisfying one of the tests or producing a tax profit, you may apply for the exercise of the Commissioner's discretion.

If you meet the income requirement

The Commissioner must be satisfied that:

• the activity, because of its nature, has not satisfied, or will not satisfy, any of the four tests, and
• there is an objective expectation, based on independent evidence (where available) that, within a period that is commercially viable for the industry, the business activity will either
• satisfy one of the four tests
• make a tax profit.

Example - the income requirement is met

Tamsin acquired a still in September 2009, and the appropriate licences and authorisations to produce and distribute an alcoholic spirit. She commenced production of the base spirit in October 2009. Legislation states that the spirit must be aged in oak casks for at least two years before it can be bottled and sold.

Tamsin developed a business plan based on advice from her accountant and information from alcohol distributors. Tamsin's business plan indicates that she will be able to commence sales of her product in the 2011-12 income year. Tamsin will have losses from her activity that she wishes to deduct against her $50,000 salary and wage income for the 2009-10 and 2010-11 income years. Her activity will be profitable in the 2011-12 income year.

As Tamsin's alcoholic beverage production and distribution activity is carried on as a business in the 2009-10 and 2010-11 income years, she will need to ask for the Commissioner to exercise discretion for these income years. Tamsin is able to present independent evidence that making a profit in the third year of operation is within the period that is commercially viable for the industry.

The Commissioner accepts that it is in the nature of the business activity that there will be a 'lead time' before a profit can be expected or one of the tests satisfied. The Commissioner would exercise discretion in such a case for each of the 2009-10 and 2010-11 income years inclusive. Any losses made in these years would not be deferred.

If you do not meet the income requirement

The Commissioner must be satisfied that:

• the activity, because of its nature, will not make a tax profit, and
• there is an objective expectation, based on independent evidence (where available) that, within a period that is commercially viable for the industry, the business activity will make a tax profit.

Example - the income requirement is not met

In the 2009-10 income year, Jack has a taxable income of $200,000, reportable super contributions of $50,000, and reportable fringe benefits of $20,000. Jack also owns a vineyard that he purchased in August 2007. The vineyard is valued at $750,000 and has excess deductions of $50,000 in 2009-10.

Jack does not meet the income requirement because the sum of his taxable income, reportable fringe benefits, and reportable super contributions is $270,000. The vineyard has not made a profit in the previous income years. Despite the fact that his business activity is being carried on with real assets worth more than $500,000, he must now apply to the Commissioner if he wants to apply his losses against his other income.

Jack has obtained an independent assessment that the vineyard will make a tax profit (assessable income greater than deductions) within seven years from when he started the business activity. The independent advice also includes evidence that the commercially viable period for the industry is at least seven years. Jack applies to the Commissioner to exercise the discretion. The Commissioner decides that there is an objective expectation, based on the independent assessment and evidence, that the vineyard will produce assessable income greater than available deductions in a given year within a period that is considered commercially viable for the industry concerned, and that Jack can apply the $50,000 against his other assessable income in the 2009-10 income year.

The nature of the business

Irrespective of whether you meet the income requirement, you must provide objective evidence (where available) that the reason your activity has not yet met one of the four tests or produced assessable income greater than available deductions (tax profit) is because of the nature of the business, and not for some other reason that is peculiar to your particular business activity.

The phrase 'because of the nature of the business' refers to inherent characteristics of the type of business activity being conducted by you, which are common to any business activity of that type. These inherent characteristics must be the reason why your activity is unable to satisfy any of the tests or make a tax profit from the period your business activity first commences until it could be expected to meet one of the tests or make a tax profit (an initial period). This initial period has to be within the commercially viable period for the industry.

A determination does not need to be made as to how long it will take your business activity to become commercially viable. Rather, it involves an enquiry into whether your business activity will satisfy a test or make a tax profit within a time frame in which other commercial businesses in the same industry would make a profit.

The period that is commercially viable will vary from industry to industry, according to factors such as anticipated income, expenses and seasonal variations.

Examples of such activities include forestry, viticulture and other horticultural activities.

The discretion is not available in cases where the failure to make a profit is for reasons other than the nature of the business activity, such as:

• starting out on a small scale
• building up a client base
• business choices made by you that are not consistent with the ordinary or accepted practice in the industry concerned (such as hours of operation, location, climate or soil conditions, or the level of debt funding).

Example - Income requirement not met - Small scale

Phillipa started a red fruit growing business in the 2007 income year. However, Phillipa planted a very small number of red fruit bushes despite the recommendation from the industry body, Red Fruit Growers United, that significantly more bushes should be planted for a commercial activity. Phillipa planned to retire in about 15 years and gradually increased the size of the orchard over the ten years before her retirement. Phillipa installed an irrigation system as recommended by the industry body, which cost $150,000.

In the 2009-10 income year, Phillipa has a taxable income of $220,000, and reportable super contributions of $35,000.

She does not meet the income requirement because the sum of her taxable income and reportable super contributions is $255,000.

Phillipa's business made losses in the 2007, 2008 and 2009 income years. The exception for the primary production business activities did not apply, as she had received more than $40,000 of non-farm income in each year. Even though Phillipa carried on the business activity with other assets valued at more than $100,000, Phillip must apply to the Commissioner if she wants to apply her losses in the 2010 and future income years against her other income.

Evidence from the industry body shows that any red fruit growing business would not be expected to make a tax profit before year five as there are inherent characteristics that prevent it from doing so until around the time of full yield.

Even though there are inherent characteristics in Phillipa's business activity that prevent her from making a tax profit in the 2010 year, there needs to be an objective expectation based on evidence from independent sources that within the commercially viable period Phillipa will make a tax profit, for the Commissioner's discretion to be exercised.

Phillipa developed a business plan for her business activity based on the material she had from the industry body. As Phillipa had planted such a small number of bushes it was not likely that the business activity would make a tax profit until she retired in fifteen years and increased the number of red fruit bushes to a commercial number.

The evidence from industry experts shows that a red fruit growing business, conducted in a commercially viable manner, should be able to make a tax profit by the fifth year.

As there is no objective expectation that Phillipa's business activity will make a tax profit within a period that is commercially viable for the industry concerned, the Commissioner's discretion would not be exercised and the losses from Phillipa's business activity would be deferred.

Example - Income requirement met: building a client base

Andrew started a clock-repair business in the 2009 income year. He was new to the region and had yet to establish his clientele. Andrew had intended to operate his business full time, but as his funding was very limited he chose to continue his part-time employment to support himself and only worked on his business activity in his spare time. Andrew's premises are in the back of a small arcade and he only opens for business on weekends, while the other shops in the arcade are open every day of the week. The arcade is not in an area that attracts business on weekends. Andrew cannot afford advertising and has so few clients that he is unable to cover his expenses; he has made losses each year.

Andrew has a taxable income of $90,000 in the 2009-10 income year. Therefore, he meets the income requirement.

Andrew's business has yet to satisfy one of the four tests. Other businesses of this type are able to satisfy a test in the first year of operation.

The inability of Andrew's business activity to satisfy any of the four tests or produce a tax profit is due to his personal business choices as to his hours of business, location and advertising - not because of any inherent characteristics that affect clock-repair businesses. Accordingly, the Commissioner would not exercise the discretion.

The inherent characteristics may be present for an initial period from the time your business activity commences. After that initial period has elapsed, which can be several years, the inherent characteristics may cease to be the cause of those business activities being unable to satisfy any of the tests or produce a tax profit.

Objective evidence

For the Commissioner to exercise discretion for lead time, you must be able to demonstrate to the Commissioner that there is an objective expectation your business activity will meet one of the tests or produce a tax profit that is within a period that is commercially viable for the particular industry in which you conduct your business. The objective expectation must be based on evidence from appropriate independent sources, where available.

Sources of independent evidence can include an independent professional individual or organisation experienced in the relevant industry, such as:

• industry or regulatory bodies
• tertiary institutions
• industry specialists
• professional or trade associations
• government agencies
• other independent entities with a similar successful business activity
• business advisers
• financiers
• banks.

You must be able to show both:

• the standard time for the industry concerned to reach the level of operations required to be commercially viable
• the time your business activity will take to pass a test or make a tax profit given your particular circumstances (you must be able to show that this time is within the standard for the industry concerned and consider your business plan, resources available to you and any relevant environmental factors).

Evidence of the commercially viable period for a specific industry may include:

• evidence of what is typically considered to be the commercially viable period for your particular industry. For example, evidence about when any first commercial crop is expected, expected yields, the year the activity is expected to become profitable for the first time (not the year the industry expects the activity to recoup the expenditure to date) and when a typical start-up activity in the industry becomes financially self-sustaining
• evidence such as industry articles, statistics, analyses, and market forecasts that support the proposals or projections made in any business plan
• evidence on the suitability of your business activity to the location where it is undertaken, such as soil and climate conditions, markets for the products or services, and transport requirements
• scientific research or other papers on relevant industries
• evidence supporting the yield and price forecasts.

Product rulings

If you have invested in an arrangement with a product ruling, and the Commissioner's discretion has been exercised in that product ruling, the discretion applies for the life of the ruling.