To offset your business loss against other income, you and your business need to meet a number of conditions.
First, you need to meet the income requirement. If this is met, you must then pass one of the four tests.
If you don't meet the income requirement you cannot offset your losses regardless of whether you pass any of the four tests unless you apply for the Commissioner's discretion.
To meet the income requirement for non-commercial loss purposes your other income must be less than $250,000.
Your other income includes:
- taxable income (ignoring any business losses)
- total reportable fringe benefits amount
- reportable superannuation contributions
- total net investment loss.
If you pass the income requirement, you must then meet one of the four tests unless either:
If you fail the income requirement
If you don't meet the income requirement but you meet one of the four tests, you can apply for the Commissioner's discretion if either:
- special circumstances occurred that were outside your control such as drought, flood, bushfire or some other natural disaster, which prevented your business activity from producing a tax profit
- due to the nature of the activity, there is
- a lead time before the business will make a tax profit
- an objective expectation, based on independent evidence, that it will make a profit in a time that is considered commercially viable for that industry.
The four tests
Once you meet the income requirement you must then pass one of the four tests.
The four tests are:
- The assessable income test – the business has assessable income of at least $20,000.
- The profits test – the business had a profit for tax purposes in three out of the past five years (including the current year).
- The real property test – the value of real property or of an interest in real property that you used in the business on a continuing basis was at least $500,000.
- The other assets test – the value of assets (excluding real property, cars, motor cycles and similar vehicles) you used on a continuing basis in carrying on the business was at least $100,000.
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If you are carrying on more than one business activity and they are similar, they can be grouped together to meet one of the four tests.
Assessable income test
To pass the assessable income test, assessable income from your business activity during the income year must be at least $20,000
Assessable income includes:
- ordinary income – for example, the gross earnings of a business activity
- statutory income – for example, capital gains.
If you pass the assessable income test, you can claim your losses in the current year.
Any income normally included as assessable income from the sale of depreciating assets in the normal course of business is included in assessable income for this test. This also applies for capital gains and diesel fuel rebates.
If you were in business for less than a year you can make a reasonable estimate of what your income would have been for that full year.
Your business will pass the profits tests if it has made a profit in three out of the past five years (including the current year).
When calculating the profit, you should exclude any loss from that business that you have deferred from earlier years.
If a business makes a profit for three years running then it will pass the profits test for the next two years regardless of whether it makes a loss, since three out of five consecutive years will be profit years.
Example: Profits and assessable income tests
Bernice works part time earning $28,000 per year. To supplement her income she starts a small business cleaning houses.
In the first year of operation her turnover is $12,000 and she makes a small profit of $1,500.
In the second year her turnover is $14,000 but she has a lot of expenses and makes a loss of $2,750. As her assessable income from the business is less than $20,000, she has not made a profit in 3 of the past 5 years (she has only been in business for 2 years), she does not have real property used for the business and does not have $100,000 of other assets, she does not pass any of the four tests. Bernice has to defer her loss.
In the third year Bernice has a turnover of $16,000 and makes a small profit of $1,500. Because Bernice's turnover is still below $20,000, she has not made a profit in 3 of the past 5 years and does not meet the other tests she can only offset her deferred loss against the amount of her business profit. The remaining $1,250 ($2,750 - $1,500) is deferred to year four.
In the fourth year, Bernice has a turnover of $18,000 and makes a profit of $1,000. Since she has now made a profit in three of the past five years she passes the profits test. She will be able to offset $1,000 of her deferred loss from year two against her business income plus the remaining $250 from her other income.
End of example
Real property test
You will pass the real property test if real property of at least $500,000 in value is used in your business on a continuing basis.
Real property includes:
- structures, such as buildings, fixed to the land
- interests in that property, such as a lease of that property.
Real property, for the purposes of this test, does not include either:
- a dwelling and adjacent land that is used mainly for private purposes
- fixtures owned by you as a tenant.
Valuing real property assets
You may value your real property assets at either their:
- reduced cost base
- market value.
What constitutes use on a continuing basis will depend on your business circumstances. However, you cannot include the value of an asset used:
- on a short-term basis
- for a one-off task
- through an agreement for intermittent use on an hourly, daily, weekly, monthly or other short-term basis.
Other assets test
You will pass the other assets test if the value of the 'other assets' you use in your business on a continuing basis is at least $100,000.
When assessing the value of these assets for the test you must use the same valuation method that you use for income tax purposes. (This does not apply if you are valuing leased assets.)
If you fail the four tests
If you meet the income requirement but your business doesn't pass any of the four tests, you can apply for a Commissioner's discretion if either:
- your business would have passed one of the tests except for special circumstances outside your control
- you have just started your business and, because of its nature, there is a lead time before either
- it passes one of the tests
- you can expect a profit.
Special circumstances include bushfires and oil spills but generally don't include economic changes.
To be able to offset your business loss against other income, you and your business need to meet a number of pre-requisites.