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Four tests

To be able to offset your business loss against other income, you and your business need to meet the pre-requisites.

Last updated 1 May 2018

If you meet the income requirement and pass any one or more of the four tests, you can offset your business losses against your other income in the relevant year. The four tests are:

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Assessable income test

To pass the assessable income test, assessable income from your business activity during the financial year must be at least $20,000.

Assessable income includes:

  • ordinary income – for example, the gross earnings (excluding GST) of a business activity, and
  • 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 fuel tax credits.

Part year trading

If you were in business for less than a year, or you stopped carrying on your business activity during the year, you can make a reasonable estimate of what your assessable income would have been for that full year. If that amount is greater than $20,000 then you are considered to have met the assessable income test.

Making a reasonable estimate

There is no set formula to make a reasonable estimate of your assessable income. However, you should consider relevant factors such as:

  • orders you have received
  • forward contracts you have entered into
  • the size of your business activity
  • the amount you have invested in the business activity
  • the type of business activity you are engaged in, and the typical income patterns for that industry
  • how your actual income would translate into an annual income on a pro-rata basis
  • cyclical or seasonal patterns in your business area, and the effect they would have on your annual income.
Start of example

Example: Making a reasonable estimate

In October 2016, Slaide started operating a shirt manufacturing business called Sonny's Shirts. Slaide's income from Sonny's Shirts was $16,000 for the year, however, the business did not operate for the full income year.

To work out his assessable income for the year, Slaide makes a reasonable estimate of what his income from Sonny's Shirts would have been if the business had operated for the full income year.

Slaide considers relevant factors of the business activity, such as the number of orders and seasonal demand, and works out the reasonable estimate of his assessable income is $22,000.

As Slaide's reasonable estimate of assessable income is greater than $20,000 he passes the assessable income test and can claim the losses in the current year.

End of example

An estimate that is reasonable when it was made will continue to be regarded as reasonable, even if it later proves to be incorrect.

However you should request an amendment if you later realise that the loss should have been deferred, as:

  • you have made an unreasonable estimate based on the information you had at the time of the estimate, and
  • your business activity did not meet the assessable income test or any of the other tests.

You must generally make the request within two years of the date of issue of the original notice of assessment.

We may review your estimate. If it is not reasonable, your income tax liability may be reassessed and penalties may be imposed.

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Profits test

Your business will pass the profits tests if it has made a tax profit in three out of the past five years (including the current year).

When calculating the profit, exclude any loss from that business that you have deferred from earlier years.

If a business makes a tax profit for three consecutive years it will pass the profits test for the next two years regardless of whether it makes a loss.

Profits made under a previous owner can be taken into account as the test examines the activity and not your ownership of it. This is provided the change in ownership, or the terms and conditions of a sale of the business, do not result in a loss of identity for the business activity.

Start of example

Example: Profits test

Nguyen buys an orange orchard from Steve as a going concern on 1 July 2017. At the end of the 2018 financial year, Nguyen's business has produced a $7,500 tax loss. The business records show that in the previous years, the orchard produced tax profits and losses:

  • 2017 – $17,500 profit
  • 2016 – $15,000 profit
  • 2015 – $4,000 loss
  • 2014 – $16,000 profit.

Nguyen needs to include the 2018 financial year when examining the profits test. In the period 2014 to 2018, three years have produced a tax profit. Nguyen meets the profits test.

End of example

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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 activity on a continuing basis.

Real property includes:

  • land
  • 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:

  • a dwelling and adjacent land that is used mainly for private purposes
  • fixtures owned by you as a tenant.

To work out whether your real property assets are at least $500,000 in value, you may value them at either:

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.

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Next steps:

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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. Only certain assets are included in this test and some are specifically excluded. The included assets are:

  • items of plant or equipment
  • items of trading stock
  • assets that are leased from another entity
  • trademarks, patents, copyrights, and similar rights.

Excluded items are:

  • assets that are real property or interests in real property (these are included in the real property test)
  • cars, motorcycles and similar vehicles.

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 the asset is partly used for other purposes, you need to apportion the value of the asset for the part that is used in the business activity.

Next steps:

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If you do not pass any test

If you satisfy the income requirement or the income year was before 2009-10 but your business activity doesn't pass any of the four tests, you can seek the Commissioner's discretion if either:

  • your business activity would have passed one of the tests except for special circumstances outside your control
  • your business has commenced, but due to its inherent nature there will be a lead time before you could be expected to make a tax profit, or pass one of the four tests.

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