Edited version of private ruling

Authorisation Number: 1011581826983

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Ruling

Subject: Non-commercial losses-Commissioner's discretion-lead time

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from business activity in your calculation of taxable income for the 2009-10 income year?

No.

This ruling applies for the following period:

1 July 2009 to 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You are currently working full time. Your business activity has taken several years to reach a point where some income could be produced. You borrowed funds to cover expenses to produce this income in the 2009-10 income year. You have limited funds for advertising.

You envisage that your output will increase markedly once you have established a contract to distribute your product. You wish to produce different products but need to complete all the processes for this activity before commencing the next one.

Once you have contracted distributors, the expenditure will be minimal and the returns significant. You are in negotiations with distributors and you are optimistic that the product will turn to profit in the 2010-11 financial year.

Reasons for Decision

You state that your activity is carried on as a business and this ruling is made on the basis of accepting this claim. As your business activity has commenced, and has been carried on as a business since January 2010, it is subject to the provisions in Division 35 of the ITAA 1997.

Under paragraph 35-55(1)(b) of the ITAA 1997, the Commissioner's discretion can be exercised where the business activity satisfies these requirements.

for an applicant who carries on the business activity who satisfies 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 satisfied, or will not satisfy, one of the tests set out in section 35-30, 35-35, 35-40 or 35-45 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 either meet one of those tests or 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).

The note to paragraph 35-55(1)(b) of the ITAA 1997 referred to the paragraph being intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. It provides the example of the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income. 

Paragraph 17 of Taxation Ruling TR 2007/6 deals with the exercise of the Commissioner's discretion under this subparagraph and the meaning of 'because of its nature'

For the failure to satisfy one of the four tests to be 'because of its nature', the failure must be because of some inherent characteristic that the taxpayer's business activity has in common with other business activities of that type (see Federal Commissioner of Taxation v. Eskandari (2004) 134 FCR 569; 2004 ATC 4042; (2004) 54 ATR 695).

Paragraph 78 of TR 2007/6 states:

The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity and would not result in the requirements of subparagraph 35-55(1)(b)(i) being met.

The example at paragraph 139 of TR 2007/6 explains the taxpayer was new to the region and industry in which he chose to commence his business. He had no clientele. His funding and his advertising were limited, he kept his part time employment and he worked at his business when he could. He chose where his business premises were located and also his opening and closing times. He made losses each year and didn't satisfy any of the four tests.

The Commissioner's view on this example is found at paragraph 140 of TR 2007/6:

The inability of Andrew's business activity to satisfy any of the four tests is due to his personal business choices as to hours of business, location and advertising, not any inherent characteristics that affect clock repair businesses. Accordingly the requirement of subparagraph 35-55(1)(b)(i) is not met and the Commissioner would not exercise the discretion.

In your circumstances, the timing of commencing business, the time taken to obtain distribution agreements and lack of advertising all contributed to the losses incurred in the 2009-10 income year. Therefore, in reference to the above paragraphs, you have not shown that the lead time is an inherent characteristic of your industry.

The Commissioner will not exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997. You cannot claim a deduction for your losses against other income in the 2009-10 income year. Therefore, you must defer the loss to a future year where the loss can be claimed against a profit from your business activity.

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