Edited version of private ruling

Authorisation Number: 1011588298503

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Ruling

Subject: Non Commercial Losses - Commissioner's discretion

Question

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 your business activity in your calculation of taxable income for the 2009-10 income year.

Answer: No

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

The following description of the scheme is based on information provided by you.

You are currently in one city market only.

This was the first year of operations and your start up costs caused a net loss.

Your sales were small.

Your business model is one where you only sell upon receiving orders.

You made a number of purchases.

You expect to pass the assessable income test in 2010-11 income year.

You did not provide independent evidence on the commercially viable period for the industry.

You did not provide evidence that because of its nature, the business activity has not satisfied one of the tests set out in section 35-30, 35-35, 35-40, 35-45 of the ITAA 1997.

You did not provide a copy of your business plan.

Your income for non commercial loss purposes for the income year ended 30 June 2010 is not greater than $250,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 35-10.

Income Tax Assessment Act 1997 Subsection 35-10(2).

Income Tax Assessment Act 1997 Subsection 35-10(4).

Income Tax Assessment Act 1997 Section 35-30.

Income Tax Assessment Act 1997 Section 35-40.

Income Tax Assessment Act 1997 Section 35-45.

Income Tax Assessment Act 1997 Section 35-55.

Income Tax Assessment Act 1997 Paragraph 35-55(1)(b).

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Summary

The Commissioner will not exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997 in relation to your business activity for the 2009-10 income year. On the facts provided, the Commissioner is not satisfied that it is because of the nature of your business activity that it has not yet satisfied one of the tests set out in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997.

The rule in subsection 35-10(2) of the ITAA 1997 will apply to defer to a future income year any loss that arises from your activity for the 2009-10 income year. A deferred loss is not disallowed and will be deductible against any future profit from your activity, or similar business activity, in future years.

Detailed reasoning

Division 35 of the ITAA 1997

All legislative references are in relation to the ITAA 1997 unless otherwise indicated.

Division 35 will apply to losses from certain business activities for the income year ended 30 June 2001 and subsequent years. Under the rule in subsection 35-10(2), a loss made by an individual from a business activity will not be taken into account in an income year unless:

· the exception in subsection 35-10(4) applies (primary producers and professional artists); or

· one of four tests in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) or 35-45 (other assets test) is met, for example, the assessable income test; or

· if one of the tests is not satisfied, the Commissioner exercises the discretion in section 35-55.

Losses that cannot be taken into account in a particular income year, because of the rule in subsection 35-10(2), are able to be applied to the extent of future profits from the business activity, or are deferred until one of the tests is passed, the discretion is exercised, or the exception applies.

The lead time discretion in paragraph 35-55(1)(b)

Paragraph 35-55(1)(b) sets out the Commissioners discretion as follows:

i.) because of its nature it has not met one of the tests set out in Division 35; and

ii.) there is an expectation that the business activity will either pass one of the tests or produce a taxation profit within a period that is commercially viable for the industry concerned.

Application of section 35-55 (Commissioners discretion) to this arrangement

As your business activity has commenced, and is carried on as a business, it is subject to the provisions in Division 35. Information provided with your application for this private ruling does not indicate whether or not your business activity has or has not met one of the tests and provides that you made a net loss in the 2009-10 income year.

You state that the business will meet the assessable income test and make a tax profit in the 2010-11 income year.

The note to paragraph 35-55(1)(b) in the legislation states:

Note: This paragraph is intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. For example, an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

The type of feature contemplated by the phrase 'because of its nature', in the context in which it appears, is that referred to in the note quoted above. That is, that there is an inherent or innate feature of the activity resulting in an inability to produce income in the year of commencement and (in most cases) a number of years thereafter. This is borne out further by paragraph 1.51 of the Explanatory Memorandum for the New Business Tax System (Integrity Measures) Act 2000, which states:

This arm [paragraph 35-55(1)(b)] of the safeguard discretion will ensure that the loss deferral rule in section 35-10 does not adversely impact on taxpayers who have commenced to carry on activities which by their nature require a number of years to produce assessable income. Examples of activities which would fall into this category are forestry, viticulture and certain horticultural activities.

The Note and the passage cited above do not support any view that the discretion should be exercised for any start-up activity that is yet, for example, to satisfy the assessable income test in section 35-30, simply because of the small scale on which it was started, or because a client base is being built up. Those sorts of constraints on being able to satisfy that test are far removed from the specific one referred to in the Note and the Explanatory Memorandum.

We do not consider that there is anything inherent or innate in the nature of your business activity that may prevent you from being able to satisfy one of the tests (even though you haven't provided evidence on whether or not you have or have not passed a test). In particular, we think your activity is of a type that is able to produce assessable income quite soon after its commencement. As you have stated, you foresee making profits from now onwards.

In conclusion, although you are accepted as carrying on a business, you are not eligible for the Commissioners discretion under paragraph 35-55(1)(b) of the ITAA 1997 for the 2009-10 income year, hence the losses will have to be deferred and be deductible against the future profit of future years.

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