Edited version of private ruling

Authorisation Number: 1011613158727

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Ruling

Subject: Non commercial losses - Commissioner's discretion - assessable income and special circumstances

Will the Commissioner exercise his discretion to allow you to include any loses from your sole trader business activity in calculating your taxable income for the year ended 30 June 2010?

No.

This ruling applies for the following period

1 July 2009 to 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

You commenced a business during the year ended 30 June 2009 as a sole trader.

Some of your potential clients were large private or government organisations. They were unwilling to enter into a contract with a sole trader. To obtain their business you ceased trading as a sole trader and established a private company during the year ended 30 June 2010.

The company operates under the same name as you operated as a sole trader with the addition of 'Pty Ltd' to the end of the name. You conduct the company in the same manner as when you operated as a sole trader.

As a sole trader you earned assessable income of less than $20,000 and made an actual overall loss. You did not meet the other assets or real property tests.

The company's assessable income was over $20,000.

You have requested the Commissioner take into account the company's assessable income when determining if you are entitled to claim the losses from your sole trader activity.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 35-10

Income Tax Assessment Act 1997 Subsection 35-30(b)

Income Tax Assessment Act 1997 Section 35-55.

Reasons for decision

Summary

The Commissioner cannot exercise his discretion under section 35-55 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to your sole trader business activity for the 2009-10 income year.

Detailed reasoning

Division 35 of the ITAA 1997 will apply to defer a non-commercial business loss from a business activity carried on by a taxpayer who is an individual, unless:

· their business activity satisfies one of the four tests listed in section 35-10 of the ITAA 1997

· the Commissioner has exercised the discretion in section 35-55 of the ITAA 1997 for the activity, or

· the individual comes within the exception to Division 35, contained in subsection 35-10(4) of the ITAA 1997 which may apply to a primary production or professional arts business.

The discretion in section 35-55 of the ITAA 1997 may be exercised for the income year in question where:

· the business activity is affected by special circumstances outside the control of the operators of the business activity, or

· because of its nature, there is a period of time before the business activity can pass one of the four tests or make a profit. This period of time would be due to the nature of the business and not because the taxpayer is starting out small or building up a client base.

The four tests

The four tests contained within the non commercial loss legislation are:

· the assessable income test where the business must produce assessable income of at least $20,000

· the profits test where the business must have produced a tax profit in three of the last five income years

· the real property test where the value of the real property (for example land and fixtures used in the business excluding dwellings and adjacent land used for private purposes) is at least $500,000, and

· the other assets test where assets used in the business (depreciable assets, trading stock excluding cars, motor bikes and similar vehicles) have a value of at least $100,000.

Paragraph 35-30(b) of the ITAA 1997 contemplates the assessable income test in situations where the activity is not carried on for the full year. In that situation a reasonable estimate of what the assessable income would have been if the activity had been carried on for the full year can be made. That estimate needs to be at least $20,000 to pass the assessable income test.

In your case, your assessable income from your sole trader activities was less than $20,000 in the period it traded. Your company earned more than $20,000 of assessable income in the period it traded. You have advised that some of the money earned by the company would not have been earned by you as a sole trader as some clients do not enter into contracts with sole traders.

However, the money earned by the company cannot be taken into account when determining a reasonable estimate for your sole trader activities as the company is a separate legal entity to you.

Based on the information provided, it is reasonable to expect your sole trader activities to have earned less than $20,000 had you traded for the full year. However, this does not meet paragraph 35-30(b) of the ITAA 1997 as the estimate of the assessable income is less than $20,000.

You have not met any of the other three tests within the legislation.

Commissioner's discretion - lead time

Taxation Ruling TR 2007/6 is about the Commissioner's discretion. It states the discretion is not intended to apply where a business activity makes a loss because of factors which can apply to any business and which do not affect the ability of the activity to satisfy one of the four tests. Rather, the discretion is intended to be available for a commercial business activity that has failed, or objectively is expected to fail for a period of time, to satisfy any of the tests for certain reasons outside the control of the operator. Paragraph 139 of Taxation Ruling TR 2007/6 provides the following example:

Andrew started a clock repair business in the 2001 income year. Andrew was new to the region and the industry 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 with 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 and has made losses each year. 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 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 case, your business activity is not considered to have a lead time due to the nature of its activities. It would be expected that this type of activity would be able to generate income shortly after commencing business.

Therefore, the Commissioner's discretion under the lead time provisions of the legislation cannot be given.

Commissioner's discretion - special circumstances

In the legislation special circumstances specifically includes drought, flood, bushfire or some other natural disaster. TR 2007/6 states that special circumstances are not restricted to natural disasters. Circumstances such as oil spills, chemical spray drifts, explosions, disturbances to energy supplies, government restrictions and illnesses affecting key personnel might, depending on the facts, constitute special circumstances of the type in question.

Paragraphs 130 to 138 of TR 2007/6 provide an example of where government restrictions would constitute special circumstances. In the example Sam operates a bluetail fishing business which passed the assessable income test in 2003 and was expected to satisfy this test in 2004. During December 2003 the local government environment protection authority placed a temporary restriction on fishing in the area in which Sam operated his business. Consequently, the business activity did not satisfy any of the tests in the 2004 income year and neither of the exceptions applied. In this case the Commissioner would exercise his discretion for special circumstances. The loss of the business due to the restriction on fishing would be special circumstances outside of Sam's control.

Your activity has been carried on by two different entities. Initially it was carried on by you as a sole trader and then as an incorporated company.

The Commissioner considers that the activity carried on by you as a sole trader is different to that carried on by the company. You are a separate legal entity to the company. Thus the impact of changing the structure of the ownership of the business activity is not a factor that be taken into account when looking at whether the discretion can be applied to the business carried on as a sole trader.

As a sole trader your failure to meet the assessable income test was not due to special circumstances outside of your control. The decision on how to structure your business activities was within your control. We accept that you may have been unaware that some clients would not enter into contracts with sole traders when you commenced the business. However, this does not change your situation to that of special circumstances.

To conclude, the tax legislation does not permit the Commissioner to exercise his discretion in your case.

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