Edited version of private ruling

Authorisation Number: 1011616843236

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Ruling

Subject: Non-Commercial Losses Lead Time

Will the Commissioner exercise the discretion in paragraphs 35-55(1)(b) or (c) of the Income Tax Assessment Act 1997 (ITAA 1997) (lead time) to allow you to include losses from your business activities in your calculation of taxable income for the 2009-10, 2010-11 and 2011-12 income years?

No.

This ruling applies for the following period

Year ended 30 June 2010

Year ending 30 June 2011

Year ending 30 June 2012

The scheme commenced on

1 July 2009

Relevant facts

You worked as an employee until you were made redundant.

You then decided to concentrate on your business activities full-time.

This decision followed market testing of your products nationally and internationally.

You have used the months since ceasing employment to conduct research into advancing your business interests.

You have a formal contract in place with a highly experienced business person to assist you get your products available for sale.

You have appointed an established industry marketing organisation which has prepared a comprehensive marketing strategy based heavily on an on-line approach.

The initial expense to produce your product is high and once it is produced, revenue from sales and royalties are received for a time into the future.

You belong to a number of professional organisations related to your business.

Relevant legislative provisions

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

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

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

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

Reasons for decision

Detailed reasoning

Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997) prevents losses from non-commercial business activities (being conducted by an individual or a partner in a partnership) being offset against other assessable income in the year the loss is incurred. The loss is deferred unless:

You satisfy the income requirement under section 35-10(2E) of the ITAA 1997 and pass one of the following four tests:

(a) at least $20,000 of assessable income in that year from the business activity (assessable income test)

(b) the business activity results in a taxation profit in three of the past five income years (profits test)

(c) at least $500,000 of real property, or an interest in real property, (excluding any private dwelling) is used on a continuing basis in carrying on the business activity in that year (real property test), or

(d) at least $100,000 of certain other assets (excluding cars, motor cycles and similar vehicles) are used on a continuing basis in carrying on the business activity in that year (other assets test)

· the Commissioner exercises his discretion (special circumstances or lead time); or

· you meet the exception test (can only be met if the activity is a primary production or a professional arts business and your assessable income from that year from other sources that do not relate to that activity is less than $40,000).

The income requirement under section 35-10(2E) of the ITAA 1997 is met if the sum of the following is less than $250,000:

· your taxable income for that year

· your reportable fringe benefits total for that year

· your reportable superannuation contributions for that year

· your total net investment losses for that year.

Losses that cannot be taken into account in a particular year of income, because of subsection 35-10(2) of the ITAA 1997, can be applied to the extent of future profits from the business activity, or are deferred until one of the tests is passed (including the income test under subsection 2E), the discretion is exercised, or the exception applies.

Are you carrying on a business?

Your activity will only be potentially subject to these provisions if it is carried on as a business. You have stated in your private ruling application that your activity was carried on as a business. This ruling is made on the basis of accepting this claim.

Commissioner's discretion

As you are an individual and your activities have commenced, and are carried on as a business, they are subject to the provisions in Division 35 of the ITAA 1997.

It is assumed that none of the four tests were, or will be, satisfied in the 2009-10, 2010-11 or 2011-12. That being the case, 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 business for those years, unless the Commissioner exercises an arm of the discretion under paragraphs 35-55(1)(a), 35-55(b) or 35-55(1)(c) of the ITAA 1997.

The first arm of the discretion in subsection 35-55(1) of the ITAA 1997 (paragraph a) relates to special circumstances applicable to the business activity, and has no relevance for the purposes of this private ruling.

The second arm of the discretion in subsection 35-55(1) of the ITAA 1997 (paragraph b) may be exercised for one or more income years where the income requirement is satisfied:

(b)        the business activity has started to be carried on; and for those years:

(i)      because of its nature it has not satisfied, or will not satisfy, one of the tests set out in Division 35 of the ITAA 1997, and

(ii)     there is an objection expectation based on evidence from independent sources (where available) that the business activity of an individual taxpayer will either satisfy one of the tests or produce a taxation profit within a period that is commercially viable for the industry concerned.

The third arm of the discretion in subsection 35-55(1) of the ITAA 1997 (paragraph c) may be exercised for one or more income years where:

(c) the business activity has started to be carried on; and for those years:

(i) because of its nature, it has not produced, or will not produce, assessable income greater than the deductions attributable to it; 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 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 these two paragraphs states:

Note: Paragraphs (b) and (c) are 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 of the ITAA 1997, 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.

You were unable to satisfy any of the four tests under Division 35 of the ITAA 1997 in 2009-10 (and anticipate you won't be able to pass any one of the four tests in 2010-11 or 2011-12). You anticipate it will take some time for you to make a profit from your activities.

Firstly, we do not consider that there is anything inherent in the nature of your business activity that prevented you from being able to satisfy one of the tests for the 2009-10 income year or will prevent you from satisfying one of the tests in future income years (2010-11 or 2011-12). In some other cases one of the four tests could be passed in the first year depending on the circumstances or in some other cases you may not be able to pass one of the tests for many years. In other words there is nothing inherent in the nature of the industry which would prevent one of the four tests being passed in the same year as the commencement of the business.

Secondly, you have stated royalties are accruing on items overseas. Royalties are considered assessable income. The note to subsection 35-55(1) of the ITAA 1997 states in part that paragraphs (b) and (c) are 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. As you are receiving assessable income from your business activities (from royalties), the Commission will not grant the discretion under subsection 35-55(1) of the ITAA 1997.

In conclusion, the requirements of paragraphs 35-55(1)(b) and (c) of the ITAA 1997 have not been met. Consequently, you are not eligible for the Commissioner's discretion for the 2009-10, 2010-11 and 2011-12 income years, therefore any losses made in those years must be deferred (unless the income requirement and one of the tests is passed, the exception applies or the Commissioner grants the discretion under paragraph 35-55(1)(a) of the ITAA 1997).

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