Edited version of private ruling

Authorisation Number: 1011617809714

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Ruling

Subject: Non-commercial losses and depreciation

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

No.

2. Are you able to depreciate the machines you purchased under Division 40 of the ITAA 1997 in the 2009-10 income year?

Yes.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You purchased a number of vending machines.

At the time of purchase you were told professionals would be engaged by the vendors to source suitable locations for your machines. They failed to do this and most of your machines have not been used since you purchased them.

You have since placed some machines which are vending products.

You are currently stocking those machines and collecting the proceeds from the machines.

When all machines are stocked and located you will be stocking them and regularly collecting the money from all the machines.

You are incurring expenses trying to find suitable locations.

You will be making a loss until the remaining machines are stocked and placed in suitable locations.

When all machines are stocked, and in suitable locations, you have projected that they will provide you with annual income of over $20,000.

Relevant legislative provisions

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

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

Income Tax Assessment Act 1997 Subsection 40-25(1)

Income Tax Assessment Act 1997 Subsection 40-25(2)

Income Tax Assessment Act 1997 Subsection 40-25(7)

Income Tax Assessment Act 1997 Section 40-60

Income Tax Assessment Act 1997 Subsection 40-60(1)

Income Tax Assessment Act 1997 Subsection 40-60(2)

Reasons for decision

Non-commercial losses

Division 35 of the ITAA 1997 applies to losses from certain business activities for the 2000-01 income year and subsequent years. Under the rule in subsection 35-10(2) of the ITAA 1997, a 'loss' made by an individual (including an individual in a general law partnership) from a business activity will not be taken into account in an income year unless:

· the 'Exception' in subsection 35-10(4) of the ITAA 1997 applies

· you meet the income requirement under subsection 35-10(2E) and you pass one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997, or

· the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

Generally, a 'loss' in this context is, for the income year in question, the excess of a taxpayer's allowable deductions attributable to the business activity over that taxpayer's assessable income from the business activity.

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 (and the income requirement is met), the discretion is exercised, or the exception applies.

Exception

Under subsection 35-10(4) of the ITAA 1997, there is an 'Exception' to the general rule in subsection 35-10(2) of the ITAA 1997 where the loss is from a primary production business activity or a professional arts business activity and the individual taxpayer has other assessable income for the income year from sources not related to that activity, of less than $40,000 (excluding any net capital gain).

Tests

In broad terms, the tests require:

(a) at least $20,000 of assessable income in that year from the business activity (section 35-30 of the ITAA 1997)

(b) the business activity results in a taxation profit in three of the past five income years (including the current year) (section 35-35 of the ITAA 1997)

(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 (section 35-40 of the ITAA 1997), 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 (section 35-45 of the ITAA 1997).

In the context of section 35-35 of the ITAA 1997 ((b) above), a 'taxation profit' for the income year in question is where the amount of assessable income from the business activity for that year, is greater than the sum of the deductions attributable to it for that year (apart from the operation of subsection 35-10(2) of the ITAA 1997).

Income requirement

You satisfy the income requirement for an income year 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.

Are you carrying on a business?

Your activity will only be subject Division 35 of the ITAA 1997 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.

Special circumstances

Paragraph 35-55(1)(a) of the ITAA 1997 sets out the first arm of the Commissioner's discretion as follows:

The Commissioner may decide that the rule in subsection 35-10(2) does not apply to a business activity for one or more income years if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

(a) the business activity was, or will be affected, in that or those income years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster;


Note: This paragraph is intended to provide for a case where a business activity would have satisfied one of the tests if it were not for the special circumstances.

Paragraph 35-55(1)(a) of the ITAA 1997 refers to 'special circumstances' outside of the control of the operators of the business activity. No exhaustive definition is given of 'special circumstances' but the paragraph does include drought, bushfire and other natural disasters.

The question of what constitutes 'special circumstances' has been judicially considered on many occasions. In the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation:

Those discretions are intended to be applied to a great variety of situations. In such a context, the core of the idea of 'special circumstances' is that there is something unusual or different to take the matter out of the ordinary course…

Later, in the Federal Court Case of Secretary, Department of Employment, Education, Training & Youth Affairs v. Barrett and Another (1998) 82 FCR 524 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed that:

The word 'special' must be read in context. In normal parlance it signifies that the event or circumstances in question are out of the ordinary or normal course.

Tamberlin J then quoted the following passage with approval from the AAT case of Re Beadle and Director-General of Social Security (1984) 1 AAR 362; (1984) 6 ALD 1:

An expression such as 'special circumstances' is by its very nature incapable of precise or exhaustive definition. The qualifying adjective looks to circumstances that are unusual, uncommon or exceptional. Whether circumstances answer any of these descriptions must depend upon the context in which they occur. For it is the context which allows one to say that the circumstances in one case are markedly different from the usual run of cases. This is not to say that the circumstances must be unique but they must have a particular quality of unusualness that permits them to be described as special.

It can be seen that to determine what are 'special circumstances', we need to look at the context in which the phrase is used. Also, it is clear that 'special circumstances' will be something out of the ordinary or unusual. 'Special circumstances' in paragraph 35-55(1)(a) of the ITAA 1997 is used in the context of a situation occurring such that it would be unreasonable for the Commissioner to apply the loss deferral rule for a particular year or years. For this to be the case, it will not only be necessary that an event or situation has occurred which is of itself unusual, but that it has resulted in the business activity failing to pass a test. Clearly, if the business activity would not have passed a test even if the event or situation had not arisen, we cannot say that the business activity was affected by 'special circumstances' in the sense in which this term is used in paragraph 35-55(1)(a), as the Note to the paragraph indicates.

In Taxation Ruling TR 2001/14, the Commissioner provides guidance to taxpayers in what he considers to be special circumstances for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. Apart from drought, flood and bushfire which are specifically mentioned in the legislation, it may also include:

· earthquakes

· diseases affecting livestock or crops

· pest plagues, or

· hailstorms.

In Taxation Ruling TR 2007/6, the Commissioner expands on his view of what would constitute 'special circumstances' in the context of paragraph 35-55(1)(a) of the ITAA 1997, to include:

· an oil spill

· a chemical spray drift

· a gas plant explosion

· a power plant shutdown

· a water authority malfunction

· government authority restriction imposed on land use, or

· other events (for example, illness of the operator or employee(s)) which have significantly affected the ability of the operator to carry on the business activity.

In your case the discretion under paragraph 35-55(1)(a) of the ITAA 1997 is relevant. The discretion is designed to allow for cases where unusual circumstances occurred to prevent businesses from meeting one of the four tests.

Your business would have passed the assessable income test under section 35-30 of the ITAA 1997 had you been able to stock and locate most of the vending machines. To date only a limited number of the machines have been placed in a location and selling stock. We do not believe the fact that you were promised the machines would be located for you, and that was not done, constitutes special circumstances in the context outlined in TR 2001/14 and TR2007/6.

The Commissioner will therefore not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 as we believe no special circumstances existed. You are therefore required to defer your losses in the 2009-10 year.

Reasons for Decision

Depreciation - Decline in Value

Division 40 of the ITAA 1997 outlines that you can deduct an amount equal to the decline in value of a depreciating asset that you hold.

Subsection 40-25(1) of the ITAA 1997 states you can deduct an amount equal to the decline in value for an income year of a depreciating asset that you held for any time during the year.

Subsection 40-25(2) of the ITAA 1997 states you must reduce your deduction by the part of the asset's decline in value that is attributable to your use of the asset, or having it installed ready for use, for a purpose other than a taxable purpose.

Subsection 40-25(7) of the ITAA 1997 in part states a taxable purpose is the purpose of producing assessable income.

Section 40-60 of the ITAA 1997 outlines when a depreciating asset starts to decline in value.

Subsection 40-60(1) of the ITAA 1997 states a depreciating asset you hold starts to decline in value from when its start time occurs.

Subsection 40-60(2) of the ITAA 1997 states the start time of a depreciating asset is when you first use it, or have it installed ready for use, for any purpose.

In application to your case, you purchased a number of vending machines which you intended to place to vend products. You are considered to have held those assets and had them installed and ready for use for a taxable purpose from the date you purchased the machines. You are entitled to the decline in value of all machines from the day you purchased them.

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