Edited version of private ruling

Authorisation Number: 1011620602832

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Ruling

Subject: disability insurance income and business expenses

1. Do your business expenses relate to your income insurance payments?

No.

2. Will the Commissioner exercise his discretion to allow you to include any losses from your business activities in calculating your taxable income for the year ended 30 June 2009?

Yes.

This ruling applies for the following period

1 July 2008 to 30 June 2009

The scheme commenced on

1 July 2008

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You operate a business activity as a sole trader.

You stopped seeing clients on medical grounds.

You received payments under a disability insurance policy.

The insurance policy protects you for loss of business income and is used to pay for business expenses.

You did not hire a replacement as your insurer would reduce the payments under the policy.

You incurred various business expenses including rental, staff wage and superannuation, insurances, professional subscriptions, education and computing.

You intend to resume seeing clients once you recover from your medical condition and continue operating the business for many years.

A summary of your business income shows you received over $20,000 of assessable income each year for the previous four years.

This ruling is given on the basis that you were operating a business for the 2008-09 income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 35-10

Income Tax Assessment Act 1997 Section 35-55.

Reasons for decision

Summary

Your business expenses do not relate to the derivation of your disability insurance payments. The payments were derived from your incapacity to conduct the business activity and not from business activities undertaken. Therefore, there is no connection between the insurance payments and the business expenses incurred.

However, the Commissioner has granted his discretion to allow you to claim the business losses incurred in operating your business in the 2008-09 income year on the basis of special circumstances. The Commissioner accepts that you would have passed the assessable income test had you not had a medical condition which prevented this.

Detailed reasoning

Relationship of disability insurance income and business expenses

You received payments under a disability insurance policy as you were unable to operate your business due to a medical condition.

Your case is similar to that of Watson v. DFC of T 2010 ATC 20-167; (2010) 75 ATR 224. In that case, the taxpayer argued that payments from an income protection policy which were made when the taxpayer became partially incapacitated were income from his business as a self-employed financial planner. However, the Full Federal Court disagreed, finding that the income was received from the policy because of the taxpayer's incapacity to conduct his business, not from the business activity he actually undertook.

Similarly, it is considered that your insurance payments were received because you were unable to undertake the full range of business activity that you would have undertaken had you not had a medical condition. The income was derived from your incapacity to conduct the business activity and not from the business activity actually undertaken.

As the insurance payments are not considered to be business income no connection exists between these payments and the expenses incurred in operating your business. It was possible to incur the expenses without generating the income.

We will also examine the application of the non-commercial loss provisions of the tax legislation to your situation.

Non-commercial loss provisions

Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997) applies to losses from certain business activities for the year ended 30 June 2001 and subsequent years. The provisions only apply to individuals who conduct a business activity as:

· a partner in a partnership that made a loss, or their net partnership distribution after deducting any eligible expenses resulted in a loss, or

· a sole trader (including an individual in a general law partnership) and made a loss.

If you are in business (for tax purposes) you can only offset the losses from a business activity against your income from other sources if you pass one of the four tests, an exception applies to you or the Commissioner exercises his discretion in your favour.

The four tests are:

· you have assessable income from the business of at least $20,000

· you have made a profit from the business in at least three out of the last five years

· you use real property worth at least $500,000 (excluding private dwellings) on a continuing basis in the business, or

· you actively use other assets worth at least $100,000 (excluding motor vehicles) in the business.

The exceptions to passing the four tests apply where you carry on a professional arts business or a business of primary production. In these situations, you may offset your business loss against your other income if your other income for that year is $40,000 or less.

The Commissioner may exercise his discretion to allow you to claim your business loss where special circumstances apply. Special circumstances in this context are those outside of the control of the business operator, including those such as drought, flood, bushfire or some other disaster, that have materially affected that activity.

It is intended that the Commissioner only exercise this arm of the discretion if one of the tests would have been satisfied but for the special circumstances.

Taxation Ruling TR 2007/6 provides guidelines on how the Commissioner exercises his discretion. The ruling states that whilst the legislation specifically refers to natural disasters as special circumstances it is not limited to these events.

TR 2007/6 provides the following example of when the discretion would be applied on the basis of special circumstances:

Allison runs a dance instruction business which satisfied the assessable income test in the 2004 income year and was expected to satisfy this test again in the 2005 income year. However in the 2005 income year Allison broke her leg and was unable to dance for 6 months. Allison had to cancel all her bookings for 6 months and as a result incurred a loss for the 2005 income year.

Allison's business did not satisfy any of the tests in Division 35 in the 2005 income year. If the Commissioner does not exercise the discretion in the 2005 income year the losses from the dancing instruction business will be deferred.

In this case the Commissioner would exercise the discretion in paragraph 35-55(1)(a) for special circumstances. Allison is a key person in the dancing instruction business. Her broken leg and inability to teach for 6 months would be special circumstances outside her control. The business activity was expected to have satisfied a test if not for these special circumstances and consequently the Commissioner would be satisfied that it would be unreasonable for the loss deferral rule in section 35-10 to apply. As a result, Allison is able to offset her business losses against her other assessable income in the 2005 income year.

Your situation is similar to the example described in TR 2007/6 (above). You are a sole trader and were unable to work during the 2008-09 income year due to a medical condition. Your business activities have produced assessable income in excess of $20,000 each year for the previous four years.

The Commissioner accepts that your business activity has been affected by your medical condition which was outside of your control and that in the absence of the medical condition it was probable that you would have passed the assessable income test in the 2008-09 income year.

The Commissioner has granted his discretion for you to include your losses from your business activity in calculating your assessable income for the 2008-09 income year.

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