Edited version of private ruling

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Ruling

Subject: Non-commercial losses Commissioner's discretion

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) 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?

No.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

When you commenced your business the model was based on a different one than the one used presently.

You decided to relocate to another location and rename the business. The new business commenced operation with a new business model to enable the business to become self sufficient.

This move coincided with the global financial crisis and since then the has faced prolonged uncertainty due to the introduction of the resale royalty scheme and the proposed changes to the way in which self-managed superannuation funds will be able to purchase assets.

The business is operated by you and others.

You have provided letters from industry representatives stating that in your industry it would take between seven to ten years before your activity becomes commercially viable.

Your income for non-commercial loss purposes in the income year before you lodged your application for a private ruling was greater than $250,000.

Reasons for decision

Division 35 of the ITAA 1997 applies to prevent losses from a non-commercial business activity carried out by an individual taxpayer (alone or in partnership) from being offset against other assessable income in the year in which the loss is incurred.

Under the measures the losses that cannot be offset against other income in the year in which they arise may be carried forward to be offset in a future year when there is a profit from the non-commercial activity (or against other income if certain criteria are satisfied or the Commissioner exercises his discretion).

You have asked for the Commissioner's discretion to be applied to your circumstances.

Under paragraph 35-55(1)(c) of the ITAA 1997, the Commissioner's discretion can be exercised where the business activity satisfies these requirements.

for an applicant who carries on the business activity who does not satisfy subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made-the business activity has started to be carried on and, for the excluded 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 paragraph 35-55(1)(c) of the ITAA 1997 referred to the paragraph being intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. It provides the example of the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

Before the Commissioner can consider exercising the discretion you must be able to show that the reason your business activity is producing a loss is inherent to the nature of the business and is not peculiar to your situation as stated in subparagraph 35-55(1)(c)(i). For example, the discretion will not be available where the failure to make a profit is for reasons other than the nature of the business such as, a consequence of starting out on a small scale, the hours worked or the need to build a client base.

In your case, you do not satisfy the income requirement as your income for non- commercial loss purposes is above $250,000. You commenced operation with a new business model after moving location. You explained the development of your clients is the inherent or innate feature of your activity.

Paragraph 17 of Taxation Ruling TR 2007/6 deals with the exercise of the Commissioner's discretion under subparagraph 35-55(1)(c)(i) of the ITAA 1997 and the meaning of 'because of its nature'.

For the failure to satisfy one of the four tests to be 'because of its nature', the failure must be because of some inherent characteristic that the taxpayer's business activity has in common with other business activities of that type (see Federal Commissioner of Taxation v. Eskandari (2004) 134 FCR 569; 2004 ATC 4042; (2004) 54 ATR 695).

Paragraph 78 of TR 2007/6 states:

The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity and would not result in the requirements of subparagraph 35-55(1)(b)(i) being met.

The example at paragraph 139 of TR 2007/6 explains the taxpayer was new to the region and industry in which he chose to commence his business. He had no clientele. His funding and his advertising were limited, he kept his part time employment and he worked at his business when he could. He chose where his business premises were located and also his opening and closing times. He made losses each year and didn't satisfy any of the four tests.

The Commissioner's view on this example is found at paragraph 140 of TR 2007/6:

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 circumstances, the timing of the re-location of your business, the change to your business model, the impact of the global financial crisis, and the introduction of the resale royalty scheme all contributed to the loss incurred in the 2009-10 income year. The Commissioner does not consider that a business such as yours is a business activity that has a lead time between the commencement of the activity and the production of any assessable income.

It is noted that you have provided information about the profitability of your type of business from independent sources. However as it is not considered that lead time is an inherent characteristic of your industry this information does not alter the Commissioner's decision about exercising the discretion under paragraph 35-55(1)(c) of the ITAA 1997.

The Commissioner will not exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997. You cannot claim a deduction for your losses against other income in the 2009-10 income year and the losses must be deferred.

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