Edited version of private ruling

Authorisation Number: 1011727735707

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Ruling

Subject: Non Commercial Losses- Commissioner's discretion - Lead time.

Question

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 and 2010-11 income years?

Answer

No.

This ruling applies for the following period

1 July 2009 to 30 June 2011

The scheme commenced on

1 July 2005

Relevant facts and circumstances

You are conducting a non-primary production business activity. While you wait to sell your assets, you use them to generate income.

A few years ago you purchased assets. A couple of years later you sold those assets. Between the commencement of the activity and the sale of assets you generated income by using them.

After selling the original assets you purchased new assets. You expect to sell the new asset in a couple of years. Hence, to maximise the revenue opportunities and further develop your income streams you have established a different arm of the business that utilises the assets you own until such time a buyer comes along to purchase the asset. The method you expect to generate income this time is different to the one you used previously.

The income you received by using your first assets and the income you received from selling those assets were declared in the income tax returns.

You have stated that this type of business takes a considerable amount of time to get started and to then sell the assets. You have also stated that the activity was affected by the global financial crisis (GFC). This has impacted on you significantly as there are already a limited number of buyers with available funds to purchase assets of this type in the market given the specialised nature of the industry.

In respect of the income producing stream, there are a number of issues that arise in establishing the business before it can generate income.

You encountered various difficulties when you commenced the activity. You have now overcome all the difficulties and you expect to commence generating income.

You have stated that given the unique nature of your business, there is a considerable period of time that can elapse before income can be generated from these activities. Your staff have been improving their qualifications in the lower economic activity periods.

You expect to be fully profitable within two to a maximum of four years.

You have provided the projected income/expenses and profit for your business activity.

You have provided copies of documents in relation to your activity.

As you have not satisfied the income requirement in subsection 35-10(2E) of the ITAA 1997, you have requested the Commissioner to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the 2009-10 and 2010-11 income years.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 sub paragraph 35-55(1)(c)(ii).

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

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

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Section 35-1 of the ITAA 1997 provides that an income requirement must be met (along with certain other tests), in order to include losses from a business activity in the calculation of taxable income. The 'income requirement' is set out in subsection 35-10(2E) of the ITAA 1997. If the income requirement is not met, the Commissioner may exercise discretion to allow the inclusion of the losses.

In order to exercise the discretion, the Commissioner must be satisfied that there is an objective expectation, based on evidence from independent sources, that your business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period for the industry (paragraph 35-55(1)(c) of the ITAA 1997).

The Commissioner's discretion in subsection 35-55(1) of the ITAA 1997 reads -

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

(c) 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)).

In your case, you do not meet the income requirement in subsection 35-10(2E) of the ITAA 1997 as your income for the purposes of paragraph 35-55(1)(c) of the ITAA 1997. Therefore you need the Commissioner's discretion to claim the losses in those income years.

You have stated that your activity is carried on as a business and this ruling is made on the basis of accepting this claim.

You commenced the business activity approximately six years ago when you first purchased your assets to sell. To maximise the revenue opportunities and further develop your income streams you used this asset to generate income. You sold those assets and purchased a new asset. You expect to generate income from the asset by applying a different method to the one you applied previously while you are waiting for a buyer to sell your asset.

The Note to paragraph 35-55(1)(c) of the ITAA 1997 states that the particular paragraph is intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. The Commissioner accepts that your activity has a lead time between the commencement and producing any assessable income. Although you have stated that in the current business environment, it is difficult to find a buyer for this type of business, the asset is available for sale soon after its ready.

Paragraph 21 of the Taxation Ruling TR 2007/6 states that the period that is commercially viable for the industry concerned is the period in which it is expected that any business activity of that type, which is carried on in a commercially viable manner, would be expected to satisfy one of the tests or produce a tax profit.

The independent evidence you have provided, states that you can be profitable within the next two to four years.

You have actually commenced the business approximately six years ago when you first purchased the assets. You have sold the assets a couple of years later and with the supplementary income you received you satisfied the assessable income test in section 35-30 of the ITAA 1997 and generated a profit.

The subsequent purchase of an asset, and using it to generate income is not considered to be a new business activity, it is the continuation of the previous business.

You have generated a profit within the commercially viable period. Therefore, the commercially viable period has lapsed. The Commissioner will not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for your activity in the 2009-10 income year.

As the projections you have provided indicate that you expect to receive a profit in the 2010-11 income year, the Commissioner is precluded form exercising a discretion for that year.

Summary of reasons for decision

The Commissioner will not exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997 for the 2009-10 income year because, on the facts provided:

§ your business activity commenced approximately six years ago; and

§ the commercially viable period for the activity has lapsed as a profit has already been made.

§ the purchase of the second asset and using it for an income generating purpose is not considered to be a separate, distinct and a new activity. It is considered to be the continuation of the previous activity. As such, it does not have a new lead time.

§ the Commissioner is precluded from exercising a discretion for the 2010-11 income year as you expect to generate a profit in that year.

As you do not expect a taxation profit in the 2009-10 income year, 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 activity for that year. A deferred loss is not disallowed and will be deductible against any taxation profit from your activity, or similar business activity, in future years.

If your activity, or similar activity should satisfy an exception or satisfy the income requirement and one of the tests in Division 35 of the ITAA 1997 in any given year, then the whole of the deferred loss will be deductible in that year.

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