Edited version of private ruling

Authorisation Number: 1011802429395

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Ruling

Subject: non-commercial losses

Question

Will the Commissioner exercise the discretion under paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your futures trading activity in your calculation of taxable income for the 2009-10 financial year?

Answer: No.

This ruling applies for the following periods

Year ended 30 June 2010

The scheme commenced on

1 July 2000

Relevant facts

You trade in futures on a daily basis.

You are a subscriber to many data suppliers.

You invest a considerable amount of time and money into this activity.

You set up an options/future trading account in 2000. You have undertaken a number of courses in this field over the last 10 years.

You have recently set up a new account with a more reputable trading platform operator. You have a current profit for the 2010-11 financial year. You hope to make an overall profit for the 2010-11 financial year.

You advise that the nature of futures trading is very volatile and profits and losses can change quite quickly.

You do not satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Subsection 35-10(4).

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

Income Tax Assessment Act 1997 Section 35-30.

Income Tax Assessment Act 1997 Section 35-35.

Income Tax Assessment Act 1997 Section 35-40.

Income Tax Assessment Act 1997 Section 35-45.

Income Tax Assessment Act 1997 Section 35-55.

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

Reasons for decision

Summary

The effect of the non-commercial losses legislation is to restrict the circumstances where a business loss can be offset against other income. The income requirement that applies for the 2009-10 and later income years further restricts the circumstances where a business loss can be offset against other income.

The Commissioner cannot exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 to include any losses from your futures trading business in the calculation of your taxable income for the 2009-10 year. It is considered that there is nothing inherent in this industry that 'because of its nature' prevents you from producing assessable income greater than the deductions attributable to it in a year. Therefore, the losses from your business will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997.

Detailed reasoning

Division 35 of the ITAA 1997 applies to losses from certain business activities. 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 satisfy subsection 35-10(2E) of the ITAA 1997 and one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 are met, or

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

Business activity

Your activity will only be potentially subject to Division 35 of the ITAA 1997 if it is carried on as a business. In your case, you advise that your futures trading activity is carried on as a business.

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).

In your case, the exception in subsection 35-10(4) of the ITAA 1997 has no application.

Subsection 35-10(2E) of the ITAA 1997

The income requirement in subsection 35-10(2E) of the ITAA 1997 applies from 1 July 2009 and will be met where the sum of the following amounts for an income year is less than $250,000:

· taxable income (ignoring losses subject to the non commercial loss rules)

· reportable fringe benefits

· reportable superannuation contributions

· net investment losses

You do not satisfy the income requirement contained in subsection 35-10(2E) of the ITAA 1997.

Therefore as you do not satisfy the income test and the exception does not apply, the losses from your activities will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997, unless the Commissioner exercises a discretion under section 35-55 of the ITAA 1997.

For an applicant who carries on a business activity and does not satisfy subsection 35-10(2E) of the ITAA 1997 for the most recent income year ending before the application is made, paragraph 35-55(1)(c) of the ITAA 1997 states the Commissioner may decide that the loss deferral 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 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)).

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 explanatory memorandum to this new legislation explains that individuals:

….must demonstrate that the reason they do not or will not make a profit is because of the nature of the business and not for some other reason which is peculiar to that individual's particular business.

The individual is required to establish objectively the commercially viable period for the industry concerned.

The phrase 'objection expectation' was discussed in the Administrative Appeals Tribunal case of Scott v. Commissioner of Taxation [2006] AATA 542; VS2005/31-33, (Scott's case) where it was said:

…in determining a commercially viable period, the test is primarily an objective one based on independent sources. According to the Commissioner, this approach was taken by the Federal Court in Commissioner of Taxation v Eskandari (2004) 134 FCR 569 where Stone J said, at 581-582:

In some cases it may be a straight forward exercise to identify the industry in which the business activity takes place. Some industries are well-established and the basis for an ''objective expectation'' can readily be based on a comparison between the tax payer's business and other businesses within that industry, particularly where businesses or business associations within the industry produce material such as annual reports or industry papers ...

Despite what Stone J said, Mr Scott contended that there were other circumstances which had to be taken into account when determining the commercially viable period expressed in the Olives Australia document. However, according to the Commissioner, this is impermissible because, as the Federal Court held in Eskandari, in most cases only objective material will be considered. It is only where, because of the nature of the industry, there is very little or no objective evidence that recourse may be had to the circumstances of the tax payer. That is not the case in the olive industry, which has been established for centuries. I agree with that submission. It seems to me that if it were permissible to take into account subjective considerations of each individual grower, there might be an almost infinitely variable period which could be described as the commercially viable period.

Further, in the case of Scott, additional plantings made at a later time were not permitted to be included in the commercially viable period, as follows:

The fact that a grower elects not to plant sufficient trees at the outset to ensure the business is commercially viable is a decision for that individual grower. Such a grower could not expect the Commissioner to exercise his discretion under s 35-55 in his or her favour because, to do so, would effectively render nugatory the rule dealing with losses from non-commercial business activities.

As highlighted in Scott's case, the reference to the period that is commercially viable involves an enquiry into whether the business activity in question will produce a profit within the time frame in which other business activities in the same industry, which behave in a commercially viable manner, do so.

The sole reliance on objection evidence and the impermissibility of subjective considerations was further emphasised in the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 as follows:

2.30 The taxpayer is required to establish objectively that the business is commercial in nature and will become profitable in a commercially viable timeframe. Objective evidence from independent sources can include evidence from an individual or organisation experienced in the relevant industry, such as industry or regulatory bodies, tertiary institutions, industry specialists, professional associations, government agencies or other independent entities with a similar successful business activity. Evidence from independent sources can also include evidence from business advisers (such as business plans), financiers and banks.

2.34 For taxpayers that do not meet the income requirement, the Commissioner may exercise a discretion after an application by a taxpayer, where the Commissioner is satisfied that - based on evidence from independent sources - the business will produce assessable income greater than available deductions, in a timeframe that is considered commercially viable for the industry concerned.

2.35 The discretion is not intended to be available in cases where the failure to make a profit is for reasons other than the nature of the business, such as, a consequence of starting out small and needing to build up a client base, or business choices made by an individual that are not consistent with the ordinary or accepted practice in the industry concerned - such as the hours of operation, location, climate or soil conditions, or the level of debt funding.

Further, the Explanatory Memorandum provides the following relevant examples:

Joe earns in excess of $250,000 and has a substantial rural property which he and his wife visit most weekends. The property has a family residence and sheds and, apart from one area of the property where a few goats are kept, is otherwise developed with nut trees.

Joe planted a large number of nut trees on the land in 2007, and has been claiming his losses from this activity, having passed the real property test in prior years. As his income is higher than $250,000, Joe applies to the Commissioner seeking the exercise of the discretion in new paragraph 35-55(1)(c) to allow him to access his losses in 2009-10.

In support of his application, Joe provides a letter from the secretary of the Nut Tree Growers' Association that states that yields from that number and type of trees would ordinarily be sufficient to allow Joe to make a profit within about six years. This is the industry norm for growers of that type of nut tree. However, because the soil on the property is not very fertile and the site does not get a lot of sun, Joe accepts that the lead time for his particular nut-growing activity will be nine years not six years. Joe otherwise manages his nut tree orchards in accordance with industry management practices.

Having examined the case, the Commissioner concludes that, despite the large number of trees on the property and the fact that the business is being conducted in accordance with industry management practices, the discretion should not be exercised in Joe's favour. This is because the lead time for this activity to become profitable is greater than the industry norm: the failure to make a profit within a commercially viable period is due to factors that are peculiar to Joe's local environment. Despite the fact that these factors are out of Joe's control, and the fact that the activities are otherwise carried on in a commercially viable way, the excessive lead time before making a profit for Joe's activities are caused by the poor soil quality and lack of sunlight. The Commissioner does not exercise the discretion in Joe's favour because there is an excessive lead time before making a profit, when compared to other businesses in the industry.

Therefore for the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to be exercised, the business activity must have inherent characteristics that cannot be overcome by conducting the business activity in a different way.

In your case, you commenced your futures trading activity in 2000.

Due to the nature of some business activities, they will not produce assessable income in the early years and therefore will not be able to produce a profit. However, the nature of a futures trading type of activity is that it is possible to derive assessable income from the first day.

It is acknowledged that results can vary for individuals and institutions with some making profits and others making losses. Therefore we have to consider whether it is 'because of the nature' of the industry that there would be reasons that would prevent you from making a profit in your 10th year.

There is nothing inherent in the nature of the activity that would prevent you from making a profit in the 10th or earlier years of your activity. There is nothing inherent in the activity that prevents you from deriving assessable income from the start. It is considered that the fact that your activity will not produce a profit in the 2009-10 financial year is not simply a result of the nature of the activity.

It can be seen from the general discussions above that a futures trading activity is not the type of industry where it was envisaged that the discretion in paragraph 35-55(1)(c) of the ITAA 1997 would apply. It does not exhibit any of the characters of these types of industries.

The Commissioner cannot exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 to include any losses from your futures trading business in the calculation of your taxable income for the 2009-10 year. It is considered that there is nothing inherent in this industry that 'because of its nature' prevents you from producing assessable income greater than the deductions attributable to it in a year.

Therefore, the losses from your business will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997.

Please note that the existence of a volatile market and the associated fluctuations are expected to occur on a regular or recurrent basis when carrying on a futures business activity. Such ordinary economic and market fluctuations are not regarded as special circumstances under paragraph 35-55(1)(a) of the ITAA 1997.

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