Edited version of private ruling

Authorisation Number: 1011804729925

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Ruling

Subject: Commissioner's discretion

Question:

Will the Commissioner exercise the discretion in section 35-55 of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your business activities in your calculation of taxable income for the 2009-10 and 2010-11 financial year?

Answer: No.

This ruling applies for the following period

Year ended 30 June 2010

Year ending 30 June 2011

The scheme commenced on

1 July 2009

Relevant facts

You commenced your business activities in 2009.

Your business activities are aimed at a winter market.

You made no sales in the 2009-10 financial year and only small sales in the 2010 winter (the 2010-11 financial year).

You expect to clear all stock in the 2011 winter (the 2011-12 financial year).

You have stated in your application that your activities will never meet the assessable income test, the real property test or the other assets test but you expect to produce a profit in the 2011-12 financial year.

Your plan is to prepare enough stock in the warmer months to sell close to and during the winter.

You have stated that you did not sell any stock in the 2009-10 financial year because it was a mild winter.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Division 35

Income Tax Assessment Act 1997 - section 35-10

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

Reasons for decision

Overview of Division 35

Under Division 35 of the ITAA 1997, a loss made by an individual from a business activity will not be deductible in the income year in which it arises unless certain conditions are met. 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, 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).

In your case, your business activity is not a primary production business activity or a professional arts business activity, therefore, the exception contained in subsection 35-10(2) of the ITAA 1997 does not apply. 

Tests 

Division 35 of the ITAA 1997 sets out four tests to determine the commerciality of a business. In broad terms, the tests require: 

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

· the business activity results in a tax profit in 3 of the past 5 income years (including the current year) (section 35-35 of the ITAA 1997);  

· 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  

· at least $100,000 of certain other assets (excluding cars, motor cycles and similar vehicles and real property that is taken into account for the real property test) used on a continuing basis in carrying on the business activity in that year (section 35-45 of the ITAA 1997).  

Your business activities did not satisfy any of the four non-commercial loss tests in the 2009-10 financial year. 

If a business does not pass any of these tests, losses must be deferred except in certain circumstances. 

These circumstances are where the Commissioner exercises the discretion under paragraph 35-55(1)(a) or 35-55(1)(b) of the ITAA 1997. If the Commissioner exercises the discretion an individual whose business activity has not passed any of the tests can offset that business loss against other assessable income in the year of that loss. 

The Commissioner's discretion - special circumstances 

Under paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner's discretion can be exercised where: 

· the business activity is affected by special circumstances such that it is unable to satisfy any of the tests; and  

· the special circumstances affecting the business activity are outside the control of the business activity.  

Taxation Ruling TR 2007/6 sets out guidelines on how the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997 may be exercised. Although not limited to natural disasters, special circumstances can including drought, flood, bushfire or some other natural disaster. Ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances.

In your case, the inability of your business activity to satisfy one of the four non-commercial loss tests was not due to special circumstances.

The Commissioner's discretion - lead time 

Under paragraph 35-55(1)(b) of the ITAA 1997, the Commissioner's discretion can be exercised where: 

· the business activity has started to be carried on but because of its nature it has not satisfied, or will not satisfy, one of the tests set out in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997; and  

· there is an objective expectation that within a period that is commercially viable for the industry concerned the activity will meet one of the tests listed above or produce assessable income for an income year greater than the deductions attributable to it for that year.  

Taxation Ruling TR 2007/6 sets out guidelines on how the Commissioner's discretion under paragraph 35-55(1)(b) of the ITAA 1997 may be exercised. The following has been extracted from paragraphs 70 to 104 of this ruling. 

The discretion is provided to ensure that certain individuals who carry on genuine commercial businesses are not disadvantaged due to particular circumstances which prevent them from satisfying one of the tests. 

This arm of the safeguard discretion will ensure that the loss deferral rule in section 35-10 of the ITAA 1997 does not adversely impact on taxpayers who have commenced to carry on activities which by their nature require a number of years to produce assessable income. The 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. Such activities have an inherent characteristic that cannot be overcome by conducting the business activity in a different way but only by changing the nature of the business. 

In your case, the nature of your business does not prevent it from producing assessable in the first year it is commenced. While it is accepted that the demand for your product is greater during the colder months, this does not explain why you made no sales in June of 2010 (2009-10 financial year) and only a small amount of sales in July and August for 2010 (2010-11 financial year).

The inability of your business activity to satisfy one of the four non-commercial loss tests is due to the small scale in which it is carried on and was not due to lead time, as set out in paragraph 35-55(1)(b) of the ITAA 1997.

Therefore, the Commissioner will not exercise the discretion in section 35-55 of the ITAA 1997 to allow you to offset the losses made from your business activities against your other assessable income for purposes of calculating your taxable income for the 2009-10 and 2010-11 financial years.

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