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Ruling

Subject: Commissioner's discretion for non-commercial losses

Question 1

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) 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 2011-12 financial year?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

Your income for non-commercial loss purposes is more than $40,000 and less than $250,000.

Your business is primarily concerned with the production and sale of your artistic works. You have incurred costs to purchase materials, hiring gallery and studio space, special framing materials and promotional activities.

You commenced business operations in the relevant financial year and during that time you have exhibited your work on several occasions, and you have sold several pieces of your work.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 35-10(1)

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

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

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

Reasons for decision

For the 2009-10 and later income years, Division 35 of the ITAA 1997 applies to defer a non-commercial loss from a business activity unless:

· you satisfy the income requirement and you pass one of the four tests

· the exceptions apply: or

· the Commissioner exercises his discretion.

Income Requirement

You satisfy the income requirement set out in subsection 35-10(2E) of the ITAA 1997 as your income for non-commercial loss purposes is less than $250,000.

Tests

Division 35 of the ITAA 1997 sets out four tests to determine the commerciality of a business. These are contained in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) and 35-45 (other assets test) of the ITAA 1997.

In broad terms, the tests require:

· at least $20,000 of assessable income in that year from the business activity;

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

· 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; 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.

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

Exceptions

Division 35 of the ITAA 1997 allows for the deferring of losses not to apply to a primary production business or a professional arts business where the assessable income from other sources, is less than $40,000.

In your situation, although you satisfy the income requirement, you do not meet any of the four tests in the relevant financial year.

Also, you do not qualify for the exception as your income from other sources is more than $40,000.

Your losses are therefore subject to the deferral rule, unless the Commissioner exercises his discretion.

The relevant Commissioner's discretion may be exercised for the income year in question where:

· it is in the nature of the business activity that there will be a period of time before it can be expected to pass one of the four tests, and

· there is an objective expectation your business activity will produce a tax profit or meet one of the four tests within a commercially viable period for your industry.

For the discretion to be applied there needs to be an inherent or innate feature of the activity resulting in an inability to produce income in the year of commencement and (in most cases) a number of years thereafter. For example, planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income and would include viticulture and certain horticultural activities.

This does not support any view that the discretion should be exercised for any start-up activity that is yet, for example, to satisfy the assessable income test in section 35-30 of the ITAA 1997, simply because of the small scale on which it was started, or because a client base is being built up.

In your case, whilst you are working on a small scale your business was able to generate income in the first year of operation.

We do not consider that there is a lead time between the commencement of your activity and the production of any assessable income. Therefore the discretion will not be exercised in your circumstances.

This means that the loss from your activity cannot be taken into account in calculating your taxable income for the relevant financial year.

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