Edited version of your private ruling

Authorisation Number: 1012570874678

Ruling

Subject: non-commercial losses

Question 1

Are you carrying on a business?

Answer

No.

Question 2

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 the calculation of your taxable income for the 2012-13 financial year?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling received, and

· further information received.

Your income for non-commercial loss purposes was less than $250,000 in the 2012-13 financial year.

You commenced activities to develop a product in the 2012-13 financial year.

You incurred costs of less than $X per month during the 2012-13 financial year.

Due to the nature of your activities, you will not earn any assessable income until the product is complete.

You expect to begin earning income from our product in the 2013-14 financial year.

You anticipate you will pass the assessable income test and make a tax profit in the 2013-14 financial year.

You have started a company. The company has applied for a standard patent in relation to the product.

The company will sell the product.

You have previously worked in a related field.

You do not have a business plan, however you have stated that it is not common practice for this type of activity.

You do not have any other employment.

Relevant legislative provisions

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

Reasons for decision

Question 1

Business losses from activities that do not meet any of the four tests under Division 35 of the ITAA 1997, or the exception in subsection 35-10(4) of the ITAA 1997, 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 that it would be unreasonable to defer the loss.

In order for Division 35 to apply, a taxpayer must have commenced business. In determining when a business commences, there are three indicators that must be present before it can be said that a business has commenced. In order for Division 35 to apply, a taxpayer must have commenced business. In determining when a business commences, there are three indicators that must be present before it can be said that a business has commenced. These are:

• purpose, intention and decision;

• acquisition of a business structure; and

• commencement of business operations

We must examine the above indicators in light of the characterisation of your business activity. In Goodman Fielder Wattie Ltd v. Federal Commissioner of Taxation 29 FCR 376; (1991) 22 ATR 26; 91 ATC 4438, Hill J stated:

Critical to the resolution of the present controversy, is the characterisation of the business activity itself which is said to have commenced. It was conceded properly by the applicant that if the business claimed to be carried on by it was to be characterised as one of manufacturing and selling monoclonal antibody products, then that business did not commence until around November 1982...

For example, for a primary production activity involving the planting and cultivating of trees, then the planting of the trees could be seen as the commencement of that business. Alternatively, if your business activity is characterised as a trading activity, involving conducting services in return for a fee, the business would generally be considered to have commenced once you begin conducting the services for a fee.

Computer software

Computer software, and licences to produce computer software, are trading stock for a person who trades in them (Taxation Ruling TR 93/12). Computer software which is produced or developed by a software manufacturer or developer for the purpose of sale is considered to be trading stock. Where the software is produced or developed for the purpose of granting licences rather than the sale of the software (the legal title remaining with the developer/supplier) and the taxpayer carries on a business of trading in software licences, the licences will be trading stock.

The information which you have provided indicates that your intention is to develop software and receive income in the form of sales of reports produced by the software.

Purpose, intention and decision

The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity.  This is developed by researching the proposed business and, in some instances, by experiment.  This process culminates in a final decision on whether to commence business.  However, not all businesses commence in such an orderly manner.

It is clear from the information you have provided that you had decided the form of that business and had shown some commitment to it by conducting market research and trials and investing time in developing the materials that will produce your product.

Acquisition of a business structure:

For a business activity to commence, an appropriate business structure should be in place. As to what this structure will consist of, and its size, this will be a question of fact and degree, and depend on the nature of the business activity. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity.

In Calkin v. CIR [1984] 1 NZLR 440 Richardson J said at 446-447:

'Clearly it is not sufficient that the taxpayer has made a commitment to engage in business: he must first establish a profit-making structure and begin ordinary business operations.'

In your case, you had not actually acquired all of the business assets that you needed to commence your business activity, including a finalised product to produce reports for sale.

Commencement of Business Operations:

As noted by Brennan J in Inglis v. Federal Commissioner of Taxation (1979) 10 ATR 493; 80 ATC 4001, the level of activity is important in deciding whether a business is being carried on.  Brennan J stated at ATC 4004-4005;  ATR 496-497 that:

The carrying on of a business is not a matter merely of intention.  It is a matter of activity. Yet the degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the supposed business is being conducted.

In your case, you had not begun ordinary business operations during the 2012-13 financial year. At that point in time you did not have your software ready to produce a product for sale.

We consider that, up to this point, your activities were preliminary to the carrying on of your intended business. The costs associated with the establishment of a trading entity are capital in nature as they relate to the structure of the business rather than the daily activities from which the business gains its assessable income (see Federal Commissioner of Taxation v. Maddalena 71 ATC 4161; (1971) 2 ATR 541.

Question 2

Non-commercial loss discretion

For the 2009-10 and later income years, Division 35 of the ITAA 1997 will apply 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

• the Commissioner exercises his discretion.

In your situation, none of the exceptions would apply and you do not satisfy the income requirement. Your losses are therefore subject to the deferral rule, unless the Commissioner exercises his discretion.

The relevant 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

• 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.

This discretion is intended to cover a business activity where there is an inherent period of time between the commencement of the activity and the production of 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.

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. Further examples that fall into this category are forestry, viticulture and certain horticultural activities.

The discretion should not 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. The discretion should not be exercised for any start-up

As you are not considered to be carrying on a business the non-commercial loss provisions do not apply and the Commissioner is unable to exercise any discretion in this matter.

However, even if you had commenced business, you have not produced any objective evidence to show that there is an inherent or innate characteristic preventing the business from producing assessable income for any period of time (Federal Commissioner of Taxation v Eskandari [2004] FCA 8; 54 ATR 695).

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