Edited version of your written advice

Authorisation Number: 1012673335432

Ruling

Subject: Non-commercial losses

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) 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?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on

1 July 2009

Relevant facts

The arrangement that is the subject of the 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:

• your previous private ruling including your business plan,

• your letter, and

• further information received.

You are a sole operator.

Your business activities commenced in the 2009-10 financial year.

You had an injury and underwent surgery which you gradually recovered from.

While recovering you continued your employment and building your business. However you later had a relapse of your symptoms and since then have been limited in your business and work activities.

You have been undergoing intensive therapy. While you have continued to keep up with some of the business activities, you have not been able to pursue most of the planned sales activities.

You satisfied the $20,000 assessable income test for the 2010-11 financial year, but have not satisfied the relevant tests in the following years.

You estimated that you would undergo treatment for a six to twelve month period. However, your recovery has been slower than expected.

Your doctor advises you continue to have restricted duties related to the number of hours worked per day, duration of sitting, standing and travel with a maximum 30 minutes with a five minute break. Your condition is managed with home exercise, physiotherapy and swimming. You continue to improve and as your fitness improves you will be able to extend your duties. You will not make a full recovery. Your condition will be reviewed next year.

While your focus has been in keeping your primary job you have been able to continue some of the projected work as per your business plan. However, it has been physically strenuous to continue work on your business after your normal job hours.

You have maintained 40 hours with your normal job throughout your injury period. You have retained your normal duties, however you have modifications to your work area and work routine as per your doctor's advice.

In the 2013-14 financial year you spent from one to four hours on weekdays and from 0 to 10 hours per day on weekends on business activities depending on how much you can manage.

You are hoping to increase your business hours in the 2014-15 financial year.

You have found it hard to increase sales as it means you have to travel to meet clients and this has been difficult with your condition. As it is essentially a client facing business you have been looking into other options of acquiring clients, such as establishing an office or employing sales staff.

You are hoping to continue to build your business but you have been advised to work at a slower pace until full recovery. You are hoping to make $20,000 business income in the 2015-16 financial year. You will later make an assessment if you can physically sustain the business or if you have to cease.

You satisfy the income requirement set out in 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)(a).

Reasons for decision

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. If your activity is not carried on as a business, and cannot reasonably be expected to produce assessable income, then you cannot claim general deductions in relation to it, regardless of the operation of Division 35.

Whether a business is being carried on depends on the 'large or general impression gained' (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all the indicators of carrying on a business, and no one indicator will be decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). These indicators are described in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production?.

In your case, you advise that you carry out some of the business activities but have not been able to pursue most of the planned sales activities. Therefore it is questionable whether you were actually carrying on a business in the 2013-14 income year. As you hope to be fully operating your business in 2015, your activities may be regarded as a business in the 2014-15 income year. If so, then Division 35 of the ITAA 1997 is relevant.

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 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:

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

n reportable fringe benefits

n reportable superannuation contributions

n net investment losses

You have advised that you will satisfy subsection 35-10(2E) of the ITAA 1997 for the relevant years.

In broad terms, the four tests require:

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

(b) the business activity results in a taxation profit in three of the past five income years (including the current year) (section 35-35 of the ITAA 1997),

(c) 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

(d) at least $100,000 of certain other assets (excluding cars, motor cycles and similar vehicles) are used on a continuing basis in carrying on the business activity in that year (section 35-45 of the ITAA 1997).

You do not/will not meet any of the four tests for the 2013-14 and 2014-15 financial years.

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.

Paragraph 35-55(1)(a) of the ITAA 1997

Paragraph 35-55(1)(a) of the ITAA 1997 provides that the Commissioner may exercise a discretion where certain special circumstances apply. The discretion in paragraph 35-55(1)(a) may be exercised where:

• the business activity is affected by special circumstances, and  

• the special circumstances affecting the business activity are outside the control of the operators of the business activity, and include drought, flood, bushfire or some other natural disaster.

Under paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner may decide that the rule in section 35-10 of the ITAA 1997 does not apply to a business activity if the Commissioner is satisfied that it would be unreasonable to apply that rule.

Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion sets out the Commissioner's interpretation of the exercise of the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 54 of this Ruling. 

Special circumstances are ordinarily those affecting the business activity such that it is unable to satisfy a test and it would be unreasonable for the loss deferral rule to apply. Ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances. These fluctuations are expected to occur on a regular or recurrent basis and affect all business within a particular industry. 

Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to special circumstances outside the control of the business activity, including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of the paragraph. Also oil spills, explosions, government restrictions and illnesses affecting key personnel might, depending on the fact, constitute special circumstances. Such events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affected the business activity.

The question of what constitutes 'special circumstances' has been judicially considered on many occasions. In the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation:

Those discretions are intended to be applied to a great variety of situations. In such a context, the core of the idea of "special circumstances" is that there is something unusual or different to take the matter out of the ordinary course

It is clear that 'special circumstances' will be something out of the ordinary or unusual. It will not only be necessary that an event or situation has occurred which is of itself unusual, but that it has resulted in the business activity failing to pass a test. Clearly, if the business activity would not have passed a test even if the event or situation had not arisen, we cannot say that the business activity was affected by 'special circumstances' in the sense in which this term is used in paragraph 35-55(1)(a) of the ITAA 1997.

The operators of the business activity must show that the special circumstances were outside their control.

In your case you suffered an injury and have not been carrying out your planned business activities. Although your business operations have been affected following your injury, it is questionable whether the slower pace of your business activities is outside your control.

The delay in producing business income is related to the hours you have been working on your business activities. You advise that it has been physically strenuous to continue work on your business after your normal job hours. You work 40 hours a week on your primary job.

Whilst your injury is acknowledged, the fact that you are unable to work on your business activities after work indicates that if less hours were spent on your primary job, then more hours could be spent on your business activities.

The fact that your focus is on your job rather than your business, has meant that your business income is lower than expected.

After considering your situation, the Commissioner does not consider your circumstances as being special circumstances that were unusual and outside your control. That is, your failure to make a profit or assessable income of $20,000 was not due to special circumstances outside of your control. The limited time spent on your business activities is not solely due to your injury and is not the kind of circumstance for which paragraph 35-55(1)(a) of the ITAA 1977 was enacted.

While it may be a practical choice in your circumstances, the amount of time spent with your business activities relates more to your choice to continue your full time work rather than special circumstances that are outside your control.

It follows that the Commissioner will not exercise the discretion in paragraph 35-55(1)(a) 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 2013-14 and 2014-15 financial years. The loss deferral rule will therefore apply to losses made from your business activity in those years.

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