Edited version of your written advice

Authorisation Number: 1012742346803

Ruling

Subject: Non-commercial losses

Question

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 2013-14 financial year?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

You meet the income requirement of Division 35 of the ITAA 1997 however the exceptions of subsection 35-10(4) do not apply as your other income exceeds $40,000.

You expect to pass the assessable income test in the 2016-17 financial year and be commercially viable in six to ten years. You have not provided an independent source to support this commercially viable timeframe.

You started your entertainment activity in 200X however you remain in your main paid employment but would like to leave that employment and spend 100% of your time on your activity. Currently you spend approximately 40 hours per week on each profession.

This industry is all about knowing and mastering your craft and your networking abilities. Your colleagues who are now full time professionals in this industry have all started with mastering the craft.

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 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 the discretion.

In your situation, none of the exceptions would apply and although you satisfy the income requirement, you do not meet any of the four tests in the year of income under consideration. Your losses are therefore subject to the deferral rule, unless the Commissioner exercises the 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.

The note to paragraph 35-55(1)(b) of the ITAA 1997 states it 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. 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 type of feature contemplated by the phrase 'because of its nature', in the context in which it appears, is that referred to in the note quoted above. That is, that there is 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. This is borne out further by paragraph 1.51 of the Explanatory Memorandum for the New Business Tax System (Integrity Measures) Act 2000, which states:

This arm [paragraph 35-55(1)(b)] of the safeguard discretion will ensure that the loss deferral rule in section 35-10 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. Examples of activities which would fall into this category are forestry, viticulture and certain horticultural activities.

The note and the passage cited above do 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. Those sorts of constraints on being able to satisfy that test are far removed from the specific one referred to in the note and the Explanatory Memorandum.

Paragraph 17 of Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion (TR 2007/6) deals with the exercise of the Commissioner's discretion under this subparagraph and the meaning of 'because of its nature'

For the failure to satisfy one of the four tests to be 'because of its nature', the failure must be because of some inherent characteristic that the taxpayer's business activity has in common with other business activities of that type (see Federal Commissioner of Taxation v. Eskandari).

Paragraph 78 of TR 2007/6 states;

The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity and would not result in the requirements of subparagraph 35-55(1)(b)(i) being met.

The example at paragraph 139 of TR 2007/6 explains the taxpayer was new to the region and industry in which he chose to commence his business. He had no clientele. His funding and his advertising were limited, he kept his part time employment and he worked at his business when he could. He chose where his business premises were located and also his opening and closing times. He made losses each year and didn't satisfy any of the four tests.

The Commissioner's view on this example is found at paragraph 140 of TR 2007/6;  

The inability of Andrew's business activity to satisfy any of the four tests is due to his personal business choices as to hours of business, location and advertising, not any inherent characteristics that affect clock repair businesses. Accordingly the requirement of subparagraph 35-55(1)(b)(i) is not met and the Commissioner would not exercise the discretion.

In your circumstances your training from 200Y and gradual exposure of your performances is designed to increase your profile and therefore be more able to produce assessable income. This process contributed to the losses in the 2013-14 financial year and although you will take time to produce assessable income the lead time is not that type as envisaged in the Explanatory Memorandum for the New Business Tax System (Integrity Measures) Act 2000 or paragraph 35-55(1)(b) of the ITAA 1997.

Consequently the Commissioner will not exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).