Edited version of your written advice

Authorisation Number: 1012919891611

Date of advice: 1 December 2015

Ruling

Subject: Non-commercial losses-special circumstances

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 for a number of financial years?

Answer:

No

This ruling applies for the following periods:

Year ended 30 June 20YY

Year ended 30 June 20ZZ

The scheme commenced on:

1 July 20XX

Relevant facts

You were employed with the education sector for a number of years.

You establish a business as a sole trader.

You developed a business plan to assist in creating an income stream when you retired.

You incurred expenditure on the purchase of materials to create products for sale to the general public.

You have not sold any products you produced.

You have made losses during a number of financial years.

You had expected to derive a profit in the future but due to being made redundant from your employment you do not have sufficient funds to continue your business as you relied of this income stream to fund the business.

You ceased your business.

You satisfy the $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You believe the loss of your employment affected your ability to fund your activity and as a result you are not able to pass one of the four tests in the XXXX to XXXX financial years.

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

Reasons for decision

For the 2009-10 and later financial 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, or

• the Commissioner exercises his 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 financial years under consideration. Your losses are therefore subject to the deferral rule, unless the Commissioner exercises his discretion.

The 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.

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.

In your case, you have requested the Commissioner not consider this discretion as your business activity ceased. However you have requested the Commissioner exercise his discretion under special circumstances to allow the losses from your arts business to be offset against your other income due to the loss of your employment income which funded your arts business.

Application of paragraph 35-55(1)(a) of the ITAA 1997- special circumstances to your activity

The relevant discretion under paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the financial year in question where your business activity is affected by special circumstances outside your control.

'Special circumstances' are those circumstances which are sufficiently different to distinguish them from the circumstances that occur in the normal course of conducting a business activity, including drought, flood, bushfire or some other natural disaster.

For individuals who satisfy the income requirement, special circumstances are those which have materially affected their business activity, causing it not to meet any of the four tests. In this context, the Commissioner may exercise this discretion for the financial year(s) in question where, but for the special circumstances the activity would have passed at least one of the tests.

To determine what are 'special circumstances', we need to look at the context in which the phrase is used. Also, it is clear that 'special circumstances' will be something out of the ordinary or unusual. '

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…

Later, in the Federal Court Case of Secretary, Department of Employment, Education, Training & Youth Affairs v. Barrett and Another (1998) 82 FCR 524 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed that:

The word 'special' must be read in context. In normal parlance it signifies that the event or circumstances in question are out of the ordinary or normal course.

Tamberlin J then quoted the following passage with approval from the AAT case of Re Beadle and Director-General of Social Security (1984) 1 AAR 362; (1984) 6 ALD 1:

An expression such as 'special circumstances' is by its very nature incapable of precise or exhaustive definition. The qualifying adjective looks to circumstances that are unusual, uncommon or exceptional. Whether circumstances answer any of these descriptions must depend upon the context in which they occur. For it is the context which allows one to say that the circumstances in one case are markedly different from the usual run of cases. This is not to say that the circumstances must be unique but they must have a particular quality of unusualness that permits them to be described as special.

The question that must be addressed is whether the situation you have described is considered special circumstances.

You argue that the loss of your tenured position with your former employer has affected your ability to fund your business to meet one of the four tests in the relevant financial years the business was operating. As stated at paragraph 14 of Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion:

The special circumstances must be outside the control of the operators of the business activity. Such circumstances are specifically defined to include drought, flood, bushfire or some other natural disaster⁴. In the case of other events, failure for no adequate reason to adopt practices commonly used in an industry to prevent or reduce the effects of special circumstances may point to the special circumstances not being outside the control of the operator.

Further as stated noted a p 49 of TR 2007/6:

49. The special circumstances must have affected the business activity. Some indicators of the effects on the business activity that could lead to the exercise of the discretion in regard to the special circumstances limb are:

· destruction of stock or equipment (refer to Example 2 at paragraph 112 of this Ruling);

· delays in ploughing, planting, harvesting etc (refer to Example 3 at paragraph 115 of this Ruling);

· delay in growth of crops (refer to Example 4 at paragraph 118 of this Ruling);

· inability of operator to perform duties (refer to Example 5 at paragraph 122 of this Ruling); and

· loss of business opportunities (refer to Example 6 at paragraph 125 of this Ruling).

A review of the information provided indicates the Commissioner would not exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 for special circumstances as the loss of your employment is not considered to be special circumstances but a normal consequence of commercial business decision made by your former employer. Your circumstances are no different to any other employee who is made redundant or suffers a loss of their employment position.

Further we believe that the inability to fund your business activity is a commercial risk of carrying out a business in your industry and not unusual or out of the ordinary. Accordingly it is not accepted that these circumstances constitute special circumstances in the way this term is used in the legislation.

As neither or the relevant discretions apply to your business the Commissioner will not exercise his discretion under section 35-55 of the ITAA 1997 for the years in question. Therefore any 'loss' for that activity cannot be taken into account in calculating your taxable income for the, 20XX-YY and 20YY-ZZ financial years.

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).