Edited version of your written advice

Authorisation Number: 1012980290975

Date of advice: 7 March 2016

Ruling

Subject: Non-commercial losses - Commissioner's discretion - lead time

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?

Answer:

No.

Relevant facts

You carry on a business.

You have produced a product available for sale.

You have not yet received any income from your activities.

Your income for non-commercial loss purposes is over $40,000 but below $250,000.

You have not passed any of the four NCL tests.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 35-1.

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 - Paragraph 35-55(1)(b).

Reasons for decision

Summary

The inability of your business activity to satisfy one of the four non-commercial loss tests or produce a tax profit is peculiar to your situation and is not due to lead time.

Therefore, the Commissioner will not exercise the discretion to allow you to offset the losses made from your business activities against your other assessable income for purposes of calculating your taxable income.

Detailed reasoning

Carrying on a business

If an activity is not carried on as a business, and cannot reasonably be expected to produce assessable income, for example, it is carried on as a hobby, then you cannot claim general deductions in relation to it, regardless of the operation of Division 35 of the ITAA 1997 (non-commercial losses). 

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. Federal Commissioner of Taxation 89 ATC 4540; (1989) 20 ATR 922). These indicators are described in Taxation Ruling TR 97/11.  

This ruling is based on the assumption that you were/are carrying on a business.

Division 35 Non-commercial losses

Under Division 35 of the ITAA 1997, a loss made by an individual from a business activity will not be deductible in the financial year in which it arises unless certain conditions are met. Losses that cannot be taken into account in a particular year of income, because of subsection 35-10(2) of the ITAA 1997, can be applied to the extent of future profits from the business activity, or are deferred until one of the tests is passed, the discretion is exercised, or the exception applies. In effect the losses are quarantined to the business activity and cannot be offset against other income until one of the tests are passed, but can be offset against the business income of later years. 

Under the rule in subsection 35-10(2) of the ITAA 1997 a loss made by an individual from a business activity will not be taken into account unless: 

• the exception in subsection 35-10(4) of the ITAA 1997 applies; or  

• you satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 and one of the four tests is met; or  

• if you do not satisfy the income requirement or if one of the tests is not met, the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

In your case, your business activities meet the definition of a professional arts business for the purposes of subsection 35-10(4), however, as your income from other sources is greater than $40,000, this exception will not apply.

Your income for non-commercial loss purposes is less than $250,000, therefore you satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997. However, your business activities have not satisfied any of the four non-commercial loss tests 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. You will not be able to offset your losses from the business activity against your employment or other income in these years, unless you can get the Commissioner's discretion.  

The Commissioner's discretion - lead time 

You have requested that the Commissioner exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997 for lead time. 

Under paragraph 35-55(1)(b) of the ITAA 1997, the Commissioner's discretion can be exercised where: 

• the business activity has started to be carried on but because of its nature it has not satisfied, or will not satisfy, one of the non-commercial loss tests set out in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997; and  

• there is an objective expectation that within a period that is commercially viable for the industry concerned the activity will meet one of the tests or produce assessable income for an income year greater than the deductions attributable to it for that year.  

Taxation Ruling TR 2007/6 sets out guidelines on how the Commissioner's discretion under paragraph 35-55(1)(b) of the ITAA 1997 may be exercised. The following has been extracted from paragraphs 70 to 104 of this ruling. 

The discretion is provided to ensure that certain individuals who carry on genuine commercial businesses are not disadvantaged due to particular circumstances which prevent them from satisfying one of the tests. 

This arm of the safeguard discretion will ensure that the loss deferral rule in section 35-10 of the ITAA 1997 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. The paragraph 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. Such activities have an inherent characteristic that cannot be overcome by conducting the business activity in a different way but only by changing the nature of the business. An example would be where a crop does not produce fruit for a number of years. Income cannot be derived for this period.

The discretion will not be available where the failure to make a profit is for reasons other than the nature of the business such as, a consequence of starting out on a small scale, the hours worked or the need to build a client base.

In your case, you have not provided any independent evidence to show the lead time for your type of business activity. However, it is generally accepted that there is nothing in the nature of your type of business activity that prevents it from producing assessable income in the first year it is commenced.

The inability of your business activity to satisfy one of the four non-commercial loss tests or produce a tax profit within an undefined period, is peculiar to your situation and is not due to an inherent feature of this type of activity (lead time), as set out in paragraph 35-55(1)(b) of the ITAA 1997.

Therefore, the Commissioner will not exercise the discretion in section 35-55 of the ITAA 1997 to allow you to offset the losses made from your business activity against your other assessable income for purposes of calculating your taxable income for the 2014-15 and 2015-16 financial years.

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