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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

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Edited version of your written advice

Authorisation Number: 1013106531696

NOTICE

The private ruling on which this edited version is based has been overturned on objection.

This notice must not be taken to imply anything about the correctness of other edited versions.

Edited versions cannot be relied upon as precedent or used for determining how the ATO will apply the law in other cases.

Date of advice: 14 October 2016

Ruling

Subject: Non-commercial business losses and the Commissioner's discretion

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 (the activity) in your calculation of taxable income for the 20WW-XX to 20YY-ZZ financial years?

Answer

No.

This ruling applies for the following periods:

● Year ended 30 June 20XX

● Year ended 30 June 20YY

● Year ended 30 June 20ZZ

The scheme commences on:

1 July 20WW

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below.

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

During the 20WW-XX financial year you commenced an activity primarily concerned with producing artistic items.

Your items are couture, in that your collections are unique, singular, and bespoke.

Your intention was to grow and develop your profile as a professional until retirement from your full time employment.

You would do this by producing complete collections to be exhibited regularly at shows/exhibitions, and undertaking other ad-hoc engagements, and commissions as opportunities arise.

You have previously conducted your activity out of your home, however you have been recently utilising a studio space that has been provided to you for free.

You have purchased some equipment for manufacturing and displaying your items. However the largest cost is the physical materials needed to make each piece.

You advised that the items are extremely costly to make, and take many hours to produce.

To date you have produced a large number of items.

Whilst you value the items at a particular figure, based on industry advice, current retail prices for similar pieces, and extensive market analysis, you accept that it will take time to become established and to get to the point where profit yielding prices are accepted by the market as fair.

You advised that the reasons for this are:

In relation to the price, you advised that 'while a high(er) price for the art will be more likely the product of steady and consistent credibility building, no-one will pay the high prices for albeit unique and high quality and creative items if the creator is unknown, and where no-one before them has paid similar high prices. However a buyer would/should not expect to pay less than the fair retail for a store bought mass produced high end designer/couture item either. The work is so unique, making such a 'fair' price evaluation difficult.'

In relation to aesthetic expectation, it is more usual in the arts buying world, which does not necessarily rely on a track record; an impulsive buyer who likes something might confidently pay the asking price. That is every creators dream. For a client who undertakes a commissioned work, it is the shared journey of creating a work that comprises the purchased satisfaction as the completed work itself.

The creation of items for show is always a construct of time. A show cannot merely be one or two items or a shop front with new items arriving on the shelf as they are made, it must have significant impact and coherence to attract an audience.

The show is planned months, if not years in advance and steadily takes shape with this focus as a body of work.

For the 20WW-XXto 20YY-ZZ financial years, you have presented your items or your items have been recognised, on a number of occasions.

Your first art show was in 20XX, and was a fully curated show/installation. There were over XYZ attendances, which, according to the events manager, was an extremely good attendance.

You are also in the process of coordinating a number of shows in the near future.

You have advised that the success of your couture label depends on the progress of presenting shows and exhibitions periodically. Therefore your business plan allows for six to seven years to realise sales and attract commissions from clients.

You have provided a letter of support from individual A, who has worked in the Industry for more than 40 years. The letter states the following:

Further you have advised:

You have not earned any business income during the 20WW-XX to 20YY-ZZ financial years, and have therefore made losses in each period.

During this period the activity relied significantly on financial support from your full time employment. However your position was made redundant in the 20YY-ZZ financial year, and as such you could no longer sustain the losses. Further you no longer have the capital available to buy materials to build up stocks for your own creative wishes, and for potential clients.

You sought extensive direction, mentoring and support, as well as thoroughly researched the business and tax circumstances which are pertinent to you current circumstances.

Based on this advice, you have changed the direction of the activity beginning from the 20ZZ- AA financial year. You have changed your business plan to shift the emphasis on your works towards being presented as performance or installation art, with the net income being derived from client subscription, ticket entrance, or commissioning fees, as well as from sales. This business model will very likely seek grant support and collaborative business/community funding support, such as support schemes for small business start-up, emerging artist support, community event funding, and disadvantage/education group funding.

During the 20ZZ-AA financial year the activity has earned assessable income of less than $5000 from the sale of a number of pieces. Further for the 20AA-BB and 20BB-CC financial years you have projected income generation, and anticipate profits in both years. Income will be from sales of your items, grants and ticket sales from shows.

For the 20WW-XX to 20YY-ZZ financial years your gross income from other sources was greater than $40,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

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 subsection 35-10(4)

Income Tax Assessment Act 1997 sections 35-30

Income Tax Assessment Act 1997 sections 35-35

Income Tax Assessment Act 1997 sections 35-40

Income Tax Assessment Act 1997 sections 35-45

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

New Business Tax System (Integrity measures) Act 2000 Explanatory Memorandum

Tax Laws Amendment (2009 Budget Measures No.2) Bill 2009 Explanatory Memorandum

Reasons for decision

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.

Taxation Ruling TR 2005/1 provides guidance on the principles to be applied in determining whether an artist is carrying on business as a 'professional artist'.

It states that common law has identified a number of indicators that are relevant in determining whether a taxpayer's activities constitute the carrying on of a business. The question whether a taxpayer's activities should be characterised as a business is primarily a matter of general impression and degree (Ferguson ATR 884; ATC 4271). As noted in the Federal Court decision in Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922, no single indicator is determinative; rather all of the indicators must be considered. Whether a business is being carried on is based on the overall impression gained after looking at the activity as a whole and the intention of the taxpayer undertaking it.

In your case, you have indicated in your application that your activity is carried on as a business. This ruling has, therefore, been determined on the basis of accepting your statement that you were carrying on a business from the 20WW-XX financial year.

Overview of Division 35

For the 2009-10 and later financial years, subsection 35-10(2) of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless:

In subsection 35-10(4) of the ITAA 1997 it is outlined that the rule in subsection 35-10(2) of the ITAA 1997 does not apply to a business activity for an income year if:

As your assessable income for the financial years in question were greater than $40,000, the exceptions do not apply.

Further, although you satisfy the income requirement, you do not meet any of the four tests in the years of income under consideration. Your losses are therefore subject to the deferral rule, unless the Commissioner exercises his discretion.

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.

Lead time discretion - paragraph 35-55(1)(b) of the ITAA 1997

You requested that the Commissioner exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997. This discretion may be exercised for the income year in question where:

i) The business activity has started to be carried on

Your ruling application states that the concept of lead time in your couture business is:

Paragraph 98 of TR 2001/14 states for a business activity to have commenced a person must have acquired the minimum level of business assets to allow that business activity to be carried on. Therefore the business is not considered to have commenced while you were acquiring the assets (tangible and intangible) to produce the art. However, the Commissioner has accepted your statement that you were carrying on a business from the 20WW-XX financial year, when you commenced creating a portfolio of art to be displayed at your first exhibition.

ii) Because of its nature it has not satisfied, or will not satisfy, one of the tests for commerciality

Guidance on what is meant by the phrase, 'because of its nature' is provided by TR 2007/6, which states:

71. …the discretion is intended to be available to a commercial activity which fails to satisfy any of the tests for reasons outside the control of the operator. This is confirmed by the Explanatory Memorandum for the New Business Tax System (Integrity measures) Act 2000 (the 2000 Explanatory Memorandum), which states at paragraph 1.48:

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 tests 1 to 4.

72. In addition, paragraph 1.51 of the EM (2000 Explanatory Memorandum) comments:

This arm of the safeguard discretion [i.e., that in paragraph 35-55(1)(b)] 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 could fall into this category are forestry, viticulture and certain horticultural activities.

Secondly, the 'Note' to paragraph 35-55(1)(b) of the ITAA 1997 states:

Note: Paragraphs (b) and (c) are 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.

Stone J in Federal Commissioner of Taxation v. Eskandari (2004) 134 FCR 569; [2004] FCA 8; 2004 ATC 4042; (2004) 54 ATR 695, confirmed this view when considering whether the Commissioner's discretion should be exercised in regard to losses incurred in a migration consultancy business. When looking at the type of activities referred to by the note and the 2000 Explanatory Memorandum, Stone J stated at FCA 31:

And further at FCA 32:

Therefore, the phrase 'because of its nature' refers to inherent characteristics of the type of business activity being conducted by the taxpayer, which are common to any business activity of that type. These inherent characteristics must be the reason why the activity is unable to satisfy any of the tests. The discretion is not intended to be available where the failure to satisfy one of the tests is for other reasons.

In your case, it is accepted that a period of time is necessary to create a collection of items to be displayed at an exhibition, and it is not until after the items are displayed and offered for sale that income can be generated. As such, for the 20WW-XX financial year it is accepted that it is in the nature of the business activity that it did not satisfy one of the tests, as the collection was being created and was not available for sale until it was displayed at your first show.

However after the collection was displayed and offered for sale during the show in 20XX, there is no inherent characteristic of the business activity that prevented it from satisfying any of the tests.

You have stated that the concept of lead time in your couture business is the time needed to:

Further, in relation to potential income from the business and lead time, you state:

As mentioned above, the note to paragraph 35-55(1)(b) of the ITAA 1997 states that the discretion 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 (emphasis added).

Further, the Explanatory Memorandum for the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 (2009 Explanatory Memorandum) states at paragraph 2.35:

Whilst the track record of an artist (portfolio or profile recognition) may influence when income may be derived by an arts businesses, and this recognition may take time to achieve, the Commissioner considers this characteristic comparable to a retail store needing to build up a client base. As stated above, the 2009 Explanatory Memorandum explains that the discretion is not intended to be exercised for that purpose.

iii) Objective expectation and commercially viable period

TR 2007/6 states that the Commissioner needs to be satisfied that there is an objective expectation, based on evidence from independent sources where available, that the business activity will satisfy a test or produce a tax profit in some future income year falling within a period that is commercially viable for the industry concerned. If the business activity is not expected to satisfy a test or produce a tax profit within this period then the discretion will not be exercised.

The 2009 Explanatory Memorandum states at paragraph 2.28:

In addition, paragraph 2.29 of the 2009 Explanatory Memorandum comments:

You have provided statements from individual A stating that “A period of 10 years is not unreasonable and (is) usual for an artist in this area to become successful”, and expert accountant individual B stating “the length of time that will generally elapse before an artist can expect to give up a full-time job is from four to six years, although an artist looking to make a reasonable income may well wait from ten to fifteen.”

The above statements are subjective in nature and are not considered objective evidence of the commercially viable period for the industry concerned, they merely confirm that there is often (but not necessary) a time-lag between commencing a career as a professional artist and the realization of financial success. This same characteristic can be said for any retail industry or service provider where a period of time is necessary for a customer base to be established through reputation or profile recognition. However, as stated above, the discretion is not available in cases where the failure to meet one of the tests (or produce a profit) is due to the need to build up a client base or following.

For the purposes of paragraph 35-55(1)(b) of the ITAA 1997, the discretion 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. In your case, your art works were not available for sale until they were displayed at 20XX show. As you have acknowledged, any person was free to recognize the value of your items and to purchase them at this point. Therefore, it is the Commissioner's opinion that the commercially viable period for the industry ceases once your items are available for sale, which in your case was in the 20XX-YY financial year.

As your business activity did not satisfy a test or produce a tax profit in the 20XX-YY (or later) financial year, the Commissioner is unable to exercise the discretion.


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