Edited version of private advice

Authorisation Number: 1051521415546

Date of advice: 4 June 2019

Ruling

Subject: Commissioner's discretion for non-commercial losses-special circumstances and lead time

Question 1

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 the 20XX-XX and 20XX-XX financial years?

Answer

No

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to allow you to include any losses from your business activity in your calculation of taxable income for the 20XX-XX and 20XX-XX financial years?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2017

Year ended 30 June 2018

The scheme commences on:

February 2017

Relevant facts and circumstances

You meet the following tests under Division 35 of the ITAAA 1997:

·  Assessable income test.

·  Real property test.

·  Other assets test.

You do not satisfy the <$250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997 for the 20XX-XX and 20XX-XX financial years.

You operate a business.

In 20XX-XX the business commenced operations.

The business operated out of a commercial premise.

In the 20XX-XX financial year the business income from sales and claimed expenses resulting in a tax loss.

You believe the loss was due to the commencement of the business, combined with a write off plant and equipment, the need to employ temporary staff, repairs to plant and equipment and the additional investment of capital into the business.

For the 20XX-XX financial year the business received sales income and as a result of a write off plant and equipment and other business operating expenses this has led to the business making a tax loss.

For the 20XX-XX financial year the business is expected to make a tax profit.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 35-1

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)(c)

Reasons for decision

For the 2009-10 and later income years, Division 35 of the Income Tax Assessment Act 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 his discretion.

In your situation, none of the exceptions would apply and although you satisfy three of the four tests in the financial years under consideration, you do not satisfy the income requirement as your income for non-commercial loss purposes was above $250,000 in the financial years under consideration. Your losses are therefore subject to the deferral rule, unless the Commissioner exercises his discretion.

If you don't meet the income requirement, the Commissioner may exercise discretion to allow you to offset your loss if:

·    special circumstances occurred that were outside your control (paragraph 35-55(1)(a) of the ITAA 1997), or

·        due to the nature of the activity, there is

• a lead time before the business will make a tax profit; and
• an objective expectation, based on independent evidence, that it will make a profit in a time that is considered commercially viable for that industry (paragraph 35-55(1)(c) of the ITAA 1997).

Special circumstances

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 do not satisfy the income requirement, special circumstances are those which have materially affected their business activity causing it to make a loss, 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 made a tax profit.

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.

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 from the business activity is not considered to be special circumstances but a normal consequence of commercial business decision made by you and others.

In your case there is no information to indicate that you suffered an injury or illness that has affected the operation of the business or that there has been a loss of business opportunities.

Your circumstances are no different to any other business seeking to establish a business which requires the purchasing of plant and equipment and commercial premises and the employment of staff. For this to occur an injection of capital into business is required either through borrowings or through use of personal funds which is not considered to be special circumstances but a normal consequence of commercial business decision made by you to establish a business.

Further, we believe that incurring expenses to employ temporary staff or to undertake repairs to machinery and plant are normal business operating expenses of any 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.

Accordingly, the Commissioner cannot exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the 20XX-XX and 20XX-XX financial years. Therefore any 'loss' for that activity cannot be taken into account in calculating your taxable income for the, 20XX-XX and 20XX-XX financial years.

Lead time

The note to section 35-55 of the ITAA 1997 states the discretion under paragraph 35-55(1)(c) of the ITAA 1997 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 any assessable income (emphasis added). 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.

For the discretion to be applied there needs to be 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. Further examples that fall into this category are forestry, viticulture and certain horticultural activities.

Taxation Ruling TR2007/6 states that the 'lead time' discretion provided for paragraph 35-55(1)(c) of the ITAA 1997 is available for a business activity if there is an initial period from when the activity commenced where the nature of the activity prevents a tax profit from being made.

TR 2007/6 does not support any view that the discretion should 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 small and business choices made by an individual that are not consistent with the ordinary or accepted practice in the industry concerned - such as the hours of operation, location, climate or soil conditions, or the level of debt funding.

In your case, based on the information provided, we do not consider that there is a lead time between the commencement of your activity and the production of any assessable income as the business was able to generate income from sales in it first and subsequent income years of operation. Therefore, we do not consider that there is anything inherent or innate in the nature of your business activity that it has not yet been able to satisfy one of the tests. The business activity is of a type that is able to produce assessable income quite soon after its commencement, as the sales income received from the business activity have demonstrated.

Therefore, the Commissioner will not exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 for the 20XX-XX and 20XX-XX financial years.

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