Edited version of private advice

Authorisation Number: 1051528900828

Date of advice: 28 June 2019

Ruling

Subject: Non-commercial losses and the Commissioner's discretion for special circumstances

Question

Will the Commissioner exercise the discretion to allow you to include any losses from your business in the calculation of your taxable income for the 20XX-XX, 20XX-XX and 20XX-XX financial years?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX to Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You do not satisfy the income requirement set out in subsection 35-10(2E) of the Income Tax Assessment Act 1997 in the 20XX-XX and 20XX-XX financial years, however you do satisfy the income requirement in the 20XX-XX financial year.

In 20XX you started a business.

When you started the business, you also worked part time at XYZ and contributed X days a week to the business.

Your spouse also worked full time for the business as the main employee. They were responsible for the co-ordination of the business operation and other aspects of the business. You also hired contractors who assisted with the manual labour side of the business.

In the first X years of business, the business met the assessable income test; however it did not produce a profit.

In the 20XX-XX financial year you were made redundant and you received a large redundancy payment. During your time off work you worked at expanding the business by developing the business and obtaining large projects, until cash flow issues required you to re-enter the workforce.

From XX/20XX to XX/20XX you worked with ABC full time. During this time, your spouse's availability to work full time in the business diminished. Due to your spouse's cultural background, they were expected to care for their parents as they aged and required more assistance and care at home. The reduced hours from your spouse put a strain on the productivity of the business.

In the 20XX-XX financial year, your spouse was still caring for their elderly parents and as a result they reduced their hours to part time. Throughout the year their parents continued to deteriorate and this resulted them having even less availability to contribute to the business.

Your spouse also experienced their own health issues which resulted in treatment and recovery for X weeks.

To assist with the reduced hours from your spouse, you trialled contractors to assist you and take charge of your regular clients. However your clients complained about the contractors regarding their standard of work and without supervision it was found to be unviable.

Cash flow issues in the 20XX-XX financial year triggered you to withdraw money from your superannuation account to pay your mortgage.

Despite the issues the business faced in the 20XX-XX financial year, the business sales increased by around $X.

In the 20XX-XX financial year you were working full time in a corporate role, and contributed to your business in the evenings and weekends.

Your spouse continued to care for their parents and eventually they told you that they could no longer do regular hours working in the business.

As you were unable to maintain the workload and were only able to offer staff work that required full supervision, you decided to reduce the business operations as your spouse was able to do this from anywhere. You cancelled commitments with clients where there was no flexibility and where travelling distances impacted on work time in the latter part of the year.

The business is currently unable to maintain regular clients and currently only has one regular clients who accepts flexibility, and intermittent deign contracts that are completed without supporting staff. Due to this and your spouse not being able to work in the business, and unless you can offer full time management, you have decided to close the business.

Your business had assessable income of at least $20,000 for the 20XX-XX and 20XX-XX financial years but not for the 20XX-XX financial year.

Your business did not meet the profits test, real property test or other assets test for the 20XX-XX financial year.

The business made losses of $X,XXX; $X,XXX and $XX,XXX for the 20XX-XX, 20XX-XX and 20XX-XX financial years respectively.

You have estimated that if your spouse had been able to work full time in the business instead of having to decrease their hours to care for their elderly parents, the business would have produced profits of $X,XXX; $X,XXX and $XX,XXX for the 20XX-XX, 20XX-XX and 20XX-XX financial years respectively.

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) and

Income Tax Assessment Act 1997 - Paragraph 35-55(1)(a).

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, you do not satisfy the income requirement (that is your taxable income, reportable fringe benefits and reportable superannuation contributions but excluding your business losses, exceeds $250,000) and you do not come under any of the exceptions in the 20XX-XX and 20XX-XX financial years. You do satisfy the income requirement in the 20XX-XX financial year however you do not pass any of the four non-commercial loss tests. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises the discretion.

The relevant discretion may be exercised for the financial years 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.

Taxation Ruling TR 2007/6, at paragraph 13A, advises that for individuals who do not satisfy the income requirement, the business activity must have been materially affected by the special circumstances, causing it to make a loss. In this context, the Commissioner may exercise this discretion for the income year(s) in question where, but for the special circumstances:

·         your business activity would have made a tax profit

·         the activity passes at least one of the four tests or, but for the special circumstances, would have passed one of the four tests.

Although your business activity has passed at least one of the four tests in the 20XX-XX and 20XX-XX financial years, both limbs of paragraph 13A of TR 2007/6 are necessary for the Commissioner to exercise the discretion. You have estimated that but for your spouse having to decrease their hours to care for their elderly parents, your business would have produced a profit of $X,XXX in the 20XX-XX financial year and $X,XXX in the 20XX-XX financial year.

For those who satisfy the income requirement, there are two main factors that should be considered in deciding if it is appropriate to exercise the discretion, for an income year:

·         the business activity is affected by special circumstances such that it is unable to satisfy any of the tests; and

·         the special circumstances affecting the business activity are outside of the control of the business operator.

You have estimated that but for your spouse having to decrease their hours to care for their elderly parents, in the 20XX-XX financial year the business would have met the assessable income test and produced a profit of $XX,XXX.

You have provided that the business would have made a profit and met the assessable income test in the years in question if your spouse was able to work full time in the business and did not have to decrease their hours. However from when the business began in 20XX through to 30 June 20XX your spouse was working full time in the business. Even though they were contributing these hours to the business it was still unable to make a profit in these years. The Commissioner would consider that your type of business would have been able to produce a profit within this time period. Therefore it would be reasonable to consider that the 20XX-XX financial year is a realistic indication of the overall business position continuing forward where the circumstances remained the same. The business was also able to increase its sales even with your spouse working reduced hours.

Therefore, the Commissioner is not satisfied that it was only the circumstances that have been put forward as special, that prevented a profit being made for the 20XX-XX, 20XX-XX and 20XX-XX financial years and prevented the assessable income test being passed in the 20XX-XX financial year. Consequently, the discretion under paragraph 35-55(1)(a) of the ITAA 1997 cannot be exercised.

Additionally, it is questionable whether your spouse looking after their elderly parents are 'special circumstances' for the purposes of the non-commercial loss discretion. Having an employee who has elderly parents and reduces their work hours to look after them is arguably not a situation that is sufficiently different to distinguish them from circumstances that a business may be expected to have to deal with in the normal course of undertaking a business.

Even if these circumstances were considered to be 'special' for the purposes of the non-commercial loss discretion, this would only be for the 20XX-XX financial year. Paragraph 52 of TR 2007/6 states that where the special circumstances in question, because of their continued existence, change, and become the ordinary or usual situation, it would not be appropriate to exercise the discretion after that time. In your case, it is considered that after the first year of these circumstances, they became the usual situation that the business operated under in the following years and therefore would no longer be regarded as 'special'.

Although it is arguable that your circumstances were 'special' for the 20XX-XX financial year, as stated previously, the Commissioner is not satisfied that it is only those circumstances that caused the business to make a loss. Therefore, even if it was accepted that your circumstances were 'special' for the 20XX-XX financial year, the discretion cannot be exercised for that year.

Your business was also impacted in the 20XX-XX financial year by your spouse requiring X weeks recovery for their own health issues. However, the Commissioner is not satisfied that but for these circumstances your business would have made a profit in the 20XX-XX financial year given that your spouse was working full time in the business for the 20XX-XX, 20XX-XX and 20XX-XX financial years but the business did not make a profit in any of those years.

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