Edited version of private advice

Authorisation Number: 1052102633907

Date of advice: 5 April 2023

Ruling

Subject: Non-commercial losses

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 the year ended 30 June 20XX?

Answer

No

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The inception of the software business was in a specified year.

The business was a start-up project that incurred a large amount of expenses.

You incurred the majority of expenses in development.

The business was a SaaS based software model that used AI models.

The business was recognised as one of the best tech innovation ideas.

You planned to charge $XX per month per client and licensing fees with other businesses.

Since it was a start-up you were spending XX hours per week coding and creating custom AI models.

You entered a market with competitors who had better market reach and were already widely adapted.

The software was a complete solution but there could be more improved features and better marketing.

You were not able to generate or raise any money as there were better solutions out there.

You lacked the business acumen which resulted in the failure of your business.

You incurred the majority of expenses in development and demoing your business.

No income was generated by your business. You gained income by providing help to other businesses where you helped to develop their systems.

You realised that there were opportunities to work for other business creating websites and webs apps.

In a specified time you realised you needed to form a separate entity and started doing consulting under a new business entity.

You worked full-time for another business for around XX hours a week.

You operated the software business for a period of X months.

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 paragraph 35-55(1)(a)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Am I in business?

Before a non-commercial loss can be allowed, we must first assess if the taxpayer is in business.

Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) defines a 'business' to include any profession, trade, employment, vocation or calling but does not include occupation as an employee. This definition, however, simply states what activities may be included in a business. It does not provide any guidance for determining whether the nature, extent, and manner of undertaking those activities amount to the carrying on of a business.

For the purpose of determining whether an activity is the carrying on of a business the facts of each case must be examined having regard to relevant indicators that have been established through case law. Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production lists these general indicators and although the ruling is in respect of primary production the general indicators can be applied to any industry. These general indicators are:

•         whether the activity has a significant commercial purpose or character

•         whether the taxpayer has more than just an intention to engage in business

•         whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

•         whether there is repetition and regularity of the activity

•         whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade

•         whether the activity is organised in a businesslike manner

•         the size or scale or permanency of the activity

•         whether the activity is better described as a hobby, a form of recreation or a sporting activity.

Based on the factors of your situation, we have considered the following indicators:

Whether the activity has a significant commercial purpose or character

This indicator generally covers aspects of all the other indicators and broadly requires that a taxpayer be able to show that the activity is carried on for commercial reasons and in a commercially viable manner. A taxpayer needs to be able to show that the interaction between the size and scale of the activity, the repetition and regularity and the intention and prospect of profit are sufficient to conclude that the activity has a significant commercial purpose.

The following indicate a lack of commercial purpose:

•         You had no clients for the software business

•         You acknowledge there were better products already in the market and these products were widely adapted

•         You were looking for investors to provide funding to develop the business

•         You only maintained the activity for X months

•         You were unable to make any income from the software

Whether the taxpayer has more than an intention to engage in business

You had more than an intention to engage in your activities, you created a software product to facilitate this a service. You invested both time and money into creating the software for the business.

Purpose and prospect of profit

Your actions to create a software program and invest money suggest you had a purpose for profit.

You state that the competition had a better product and that your product could be improved and needed better marketing. You also stated you ran out of money and were unable to get investors. This suggests that you had no prospect of profit.

You commenced consulting work during this time and discovered an opportunity for profit there. Due to the greater prospect of profit, you stopped working on business and focused on creating a new business where you created websites and webs apps.

Whether there is repetition and regularity of the activity

You spent XX hours a week on the business over a period of X months. X months operating is not considered to be a long enough period to be repetitive or regular.

The size, scale, and permanency of the activity

You had no client based for your software and as a result it was a small scale operation. You only maintained the activities for X months before ceasing activities in favour of operating your new business.

Whether the business is of the same kind that is being carried on in a similar manner to that of the ordinary trade in that line of business

Due to the small time in which you were operation and lack of clients it can be said you were not operating in a similar manner to that of other businesses in your industry.

Whether the activity is planned, organised, and carried out in a businesslike manner

Activities are more likely to amount to the carrying on of a business where they are carried out in a systematic and organised manner. You stated you lacked business acumen and you had no business plan on how you were going to enter a market with more developed and widely adapted competition. You were also looking for investors which is more akin to operating a start-up than a business.

Whether the activity would be better described as a hobby, recreational or sporting activity

Your activities would not be better described as a hobby, recreation, or a sporting activity. There is nothing to suggest you do this for any purpose other than to make income.

Has a special circumstance occurred?

Division 35 of the ITAA 1997 prevents losses from a non-commercial business activity carried out by an individual taxpayer (alone or in partnership) from being offset against other assessable income in the year in which the loss is incurred, unless:

•         the individual meets the income requirement and the business activity satisfies one of the 4 stipulated tests (paragraph 35-10(1)(a));

•         an exception in subsection 35-10(4) applies; or

•         the Commissioner exercises the discretion in subsection 35-55(1) for the business activity for one or more income years.

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

You have requested the Commissioner to exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 in the 20XX financial year, on the basis of special circumstances.

'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, the business activity must have been materially affected by the special circumstances, preventing it from making a profit or passing one of the four tests. In this context, the Commissioner may exercise this discretion for the income year(s) in question where, but for the special circumstances your business would have:

•         made a tax profit or

•         passed one of the four tests.

Taxation Ruling TR 2007/6 sets out the Commissioner's interpretation of the exercise of the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 53 of this ruling:

Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to special circumstances outside the control of the business activity, including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of the paragraph. These events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affected the business activity.

For the Commissioner to excise the discretion they must be satisfied that where a business activity has been affected by special circumstances outside the control of the operators of that activity, had these circumstances not existed, the activity would have satisfied one of the four tests in Division 35, or made a tax profit.

Special circumstances discretion is not intended to be available where the failure to make a profit or to meet a test is for reasons other than circumstances outside of the business operators' control.

You have not provided a special circumstance that has affected you. You stated that you lacked business acumen and this resulted in failure, there were better products than yours already in the market and these were widely adapted, your product could have had more features, you could have had better marketing and you made no income from the software.

The circumstances you have provided do not constitute a special circumstance. These occurrences are standard risks of carrying out a business in your industry and are not unusual or out of the ordinary and were in your control.

Conclusion

You have not passed several tests as to whether you were operating a business. You have not stated a special circumstance that affected you in a way that caused you to not meet one of the tests. The information you have provided around why the business failed to meet a test is not a special circumstance. At this stage we can conclude that you were not operating a business nor were you experiencing any special circumstances.

Therefore, the Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the years in question. As a result, you cannot claim losses from your activities in software business against your other income in the 20XX financial year.

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