Edited version of private advice

Authorisation Number: 1052116573394

Date of advice: 15 May 2023

Ruling

Subject: Commissioner's discretion - non-commercial losses

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 charter boat business in your calculation of your taxable income for the 20XX-XX financial year?

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 charter boat business in your calculation of your taxable income for the 20XX-XX financial year?

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

You do not satisfy the under $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You carry on a business activity in the City A which you commenced on a specified date.

You entered into a contract on a specified date to purchase the business which settled on a specified date.

You were motivated to purchase the business by the extension of the temporary full expensing.

You provided us with your assessable income for the relevant financial year.

You incurred tax losses in the specified financial year, which was due to utilising temporary full expensing.

You have projected that your business will be profitable in the next financial year.

You advised that your business was affected by the COVID-19 pandemic and the Government's response to the pandemic, including the introduction of the temporary full expensing measures.

You provided us with information on the commercially viable period for a charter boat business.

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)

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

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

Reasons for decision

Summary

Having regard to your full circumstances, it is not accepted that your business activity was affected by special circumstances outside your control and anything inherent in the nature of your activity that prevented you from making a tax profit. Consequently, the Commissioner will not exercise the discretion in paragraph 35-55(1)(a) or 35-55(1)(c) of the ITAA 1997 for the relevant financial years.

Detailed reasoning

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, you do not satisfy the income requirement and you do not come under any of the exceptions. 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 in the 20XX-XX financial year, under paragraph 35-55(1)(a) and 35-55(1)(c) of the ITAA 1997, on the basis of special circumstances and lead time.

Temporary full expensing

A taxpayer has a choice whether to apply the temporary full expensing provisions in relation to the purchase of their assets for their business (refer to Law Companion Ruling LCR 2021/3 Temporary full expensing, paragraphs 86-66). Alternatively, they may choose to instead apply the general depreciation rules in Division 40 of the ITAA 1997 (LCR 2021/3 paragraphs 150, 154 and 155). Normally, the effective life for the asset is several years (refer to Taxation Ruling TR 2022/1) and section 40-102 of the ITAA 1997 provides a capped life for the asset. However, you have chosen to apply the temporary full expensing provisions to claim the full cost of the asset.

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 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; and

•         the activity passes at least one of the four tests or, but for the special circumstances, would have 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 48 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.

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, such as, utilising temporary full expensing or a business choice made on the number of hours worked.

In your case, you advised that your business was prevented from making a tax profit due to utilising temporary full expensing and the COVID-19 pandemic. You commenced your business activity in a specified month during the ruling period after the commencement of the COVID-19 pandemic.

The question that must be addressed is whether the situation described is considered special circumstances. It is not accepted that these circumstances constitute special circumstances in the way this term is used in the legislation. You have chosen to claim the favourable tax provisions offered in the relevant financial year. Choosing to apply the temporary full expensing provisions to your income tax return does not constitute special circumstances to allowing the exercising of the Commissioner's discretion.

Therefore, the Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the years in question.

Lead Time

Under paragraph 35-55(1)(c) 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 produced, or will not produce, assessable income greater than the deduction attributable to it; and

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

Where a taxpayer chooses to carry on the business activities in a manner that does not produce a tax profit within the period that is commercially viable for the industry concerned, paragraph 35-55(1)(c) of the ITAA 1997 may not be satisfied.

The Commissioner's approach to exercising the discretion under section 35-55 of the ITAA 1997 is outlined in TR 2007/6 Income Tax: non-commercial losses: Commissioner's discretion.

TR 2007/6 states that the lead time discretion provided by 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.

For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is not making a tax profit is inherent to the nature of the business and is not peculiar to your situation.

The lead time discretion is not intended to be available where the failure to make a profit or to meet a test is for reasons other than the nature of the business, such as, a consequence of starting out small and needing to build up a client base, or business choices made by an individual (for example, the size and scale of the activity, the hours of operation, utilising temporary full expensing and or the level of debt funding) that are not consistent with the ordinary or accepted practice in the industry concerned.

Your decision to utilise temporary full expensing resulted in the business making a loss. This was a business choice that affected your activity rather than an inherent characteristic of the industry.

Having regard to your full circumstances, it is not accepted that it is in the nature of the business activity that has prevented you from making a tax profit.

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

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