Edited version of private advice

Authorisation Number: 1052132958040

Date of advice: 30 June 2023

Ruling

Subject: Non-commercial losses - lead time

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 of running a website within your calculation of taxable income for the 2022 to 2023 financial years?

Answer

No. The Commissioner will not allow you to include any losses from your business activity in your calculation of taxable income for the 20XX to 20XX financial year.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 September 20XX

Relevant facts and circumstances

•         You started to build websites for local businesses locally during 20XX to gain experience in developing and designing websites.

•         You commenced your business on 1 September 20XX.

•         You meet the <$250,000 income requirement.

•         You created the website "The Website" in late 2017.

•         You advised that, to calculate the timeframe for The Website to become financially viable, you took two (2) websites that are similar to your website and averaged out the time that they took to become profitable. (Based on your research, one took a few months and the other took 10 years).

•         You have not provided any supporting evidence from an industry body that states it takes between three (3) to five (5) years for a website to become profitable.

•         The Website has been making a loss since it commenced operation.

•         The Website is a freelance marketplace for freelancers who sell virtual services, such as web development, web design and translation services. The website also allows hosting.

•         In mid-20XX, you began coding the new part of The Website for hosting services.

•         You and your web developer completed the coding and launched that additional part of The Website in August 20XX.

•         Your current web developer is located in Europe. The website designers are located in Europe and North America.

•         You submitted that that due to war, the web developer was required to move the power supply to a secondary country to ensure a constant power supply to the server.

•         You submitted that building a Google ranking, being Search Engine Optimisation (SEO), takes time and money.

•         In your submission, you advised that the cost of SEO and the extended time to acquire sellers on the website is the main factor why The Website is profitable.

•         In the first 3 months of 20XX, you spent over 50% of your employment income paying web developers, paying sellers to sign up onto your website to increase The Website presence, hiring a vocalist, videographer, and a musical studio overseas to produce an album which would be launched on YouTube, Apple Music, Spotify, and other platforms to raise awareness of your website.

•         You stated that you would donate all album sales to a charity.

•         As of the publishing date of this ruling, there have been 109 views on YouTube of the video clip.

•         You advised that there have been minimal sales from the album via Spotify.

•         You advised that marketing is not your strong point and that you are currently seeking someone to assist you in respect to this side of the business.

•         You expect your business activity to be commercially viable in 20XX.

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)(b)

Reasons for decision

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)(b) of the ITAA 1997 in the 2022-23 financial years, on the basis of the nature of your activity. E.g.: Lead time.

Under paragraph 35-55(1)(b) 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 satisfied, or will not satisfy one of the 4 tests; and

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

This discretion is intended to cover a business activity that have a lead time between the commencement of the activity and the production of any assessable income.

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 paragraphs 35-55(1)(b) and (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 one of the four tests from being met (paragraph 35-55(1)(b)), or a tax profit from being made (paragraph 35-55(1)(c)).

For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is not satisfying the assessable income test (which is the test relied on in the ruling application) 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, and or the level of debt funding) that are not consistent with the ordinary or accepted practice in the industry concerned.

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 passing the assessable income test. The business has also exceeded the commercially viable period that you provided of 3 to 5 years. The business has not made a profit, and there have been no future projections of profit provided. You are gradually building your client base, which is not considered an eligible reason.

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

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