Edited version of private advice

Authorisation Number: 1052139781307

Date of advice: 25 July 2023

Ruling

Subject: Non-commercial losses - special circumstances

Question

Will the Commissioner exercise his discretion to allow you to include any losses from your business activity in the calculation of your taxable income for the relevant financial year?

Answer

No

This ruling applies for the following period:

30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

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

You carry on a business which you purchased at a specified date as a going concern.

At the time of purchase the property was operating as an already existing business. You provided us with details about the property.

A building inspection was conducted prior to purchase and where you were unaware that repairs were required prior to the purchase. You provided us with details about the repairs that were required to the property.

You provided us with details about who you rent out your property to and what they use it for.

You had tenants in occupancy, prior to handover one of the apartments was vacated.

You provided us with details about 1 of the apartments that was in need of repairs.

You provided your profit and loss statement for the financial year for the ruling period which showed a tax loss.

You purchased a significant amount of depreciable assets, which were written off under temporary full expensing. This contributed to the business suffering a taxation loss.

You provided your profit and loss statement for the current financial year showing your year-to-date figures which show a tax profit.

You provided us with documentation in relation to your repairs and temporary full expensing.

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 subsection 35-55(1)(a)

Income Tax Assessment Act 1997 subsection 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 a 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 the discretion in paragraph 35-55(1)(a) of the ITAA 1997 in the relevant financial yar, on the basis of special circumstances. We also took the time to see if paragraph 35-55(1)(c) would be applicable to your circumstances.

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). 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 is for reasons other than circumstances outside of the business operators' control, such as, utilising temporary full expensing.

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 meet one of the tests or produce assessable income for an income year greater than the deductions attributable to it for that year.

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, and or the level of debt funding) that are not consistent with the ordinary or accepted practice in the industry concerned.

Application to your circumstances

In your case, you advised that the use of temporary full expensing was the reason behind the majority of your loss.

While we appreciate your situation it is not accepted that these events constitute special circumstances in the way this termed is used in the legislation. You have chosen to claim the favourable tax provisions offered during the ruling period. Choosing to apply the temporary full expensing provisions for your relevant income tax return does not constitute special circumstances to allowing the exercising of the Commissioner's discretion.

Whilst we acknowledge did your business did not operate for the entire financial year, the Commissioner is not satisfied had you operated your business for the entire financial year that you would have made a tax profit.

We took the opportunity to look at if we could consider granting Commissioner's discretion for lead time. Upon confirmation that the business was purchased as a 'going concern' we concluded that the loss could not be attributed to lead time as lead time is from the commencement of the business activity and not commencement of the purchase of the business.

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

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