Edited version of private advice

Authorisation Number: 1052172521072

Date of advice: 21 March 2024

Ruling

Subject: Commissioner discretion - non commercial losses

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your business activity in the calculation of your taxable income for the 20YY income year?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20YY

The scheme commenced on:

XX May 20YY

Relevant facts and circumstances

You registered a business in May 20YY.

You created the business with the intention of renting out vehicles as well as other equipment, predominately to XXXX in Australia.

On that same date, May 20YY, you purchased various items from Business A

In June 20YY you purchased additional equipment from business A.

In June 20YY you leased back all the items acquired from business A to them for a term of 60 months.

In the month of June 20YY, you purchased several vehicles for the business purposes.

Y of the vehicles were purchased from a vehicle dealership (the Dealership). Based on the information provided these vehicles remained at the Dealership's premises for display purposes since purchase until now.

You leased backed X of the vehicles to the Dealership shortly after purchase for display purposes. We twice requested a copy the lease or hire agreement, only a copy of tax invoices provided.

You had a contract for vehicle hire to Individual A late June 20YY for 28 days which, as advised, was generated via word of mouth. We requested a copy of the contract twice but only a tax invoice was provided.

We requested a copy of the insurance policy for each vehicle for the 20YY income year, however you provided an insurance policy for motor vehicles that were not for hire.

The insurance policy was for yourself under the business described as "XXXX with the period of cover from June 20YY to June 20YY.

You also purchased other accessories in June 20YY. These assets are available for hire with vehicles. No income has been derived from the accessories in the 20YY and 20YY income year.

You reported income for the 20YY income year which resulted from the following:

•         Income from leasing a vehicle to Individual A for 28 days via word of mouth. Except for a tax invoice, there was no lease agreement in place.

•         Income from leasing X vehicles that were acquired from the Dealership and leased back to them. Except for tax invoices, there was no lease agreement in place.

•         Income from leasing back other equipment to the business A.

For the 20YY income year you reported a significant loss, most of the loss was due to depreciation deduction claimed under the temporary full expensing measure.

For the 20YY income year, you reported the following income for the business:

•         Income from hiring of other equipment to the business A.

•         Income from hiring of vehicles:

o   One month lease for leasing back X vehicles to the Dealership for display purposes, and

o   First rental payment from a vehicle rental platform in June 20YY.

You registered for a vehicle rental platform for hiring out your vehicles in the second half of the 20YY income year. The use of the vehicle rental platform was part of your business plan under marketing and customer management. You received your first client and payment via the vehicle rental platform in the second half of the 20YY income year.

Prior to receiving a payment from your first client via the vehicle rental platform you did not receive any income for hiring of vehicles for the purpose of XXXX from July 20YY to June 20YY.

You stated a Covid-19 lockdown from July 2021 to October 2021 made deriving income impossible from the hiring of vehicles.

During the 20YY income year, you sold your land at a substantial profit. You funded your purchases of vehicles and other assets with the proceeds from the sale of your land.

You do not satisfy the under $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997 for the 20YY income year.

You provided the following information:

•         Business plan

•         Income transaction list and tax invoices issued by the business for June 20YY

•         Equipment hire agreement for business A

•         Tax depreciation schedule with asset locations

•         Tax invoices of vehicle purchases

•         General ledger and monthly income for the 20YY income year

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)(c)

Assumptions

You were dealing at arm's length with business A, the Dealership and Individual A.

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your business activity in the calculation of your taxable income for the 20YY income year?

Summary

You are not considered to have commenced your vehicle rental business activity in the 20YY income year.

The leasing back arrangements with the Dealership and business A at the end of June 20YY income year were considered passive investment in nature and did not constitute carrying on a business. Your business is renting out vehicle XXXX. However, notwithstanding of significant assets purchased at the end of the 20YY income year, your only transaction was renting a vehicle to an individual via word of mouth without a rental agreement. In weighing up all the relevant facts surrounding your case and in light of the relevant business indicators, it is considered that your vehicle rental business had not commenced in the 20YY income year.

The Commissioner would not be in a position to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the 20YY income year because it is considered that your vehicle rental business had not actually commenced in the relevant income year.

Detailed reasoning

Division 35 of the ITAA 1997 prevents losses from a non-commercial business activity carried out by an individual (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.

Division 35 applies only to activities that are carried on as a business and does not apply to activities do not constitute a business, for example, the receipt of passive income from investments such as rent from property or lease of an asset.

Section 35-5(2) provides:

This Division is not intended to apply to activities that do not constitute carrying on a business (for example, the receipt of income from passive investments).

You have requested the Commissioner to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 to offset your loss from your business activity against your other income for the 20YY income year.

Passive receipt of income

Paragraph 8 of Taxation Ruling TR 2003/4 Income tax: boat hire arrangements (which is about whether boat charter activities generate business or investment income) states:

The receipt of income from the lease of an asset does not of itself amount to the carrying on of a business (see FC of T v. McDonald 87 ATC 4541; (1987) 18 ATR 957), but instead would generally be the passive receipt of income from property.

In FC of T v. McDonald 87 ATC 4541, when determining whether the parties were carrying on a business, Beaumont J gave consideration to their minor, if any, active participation in the investment. In his view, there was a mere investment in property and the parties were not carrying on a business.

In the present case, you acquired a number of vehicles in June 20YY. As per the tax invoices provided, X of the vehicles were leased back to the Dealership for display purposes. This type of activity is more of a passive nature (investment) and would likely not amount to carrying on a business.

You also acquired various other equipment from business A. These items were leased back to business A almost immediately for a lease term of 60 months.

Based on the information available to the Commissioner, it can be said that your lease-back arrangements with both, business A and the Dealership, were a mere passive investment in nature and did not amount to carrying on a business.

Whether a business activity has started to be carried on for the purposes of the Commissioner's discretion in section 35-55

For the Commissioners discretion in paragraph 35-55(1)(c) to apply it must first be established that the business activity has started to be carried on.

Section 995-1 of the ITAA 1997 defines a 'business' to include any profession, trade, employment, vocation or calling but does not include occupation as an employee. Although the term 'business' is defined, the ITAA 1997 does not contain a specific definition of when a business activity is being carried on, or what a business activity is.

Taxation Ruling TR 2001/14 Income tax: Division 35 - non-commercial business losses states at paragraph 37:

The composite term 'business activity' is otherwise undefined in the ITAA 1997. The inclusion of the extended definition of 'business' in the composite term does not, however, alter the ordinary meaning of the composite term in any significant way. That ordinary meaning is an activity forming part or all of the taxpayer's activities 'engaged in for the purpose of profit on a continuous and repetitive basis' (Hope v. The Council of the City of Bathurst 80 ATC 4386 at 4382; (1980) 12 ATR 231 at 236), or an activity that is one of the activities that makes up the 'course of conduct' (FC of T v. Murry 98 ATC 4585 at 4596; (1998) 39 ATR 129 at 145) that is the taxpayer's business.

Under paragraph 98 of TR 2001/14, for a business activity to have commenced a taxpayer must have:

•         made a decision to commence the business activity;

•         acquired the minimum level of 'business assets' to allow that *business activity to be carried on; and

•         actually commenced 'business operations'.

Decision to commence

It is clear from the information provided that you have made a decision to commence your business.

Acquisition of a business structure

Most business activities have a structure that provides the framework of the business. It is usually a collection of capital assets.

You have decided to operate the business hiring out vehicles and other equipment. You purchased a number of vehicles and other assets in late June 20YY.

Commencement of business operations

The actual date of commencement of a business is a question of fact (Goodman Fielder Wattie Ltd v FC of T 91 ATC 4438 at 4446; (1991) 22 ATR 26 at 35).

As noted by Brennan J in Inglis v Federal Commissioner of Taxation (1979) 10 ATR 493; 80 ATC 4001, the level of activity is important in deciding whether a business is being carried on. Brennan J stated at ATC 4004-4005; ATR 496-497 that:

The carrying on of a business is not a matter merely of intention. It is a matter of activity. Yet the degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the supposed business is being conducted.

Brennan J further stated:

At the end of the day, the extent of activity determines whether the business is being carried on. That is a question of fact and degree.' (emphasis added)

Based on the decision in Calkin v CIR [1984] 1 NZLR 440, two different types of activity are relevant: acquisition of the minimum level of 'business assets'; and the commencement of 'business operations'. Both are necessary to be able to conclude that a business has commenced.

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 (TR 97/11) lists these general indicators of carrying on a business 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 planned, organised and carried on in a businesslike manner such that it is directed at making a profit

•         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

Of these indicators, paragraph 16 of TR 97/11 says when considering whether a person is carrying on a business, all of the indicators must be weighed up. However, in doing so, equal weighting may not be given to each indicator. Whether a business is carried on depends on the general impression gained and whether it has a commercial flavour or character. In most cases, the greatest weighting is given to the repetition and regularity of the activities followed by organisation in a business-like manner as a supportive indicator.

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.

You have displayed the following characteristics:

•         Much of the income you generated in the 20YY income year resulted from the leasing back of other equipment to business A and the leasing back of vehicles to the Dealership for display purposes. As stated earlier, this is considered to be passive income as it takes negligible effort to acquire the payment resulting from the hire of assets. Your receipt of payment from business A and the Dealership for the lease or hire of assets is characteristic of income from property rather than from the carrying on a rental business.

•         You provided a tax invoice for renting a vehicle to Individual A for 28 days from June 20YY to July 20YY. As advised, you obtained this client via word of mouth. Assuming this was an arm's length transaction, you only had one client in the 20YY income year renting a vehicle. This is not sufficient activity to established regularity.

•         You had not implemented the steps outlined in your business plan in the 20YY income year.

•         There was no formal lease/rental agreement in place between you and the Dealership for the lease back of X vehicles to them. There was also no formal rental agreement in place between you and Individual A renting a vehicle. Your lack of formal rental agreements for your vehicle hire does not constitute business like behaviour.

•         No evidence of insurance held/maintained for your vehicles for hire as of June 20YY.

•         In your business plan, you stated that you were aware that using a vehicle rental platform could be leveraged to assist in renting your vehicles. You further stated that a membership with the vehicle rental platform would provide additional support in marketing and promotions, more frequent rentals and that customers' booking and transactions are processed via the platform, and all your vehicles would be fully insured and covered by road assist through the vehicle rental platform network. Your business plan outlined the operations of your vehicle rental business via the vehicle rental platform. However, none of these were implemented in the 20YY income year as you did not register to become a member with the vehicle platform until the second half of the 20YY income year.

•         The absence of any advertisement or marketing activities to the general public to reach potential customers that would be normally expected from a business with a view to growing market share and revenue is a matter that weighs significantly against a commercial purpose.

The above factors indicate that at the end of the 20YY income year, the activity was not carried out in a way that would be normally carried out by entities undertaking this type of activity with a commercial and profit making purpose.

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

Relevantly, this indicator is particularly related to whether the activity is preparatory or preliminary to the ultimate activity; and whether there is an intention to make a profit.

You have displayed more than an intent to carry on a business.

As stated earlier, the carrying on of a business is not a matter merely of intention. It is a matter of activity.

You made large capital purchases in late June 20YY to facilitate the operation of a vehicle rental business. However, whether you actually commenced business operations at the end of the 20YY income year is a question of fact and degree.

Whether there is repetition and regularity of the activity

You have not displayed repetition or regularity.

A business of hiring vehicles would be expected to participate in the hiring of vehicles on a regular basis.

You had a single client in June 20YY who hired a vehicle, this indicates a lack of regularity and repetition for a business activity.

Furthermore, in the following income year, though you stated Covid lockdown affected your ability to trade from July 2021 till October 2021 you did not have a second vehicle hire till the second half of the 20YY income year.

As discussed earlier, the leasing back other equipment to business A and vehicles to the Dealership is considered to be a source of passive income and would not be considered as a business activity.

The size, scale, and permanency of the activity

As stated earlier, two different types of activity are relevant: acquisition of the minimum level of business assets; and the commencement of business operations. Both are necessary to be able to conclude that a business has commenced.

You have displayed a degree of size and scale, but only in terms of acquisitions of assets. There was no corresponding level of management input to undertake the activity with this number of assets as expected for a business of similar level of capital investment. Except for the lease-back of other equipment to business A and the lease back of X vehicles to the Dealership for display purposes, you had only one rental transaction obtained via word of mouth.

Your activity during the relevant period does not demonstrate the level of commercial activity of a business operating in a commercial manner.

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

Activities are more likely to be carrying on a business where they are carried on in a similar manner to other businesses in the industry.

Behaviour that would indicate that a business of vehicle rental is being carried on would be:

•         The renting of vehicles to the public resulting in income being generated as a result of your efforts,

•         Strategy to reach potential customers though marketing and advertising or the use of third party services,

•         Insurance in place for the vehicles and the business to mitigate the risks that could arise in the course of the business,

•         Substantial levels of repetition and regularity of vehicles being rented out though the effort of the business, and

•         Formal, written rental agreements outlining the terms and conditions of the lease and the responsibilities of the hirer/lessor and hiree/lessee.

Your operation does not yet meet a number of these factors. In your case:

•         You had no marketing strategy in place at the time other than world of mouth to reach potential clients,

•         No evidence of insurance held/maintained for all the vehicles you acquired or rented out at the end of June 20YY. The only insurance policy provided was for not-for-hire vehicles under a 'automotive mechanical repair' business,

•         You only had one individual customer hiring a vehicle for the 2021 income year. The lease back of X vehicles to the Dealership for display purposes is considered to be a source of passive income, not a business activity,

•         Lack of formal, written agreements for the renting of vehicles that would normally be expected from a similar business. You had no written rental agreement in place for the vehicle you rented out to the individual. You also had no written lease or hire agreement in place for the X vehicles you leased back to the Dealership.

The above factors indicate that it is unlikely that your activities are of the same kind and carried on in a similar manner to another commercial business. This suggests a lesser likelihood that a business is being carried on.

Whether the activity is planned, organised, and carried out in a businesslike manner such that it is directed at making a profit

A business plan normally involves setting profits targets, establishing a budget, maintaining operations on a consistent basis, retaining, and pursuing profitable activities, discontinuing unprofitable activities and keeping appropriate business records.

In this case it is accepted that you have kept records of your expenses and provided future projections showing how you plan to make the business profitable.

However, the impression gained is that your activity was not carried on in a businesslike manner in the 20YY income year and that the activity was still in the preparatory stage of a business. This is based on the following factors:

•         You provided a business plan which outlined how you intended to operate the activity and make a profit; however these steps were not implemented in the 20YY income year.

•         Except for the acquisitions of capital assets which occurred in late June 20YY, your activity in general was passive in nature.

•         Your market was restricted to word of mouth, no evidence of marketing activities to obtain customers during the relevant period. Your strategy utilising the vehicle rental platform for listing your vehicles on their rental site, for booking and insurance, and your marketing steps as outlined in your business plan were not in place until late in the 20YY income year.

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

In this case, the activity is not considered a hobby, a form of recreation or a sporting activity, so this indicator is not relevant to your circumstances.

After weighing up the indicators of carrying on a business outlined in TR 97/11 and objective facts surrounding your case, it is considered that you were not carrying on a business in the 20YY income year, because during the relevant period, your activities did not have a significant commercial purpose or character, no regularity and repetition and your activities were not carried on in a businesslike manner.

Conclusion

It is accepted your acquisition of capital assets at the end of June 20YY was directed toward a business purpose. However, it is considered that your business has not commenced immediately on the acquisition, and the business operations had not actually commenced in the 20YY income year.

Your lease-back agreements with both, business A and the Dealership were passive investment in nature and did not amount to carrying on a business. The income received from these lease-back arrangements represents the passive receipt of income.

The activity of hiring vehicles for the purpose of XXXX is not considered to be in business in the 20YY income year. Your business plan outlined how you intended to operate the activity and make a profit; however these steps were not implemented in the 20YY income year. A single client, obtained via word of mouth, who hired your vehicle for 28 days without a written rental agreement, is not sufficient for one to be considered carrying on a business of hiring out vehicle. The fact that you had no more hires until the second half of the 20YY income year would suggest the single client in late June 20YY was an isolated transaction and not a result of your effort operating a business.

Division 35 of the ITAA 1997 is not intended to apply to activities that do not constitute carrying on a business. As your activities did not amount to carry on a business in the 20YY income year, the Commissioner would not be in a position to exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 to allow you to offset any losses from your business activity against your other income in the calculation of your taxable income for the relevant income year.

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