Edited version of private advice

Authorisation Number: 1052245131428

Date of advice: 4 June 2024

Ruling

Subject:Commissioner's discretion - sole trader 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 sole trader business activity in your calculation of taxable income for the 20YY-YY financial year?

Answer

No.

This ruling applies for the following period

Year ended 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

You experienced personal and health issues.

In early 20YY you commenced business operations as a sole trader.

In the 20YY-YY financial year your business made a loss.

In the 20YY-YY financial year:

•         your total business income and capital expenditure increased

•         your usual income increased when you received extra unexpected income

•         you do not satisfy the less than $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997

•         you decided not to use the TFE provisions, instead use the general depreciation rules

•         your business activity has made a loss.

In the 20YY-YY financial year:

•         natural disasters occurred which led to the cancellation of your jobs

•         you expect your business activity to make a profit.

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)

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 that these prevented you from making a tax profit. Consequently, the Commissioner will not exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 for the 20YY-YY financial year.

Detailed reasoning

Non-Commercial Loss

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.

The sum of the required elements for calculating your income was more than $250,000, due to you receiving extra unexpected income and the sale of shares. There is no discretion available to the Commissioner in the legislation in circumstances where the income requirement is not met, even if it was beyond the taxpayer's control.

Receiving the payments did not affect the business activity, causing it to make a loss. Instead, it caused you to not satisfy the income requirement measure under subsection 35-10(2E) of the ITAA 1997.

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

Special Circumstances

You have requested the Commissioner to exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 in the 2022-23 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 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.

Paragraph 12 states:

The Commissioner's discretion in paragraph 35-55(1)(a) may be exercised for the income year(s) in question where the business activity is affected by special circumstances outside the control of the operators of the business activity.

While there were some personal issues that occurred prior to the commencement of your business, there was no evidence provided that show special circumstances, as outlined in the legislation, occurred that affected your business and prevented you from making a profit for the 2022-23 financial income year.

Personal

Your personal and health issues were known circumstances that happened before the start of your business. It was not shown how these issues affected your business activity in such a way that you were unable to produce a tax profit in the 20YY-YY financial year, and that had it not been for these issues you would have made a tax profit in the 20YY-YY financial year (subsection 35-55(1) of ITAA 1997).

Interaction between Non-commercial loss provisions and Temporary Full Expensing

It is common for taxpayers to utilise the TFE provisions to claim immediate deductions for the purchase of new business assets however, it remains the decision of the taxpayer to make these purchases.

In circumstances where a taxpayer has utilised the TFE, and due to the value of the immediate write off of assets, has failed to make a tax profit, the Commissioner would not exercise his discretion as the taxpayer has full control of this business decision. In that case the business would fail to make a tax profit due to the decision to utilise the TFE provisions and not because of circumstances outside the control of the operators. The taxpayer may choose to instead apply the general depreciation rules in Division 40 of the ITAA 1997 (Law Companion Ruling LCR 2021/3 paragraphs 150, 154 and 155).

In 20YY-YY you incurred an amount on capital expenditure. This is a business decision to purchase certain equipment and would not be a 'special circumstance' as outlined above. You have now chosen not to utilize the TFE provisions in 20YY-YY and changed to utilizing the general depreciation rules. This has resulted in a business loss in the 20YY-YY financial year and consideration of 'special circumstances' in your situation.

Natural disasters

The occurrence of the natural disasters is considered as 'special circumstances' which are outside the control of the operators of a business.

However, in this case the particular disasters occurred in the 20YY-YY financial year, after the ruling request period, which is the 20YY-YY financial year. Therefore, these cyclones did not cause a business loss in the 20YY-YY financial year.

Conclusion

The question that must be addressed is whether special circumstances occurred that affected your business activity such that it would have made a profit had it not been for them. It is not accepted that there were special circumstances that affected your activity in the way this term is used in the legislation for the 20YY-YY financial year.

Therefore, the Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the year in question. Consequently, it would not be unreasonable for the loss deferral rule to apply in the 20YY-YY financial year.

You must defer the loss in the 20YY-YY financial year to a future year where you meet a test or make a profit from your business activity.

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