Edited version of private advice

Authorisation Number: 1052287117386

Date of advice: 23 August 2024

Ruling

Subject: Commissioner's discretion - non-commercial loss

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 XXXX activity in your calculation of taxable income for the 1 July 20XX to 30 June 20XX income year?

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 July 20XX

Relevant facts and circumstances

You satisfy the less than $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You have X years of experience with XXXX.

You did not complete any XXXX courses; however, you state that you studied much of the processes online through tutorials, videos and reading books.

Since lodging your application, you created a website to advertise your XXXX ability.

You intend to make videos and post them online. You also intend to build XXX for clients.

You have stated that you intend to quit your current full-time employment once XXXX becomes your main source of income.

During the 20XX financial year, you were commissioned to create 2 pieces of XXXX.

In the 20XX financial year, you are in the process of acquiring a piece of work to the value of $XXX.

During the 20XX financial year, you created the two pieces of XXXX with no profit, as you advised that you were only charging the cost of materials as a ploy to have the opportunity to make XXX for other people and potential future clients.

You do not have a formal business plan. However, you have provided an estimated profit and loss for the years titled 20XX, 20XX and 20XX year.

The size and scale of your operation is not a factory operation and you do not intend to upscale to a high output XXX manufacturing business.

You state that you operate from your own private premises on acreage in a large shed with enough space to generate profit from the activity yourself with no-one else working with you.

Relevant legislative provisions

Income Tax Assessment Act 1997 (ITAA 1997) subsection 35-10(1)

Income Tax Assessment Act 1997 (ITAA 1997) subsection 35-10(2)

Income Tax Assessment Act 1997 (ITAA 1997) subsection 35-10(2E)

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

Reasons for decision

Am I in business?

Before a non-commercial loss can be allowed, we must first assess if the taxpayer is in business.

Section 995-1 of theITAA 1997 defines a 'business' to include any profession, trade, employment, vocation or calling but does not include occupation as an employee. This definition, however, simply states what activities may be included in a business. It does not provide any guidance for determining whether the nature, extent, and manner of undertaking those activities amount to the carrying on of a business.

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. The courts have developed a series of indicators to determine whether a business is being carried on. Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production (TR 97/11) lists these general indicators 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 organised in a businesslike manner

•         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.

•         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.

The following indicate a lack of commercial purpose:

•         You had two customers during the 20XX financial year.

•         You provided a basic business plan and have stated that you have the intention to generate material revenue.

•         You were unable to make any profit from the sale of XXXX XXX.

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

You had more than an intention to engage in your activities, as you are maintaining a website to advertise your XXXX services. You have invested both time and money into creating the website for the business.

Purpose and prospect of profit

Your actions to provide XXXX services to customers demonstrate that you had a purpose for profit.

You state that your intention was to gain monetarily from the XXXX activity and not spend more than you generated. However, the first year of operation you made $XXX of gross sales and had expenses of $XXX. This suggests that you had no prospect of profit.

Whether there is repetition and regularity of the activity

You spend between 2 weeks and 2 months per item of XXX when building. You operate from your own private premises on acreage in a large shed with enough space with no-one else working with you. You currently are working full-time in paid employment. In the 20XX financial year, you sold 2 pieces of XXX at cost.

The size, scale, and permanency of the activity

You stated that the size and scale of your operation is not a factory operation and that you do not intend to upscale to a high output XXX manufacturing business. In the 20XX financial year you had 2 clients purchase goods at cost, and in the 20XX financial year, you have stated that you have a potential client requesting a $XXX item of XXX and as such, it is considered to be a small-scale operation.

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

Due to the small time in which you were operation and lack of clients it can be said you were not operating in a similar manner to that of other businesses in your industry.

Whether the activity is planned, organised, and carried out in a businesslike manner

Activities are more likely to amount to the carrying on of a business where they are carried out in a systematic and organised manner. You did not provide a formal business plan on how you were going to enter a market with more developed and widely adapted competition. You provided a simple revenue and expense table that you expected the business would follow.

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

Your activities would not be better described as a hobby, recreation, or a sporting activity. There is nothing to suggest you do this for any purpose other than to make income.

Lead Time

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 20XX-XX financial years, on the basis of the nature of your activity. That is, 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).

TR 2007/6 states, at paragraphs 17, 18 and 19 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 (paragraph 78 of TR 2007/6). Your situation is consistent with Example 9 at paragraphs 139 and 140 of TR 2007/6.

Conclusion

You have not passed several tests as to whether you were operating a business.

When reviewing the conditions set out above, you do not meet the following: the prospect of profit, repetition and regularity of the activity, size scale and permanency and whether the activity is planned, organised, and carried out in a businesslike manner.

Having regard to your full circumstances, it is not accepted that it is the nature of the business activity that has prevented you from passing the assessable income test. The business has not made a profit, and whilst there has been a limited / conservative projection of future profits provided, it is considered that 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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