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Edited version of private advice

Authorisation Number: 1052397363752

Date of advice: 15 May 2025

Ruling

Subject: Deductions - Commissioner's discretion - commercial loss rules

In this ruling:

Question 1: Can the Taxpayer deduct each of the relevant expenses in full during the 2024 income year, under either section 8-1, section 40-880, or section 328-180?

Answer

Yes

Question 2: Will the Commissioner exercise the discretion in section 35-55 so that the rule deferring losses from non-commercial business activities doesn't apply to the Taxpayer during the 2024 income year?

Answer

Yes.

This ruling applies for the following period:

2024 income year

Relevant facts and circumstances

1.         The Taxpayer was an Australian resident in the 2024 income year for Australian tax purposes.

2.         The Taxpayer wasn't a resident of the USA in the 2024 income year for tax purposes.

3.         Paragraph redacted for privacy reasons.

4.         Paragraph redacted for privacy reasons.

5.         The Taxpayer and related entities were involved in research and development concerned with enabling certification for the commercial production of X plants.

6.         The Taxpayer personally obtained royalty rights several years ago on the sale of X plants in the USA and Australia.

7.         The Taxpayer is a party to a USA LLC, and the LLC will sell the X plants as 1-year old plants in the next 2-3 years months. The Taxpayer will receive a royalty personally on sale.

8.         Currently X mature X plants are being grown in the USA, and the Taxpayer expects a proportion of them to produce flowers in the next few months, and seeds to be available within the next 12 months.

9.         In the USA, royalties should commence in the next 12 to 36 months. Around X seedlings will be sold in the YYYY income year as a one-off special order, and royalties may commence with this sale. However, future sales will be seedlings produced from the seeds of the YYYY harvest, and will be grown for 12 months and will be sold as certified one-year old plants starting in two or three years, and every year thereafter. The Taxpayer's expectations for plantings by customers and royalties were listed in Table 1 but have been redacted for privacy reasons.

Table 1: expected plantings and royalties (redacted for privacy reasons)

10.      In the 2024 income year, the Taxpayer, in his personal name, started making payments to a consulting company in the USA for the following services.

•                A business plan for the royalty generation business, including oversight procedures of the USA operation including control and management of sales to ensure royalty payments are correctly applied and paid in the agreed timeframes. General oversight of the business will be through a local contract manager with computer management systems in place. This will ensure that the royalty business structure operates properly, including for banking, taxation, and international transfers.

•                Advice on business structures in the USA and Australia to ensure tax compliance in both the Australia and the USA without unnecessary double taxation.

•                See Table 2 for amounts.

Table 2: Expenses in the 2023/24 income year

Expenses

$USD amount

$AUD amount

USA and Australian accounting structure and systems set up advice

$x

$y

USA and Australian legal services, including proposed business terms and conditions, liability protection, and annual retainer

$x

$y

Business plan for rights (spanning multiple years)

$x

$y

Annual management fees

$x

$y

USA computer and software

$x

$y

Annual incidental, legislative, and office fees

$x

$y

Totals

$x

$y

11.      The computer costs include the costs of computer hardware.

12.      The Taxpayer's aggregated turnover was below $10M AUD in the ZZZZ and 2024 income years.

13.      At 30 June 2024, the Taxpayer hadn't received any royalty payments from the sale of X plants at any time since obtaining royalty rights several years ago.

Assumptions

A.    If the Taxpayer receives the payments described in this ruling as royalties, he will derive them in his personal name, and the amounts will be assessable income in Australia.

B.    Any computer hardware and software was used exclusively for the Taxpayer's X plant royalty business.

Relevant legislative provisions

Income Tax Assessment Act 1997

Section 8-1

Section 40-30

Section 40-880

Section 328-175

Section 328-180

Income Tax (Transitional Provisions) Act 1997

Section 328-180

Further issues for you to consider

We have limited our private ruling to the questions raised in your application. There may be related issues that you should consider, including:

•   the correct exchange rate to use when converting USA currency into Australian currency for tax purposes (including for calculating deductions under this ruling)

•   the correct Australian tax treatment for the royalties, including whether they will be treated as royalties for Australian tax purposes or under the USA DTA, and withholding tax

•   whether the USA DTA will apply to limit Australian taxing rights over the royalties

•   if any royalties aren't included in the Taxpayer's assessable income, whether this will reduce or deny any deductions under Australian taxation law

•   GST implications for the X plant royalty business

•   deductibility of any similar expenses in future years.

Reasons for decision

In these reasons:

Question 1: Can the Taxpayer deduct each of the relevant expenses in full during the 2024 income year, under either section 8-1, section 40-880, or section 328-180?

Answer

Yes

Summary

14.      The Taxpayer can claim upfront deductions for:

•                the accounting structure, business plan, and contract terms and conditions as eligible capital expenditure for a proposed business under subsection 40-880(2A)

•                the computer as an instant asset write-off under section 328-180

•                the remaining annual expenses as a general deduction under section 8-1.

15.      Note that Division 35 may have applied to prevent the Taxpayer from claiming losses from his royalty generation business, if the Commissioner hadn't exercised the discretion not to apply that Division. See Question 2.

Explanation

Section 8-1 allows upfront deductions for expenses gained in producing assessable income that don't have a capital character.

16.      Section 8-1 allows deductions that meet either of two 'positive' limbs and don't meet any of four 'negative' limbs. Subsection 8-1(1) says you can deduct losses or outgoings to the extent that it's:

•                incurred in gaining or producing your assessable income, or

•                necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

Subsection 8-2(2) has four negative limbs that deny deductions that would otherwise be allowable under the positive limbs. Relevantly, you can't deduct a loss or outgoing to the extent that it's:

•                of capital, or of a capital nature, or

•                incurred in gaining or producing exempt income or non-assessable non-exempt income.

17.      Broadly, expenditure is likely to have a capital nature if it's a non-periodic payment made for the purpose of achieving a lasting advantage: see TR 2011/6 at paragraph 66.[1]

Section 40-880 allows deductions for business-related capital expenditure, but the timing depends on whether your business had started or is merely proposed.

18.      Section 40-880 allows deductions for certain business-related capital expenditure, either over 5 years or upfront.

19.      Subsection 40-880(2) allows deductions for capital expenditure over 5 yearsstarting in the year you incur it, if it's in relation to:

•                your business,

•                a business that used to be carried on, or

•                a business proposed to be carried on.

20.      Subsection 40-880(2A) allows upfront deductions for capital expenditure you incur if it's:

•                incurred in relation to a business that's proposed to be carried on, and

•                the expenditure is incurred in obtaining advice or services relating to the proposed structure, or proposed operation of the business, and

•                you are either a small business entity or a business with aggregated turnover under $50M (or a non-business entity unless part of a large business).

21.      The rest of section 40-880 has exceptions and limitations. Relevantly, you can only deduct expenditure to the extent the business is, was, or is proposed to be carried on for a taxable purpose: subsection 40-880(3). Also, you can't deduct anything excluded from the cost of a depreciating asset or the cost base of a CGT asset: see subsection 40-880(8).

22.      Subsection 40-25(7) says 'taxable purpose' includes the purpose of producing assessable income.

Subdivision 328-D allows an upfront deduction to small business entities for certain depreciating assets.

23.      Subdivision 328-D is about capital allowances for small business entities.

24.      Section 328-175 says you can calculate your deductions for depreciating assets under Subdivision 328-D if you are a small business entity and started to use the assets or have them installed ready for use during or before that income year. Depreciating assets are broadly assets with a limited effective life and reasonably expected to decline in value, with a few exceptions not relevant to this ruling: see section 40-30. There are exceptions to Subdivision 328-D deductibility in section 328-175 (like primary production assets, capital works, and certain fringe benefits) but they aren't relevant to this ruling.

25.      Section 328-180 says you deduct the taxable purpose proportion of the adjustable value of a depreciating asset for the income year in which you start to use the asset, or have it installed ready for use if:

•                you were a small business entity for that year and the year in which you started to hold it, and

•                you chose to use this Subdivision for each of those years, and

•                the asset is a depreciating asset whose cost at the end of the income year in which you started to use it, or have it installed ready for use, for a taxable purpose is less than $1,000.

26.      Paragraph 328-180(4)(d) of the Income Tax (Transitional Provisions) Act 1997 increases the $1,000 limit to $20,000 if you first acquired the asset at or after the 2015 budget, and you first used the asset (or installed it ready for use) for a taxable purpose on or after 1 July 2023 and on or before 30 June 2024.

27.      You are a small business entity if you carry on business and your aggregated turnover[2] for the previous income year is under $10M: see section 328-110.

Applying these provisions requires us to determine whether the Taxpayer is carrying on business and whether his royalties will be assessable income (rather than exempt or non-assessable non-exempt income).

28.      The three provisions we've outlined require us to determine some related questions.

•                Deductions under section 40-880 require a connection to a business activity.

•                Deductions under both section 40-880 and section 328-180 require that you are a business entity with turnover under relevant thresholds.

•                Deductions under section 8-1 require that the expense was incurred in gaining or producing assessable income and wasn't incurred in producing exempt or non-assessable non-exempt income.

•                Deductions under sections 40-880 and 328-180 may be reduced to the extent the relevant business or asset wasn't applied to a taxable purpose.

29.      To determine the Taxpayer's eligibility under these provisions, we'll address whether the Taxpayer's X plant royalty operation is a business.

The Taxpayer's X plant royalty operation is a business, and it started in the 2024 income year: from that time, he had the purpose of making a profit and was conducting the operation in a businesslike manner.

30.      TR 97/11[3] (at paragraphs 11 through 18) gives guidance about whether an activity is carrying on a business. Very broadly:

•                relevant indicators include whether the activity is a significant commercial activity, purpose and intention to make a profit, whether the activity is profitable, repetition and regularity, whether the activity is conducted in a businesslike manner, size and scale, and the taxpayer's knowledge and skill

•                each case turns on its facts, but the question is generally determined by weighing all the relevant indicators

•                no single indicator is decisive, and the weighting may vary from case to case

•                the indicators must be considered in combination and as a whole.

31.      TR 97/11 at paragraph 41 says that:

•                preparatory activities (such as experimental or pilot activities) before commencing a business don't amount to a business (and preparatory expenses aren't deductible)

•                experimental or pilot activities should be distinguished from activities that have a sufficient commercial character to be regarded as a business in their own right

•                where a business has commenced, expenses may be deductible even if no income is derived in the relevant year.

32.      On these facts, we're satisfied that the Taxpayer's X plant royalty operation is a business, and that business started during the 2024 income year. Most of the indicia in TR 97/11 are satisfied from that time. He had a business plan, a plan to make a substantial profit from the royalties, and was conducting himself in a systematic and businesslike way by seeking regulatory certification and getting professional advice. We don't think his business started before the 2024 income year. While he obtained royalty rights several years ago, he took no action to establish a business structure or prepare a business plan until 2024.

We've assumed that the Taxpayer's royalties will be included in his assessable income.

33.      We don't have enough information to determine the correct tax treatment for any future payments, described in this ruling as royalties, for the purposes of Australian taxation law and the USA DTA.

34.      We have assumed that the Taxpayer will derive any royalties personally and they will be included in his assessable income when derived.

35.      This ruling won't apply to the extent that this assumption isn't correct. If the royalty payments aren't assessable income to the Taxpayer once received (including, for example, that the royalties will be exempt income or non-assessable non-exempt income, or the USA DTA will apply to give sole taxing rights to the USA) then the expenses won't be deductible.

The Taxpayer's expenditure qualifies for deductions: the accounting structure and business plan qualify as capital expenditure for a proposed business, the computer qualifies for the instant asset write-off, and the remaining expenses are general deductions.

36.      Having determined that the Taxpayer is carrying on a business, we will apply the substantive deduction provisions in sections 8-1, 40-880, and 328-180.

37.      We think the expenses for advice about accounting structures, a business plan, and legal services about 'proposed business terms and conditions' would be eligible for an upfront deduction under subsection 40-880(2A).

•                The payments are capital expenditure because they establish a lasting structure that will potentially generate royalties for many years.

•                They directly relate to his proposed business and qualify as expenditure for advice and services about a structure, or operation of a business, under subsection 40-880(2A).

•                The Taxpayer is a small business entity because his aggregated turnover for the relevant years was under $10M AUD.

•                The business is for a taxable purpose, because he's carrying it on for the purpose of generating royalties that will be included in his assessable income.

•                When incurred, that business would have been merely proposed (rather than already carried on), because we've concluded that the Taxpayer's royalty operation only became a business through incurring these expenses.

38.      The costs of buying any computer hardware used in the business would be deductible under section 328-180. A computer is a depreciating asset as it has a limited life. The Taxpayer is a small business entity. The computer would be eligible for an upfront deduction under section 328-180 because the cost (about $Y AUD) was below the $20,000 threshold applying to the 2024 income year. The Taxpayer can claim the decline in value to the extent the computer was used or held ready for use in his X plant royalty business, as this qualifies as a taxable purpose. (Note that the Taxpayer would need to reduce the deduction to the extent of any private or non-taxable use.)

39.      The remaining expenses (annual lawyer retainer, insurance, incidentals etc) are deductible under section 8-1. They are periodic and ongoing expenses incurred in running the business, and don't have a capital character because they don't achieve any lasting advantage for the business.

40.      To summarise, all the expenses covered by this ruling are deductible in full during the 2024 income year, under either section 8-1, section 40-880, or section 328-180.

Question 2: Will the Commissioner exercise the discretion in section 35-55 so that the rule deferring losses from non-commercial business activities doesn't apply to the Taxpayer during the 2024 income year?

Answer

Yes.

Summary

41.      Division 35 prevents individuals from deducting losses from certain non-commercial business activities.

42.      One exception is where the Commissioner exercises a discretion (in section 35-55) not to apply Division 35.

43.      Division 35 won't apply because the Commissioner has decided to exercise the discretion in section 35-55, on the basis that there's an objective expectation that the Taxpayer will generate a profit within a period that's viable for the relevant industry.

Explanation

44.      The non-commercial loss rules in Division 35 quarantine losses for individuals from 'non-commercial' business activities.

45.      Where your deductions or section 40-880 expenditure exceed your assessable income from a business activity, section 35-10 prevents you from deducting the loss from the business activity to the next income year.

46.      Section 35-10 won't apply if an exception applies. One of the exceptions is where the Commissioner exercises a discretion in section 35-55 to allow losses from the business activities when satisfied it would be unreasonable to apply the rule.

47.      There are two grounds for the Commissioner's discretion in section 35-55.

•                First, that the business activity was or will be affected by special circumstances outside the control of the operators.

•                Second, that the business, because of its nature, hasn't produced, or won't produce, assessable income greater than the deductions, and there's an objective expectation, based on evidence from independent sources (where available), that, within a period that's commercially viable for the industry concerned, the activity will produce assessable income for an income year greater than the deductions available to it. (The note says the second ground is intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income.)

48.      TR 2007/6,[4] a taxation ruling about the Commissioner's discretion, says:

•                the phrase 'because of its nature' means the failure must be because of some inherent characteristic that the business activity has in common with other business activities of that type [17]

•                the Commissioner must be satisfied that an objective expectation exists that the business activity will satisfy a test or produce a tax profit within a period that's commercially viable for the industry concerned [20]

•                the period that's commercially viable for the industry concerned is the period in which it's expected that any business activity of that type, carried on in a commercially viable manner, would be expected to satisfy one of the tests or produce a tax profit.

49.      On these facts, and other available information, the Commissioner is satisfied that it's appropriate to exercise the discretion on the second ground. The Taxpayer's related entities are currently growing X plants to produce a crop of seeds. Once that crop of seeds is produced, related companies will be able to start growing X plant seedlings, and then start selling one-year old X plants to farmers in the next 2-3 years. This will generate royalties for the Taxpayer and will result in a profit for the Taxpayer in the 2-3 income years. We think the combination of a one-year growing time combined with several months to produce certified seed means the delay (of approximately two years) can be taken to be a commercially viable period for the relevant industry.

50.      Since the Commissioner is satisfied that it's appropriate to exercise the discretion in section 35-55, the non-commercial loss rules in Division 35 won't prevent the Taxpayer from claiming a loss from his plant X royalty business in the 2024 income year.


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[1] Taxation Ruling TR 2011/6 Income tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues.

[2] The meaning of 'aggregated turnover' depends on several related terms. 'Aggregated turnover' means the annual turnover of you, your connected entities, and your affiliates: see section 328-115. 'Annual turnover' means the total ordinary income derived in the ordinary course of carrying on a business: section 328-120. Speaking broadly, whether an entity is 'connected' with you depends on control relationships worked out under section 328-125 that could depend on entitlements to income, capital distributions, or voting rights or (in the case of a discretionary trust) influence over a trustee. An entity may be an 'affiliate' of yours if it acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to its business affairs: see section 328-130.

[3] Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production?

[4] Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion.

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