Edited version of private ruling

Authorisation Number: 1011521233097

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Ruling

Subject: Non Commercial Losses- Commissioner's discretion - lead time.

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 your calculation of taxable income for the 2009-10 to 2012-13 income years?

No.

This ruling applies for the following periods

Year ended 30 June 2010 to 2013

The scheme commenced on

1 July 1999

Relevant facts and circumstances

You are conducting a business activity which commenced in an earlier income year.

The business was run on a small scale when it commenced. Subsequently you undertook major capital investment in plant and equipment to commercialise the business.

At present you are leasing the premises to conduct the activity. The facility is purpose designed for your needs. Over the last ten years, a substantial amount of specialty equipment has been acquired from both local and overseas sources. You have a large inventory of assets.

Your business activity provides services to various other businesses. You are well recognised in the industry.

You wish to move the business to your own premises from early next year. You have purchased most of the equipment for running a high quality business. This new facility will require a new fit out. This move to your own facility means that you will not incur external rent, however, you will incur depreciation and interest costs.

You have your own website which has been operational for a few years.

The business mostly gains its clientele through 'word of month' and by advertising in the press. The nature of the industry encourages people to enquire after hearing output produced on previous projects.

You have not received profits in recent years. You have stated that the revenue has dropped across the industry in recent times due to the transition/changes in final product you sell. You believe it will be a few years before stability returns to the industry.

You have satisfied the tests in Division 35 of the ITAA 1997 during earlier years.

You have provided information regarding your income, expenses and losses for the earlier years and estimates for the future income years.

You have also provided documents in relation to the industry.

You have stated that the restructure in the industry is a worldwide phenomenon and has had a dramatic effect on the commercial results of your activity.

You have advised that you did not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 in the 2008-09 income year and will not satisfy the income requirement in the 2009-10 to 2012-13 income years.

Therefore, you have requested the Commissioner to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the business activity for the 2009-10 to 2012-13 income years.

Relevant legislative provisions

Income Tax Assessment Act 1997 paragraph 35-55(1)(c).

Income Tax Assessment Act 1997 sub paragraph 35-55(1)(c)(ii).

Income Tax Assessment Act 1997 paragraph 35-10(2).

Income Tax Assessment Act 1997 paragraph 35-10(3).

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

Reasons for decision

Division 35 of the ITAA 1997 applies to losses from certain business activities for the 2000-01 income year and subsequent years. Under the rule in subsection 35-10(2) of the ITAA 1997, a 'loss' made by an individual (including an individual in a general law partnership) from a business activity will not be taken into account in an income year unless:

· the 'Exception' in subsection 35-10(4) of the ITAA 1997 applies, or

· satisfy subsection 35-10(2E) of the ITAA 1997 for that year and one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 is met, or

· the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

Losses that cannot be taken into account in a particular year of income, because of subsection 35-10(2) of the ITAA 1997, can be applied to the extent of future profits from the business activity, or are deferred until one of the tests is passed, the discretion is exercised, or the exception applies.

In broad terms, the tests require:

(a) at least $20,000 of assessable income in that year from the business activity (section 35-30 of the ITAA 1997)

(b) the business activity results in a taxation profit in three of the past five income years (including the current year) (section 35-35 of the ITAA 1997)

(c) at least $500,000 of real property, or an interest in real property, (excluding any private dwelling) is used on a continuing basis in carrying on the business activity in that year (section 35-40 of the ITAA 1997), or

(d) at least $100,000 of certain other assets (excluding cars, motor cycles and similar vehicles) are used on a continuing basis in carrying on the business activity in that year (section 35-45 of the ITAA 1997).

In the context of section 35-35 of the ITAA 1997 ((b) above), a 'taxation profit' for the income year in question is where the amount of assessable income from the business activity for that year, is greater than the sum of the deductions attributable to it for that year (apart from the operation of subsection 35-10(2) of the ITAA 1997).

Section 35-1 of the ITAA 1997 provides that an income requirement must be met (along with certain other tests), in order to include losses from a business activity in the calculation of taxable income. The 'income requirement' is set out in subsection 35-10(2E) of the ITAA 1997. If the income requirement is not met, the Commissioner may exercise discretion to allow the inclusion of the losses.

In your case you do not satisfy the income requirement as your income in terms of subsection 35-10(2E) is above $250,000.

In order to exercise the discretion, the Commissioner must be satisfied that there is an objective expectation, based on evidence from independent sources, that your business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period (paragraph 35-55(1)(c) of the ITAA 1997) for that industry.

Your activity will only be potentially subject to these provisions if it is carried on as a business. You have stated that the activity is carried on as a business and this ruling is made on the bases of accepting this claim.

The Commissioner's discretion in paragraph 35-55(1)(c) of the ITAA 1997 reads -

The Commissioner may, on application, decide that the rule in subsection 35-10(2) does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

(c) for an applicant who carries on the business activity who does not satisfy subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made - the business activity has started to be carried on and, for the excluded years:

(i) because of its nature, it has not produced, or will not produce, assessable income greater than the deductions attributable to it; and

(ii) there is an objective expectation, based on evidence from independent sources (where available) that, within a period that is commercially viable for the industry concerned, the activity will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C)).

The Note to paragraph 35-55(1)(c) of the ITAA 1997 states that the particular paragraph 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.

It has been accepted based on the information you have supplied that you started carrying on your business activity in an earlier income year. You have received income since the commencement and have satisfied the assessable income test in section 35-30 of the ITAA 1997 previously. You have not generated profits during the past income years.

You have not provided independent evidence of the lead time for your industry. However, we do not consider that there is anything inherent or innate in the nature of your activity that results in a period of time between when the activity commences and when it first produces assessable income. In particular, we think your activity is an activity that is able to produce assessable income quite soon after its commencement as the income from your business activity has in fact demonstrated.

You have stated that there is a decline in sales due to the product restructure in the industry. Changes or updates to products are a common occurrence in any industry and are not considered as a special circumstance in terms of paragraph 35-55(1)(a) of the ITAA 1997.

In view of the above facts the discretion in paragraph 35-55(1)(c) has not been exercised for your business activity.

Summary of reasons for decision

The Commissioner will not exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997 because, on the facts provided, the Commissioner is satisfied that your activity is an activity that can produce income soon after its commencement hence the activity does not have lead time.

Therefore, the Commissioners discretion in paragraph 35-55(1)(c) does not apply to your activity.

As you do not expect a taxation profit in the 2009-10 to 2012-13 income years, the rule in subsection 35-10(2) of the ITAA 1997 will apply to defer to a future income year any loss that arises from your activity for those years. A deferred loss is not disallowed and will be deductible against any taxation profit from your activity, or similar business activity, in future years.

If your activity, or similar activity should satisfy an exception or satisfy the income requirement and one of the other tests in any given year, then the whole of the deferred loss will be deductible in that year.