Edited version of private ruling

Authorisation Number: 1011587299148

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Ruling

Subject: Non Commercial Losses - Commissioner's discretion

Question

Will the Commissioner exercise the discretion under paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997), thus allowing you to offset losses from your business against your other assessable income for the years ended 30 June 2010 and 30 June 2011 ?

Answer

No

This ruling applies for the following period :

1 July 2009 to 30 June 2011

The scheme commenced on:

1 July 2009

The business commenced operations several years ago. The business is licensed by the relevant state authority.

The current owner of the service, and the premises is the taxpayer.

At a point in time the level of competition increased significantly. Later, competitors had developed or acquired a significant number of businesses in the area, contributing to excess capacity and declining profitability .

The business was restructured in anticipation of an expansion. Specifically, the business was acquired by the taxpayer, to provide the funding for expansion.

Eventually, the business was sold.

This ruling applies for the following period :

1 July 2009 to 30 June 2011

The scheme commenced on :

1 July 2009

Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997)

Overview

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

· one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 is met (along with the income requirement), or

· if one of the tests is not satisfied, the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

You state that your activity is carried on as a business and this ruling is made on the basis of accepting this claim.

From the 2009-10 income year, satisfaction of any of the four tests will no longer automatically prevent the loss deferral rule in subsection 35-10(2) applying to a loss made from a business activity carried on by an individual who does not satisfy subsection 35-10(2E) of the ITAA 1997 (the income requirement). You have stated in your private ruling application that you do not satisfy the income requirement under subsection 35-10(2E).

As you do not satisfy the income requirement, the loss deferral rule under subsection 35-10(2) of the ITAA 1997 will apply to the loss from your activity unless the Commissioner exercises the discretion under subsection 35-55(1) of the ITAA 1997.

You have applied for the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997 as you consider that your activity was adversely affected by special circumstances outside your control.

For those individuals who do not satisfy the income requirement in subsection 35-10(2E), special circumstances are those which have materially affected the business activity, causing it to make a loss. For these individuals 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 such that it is unable to produce a tax profit; and

· the business activity either satisfies at least one of the tests or is affected by special circumstances such that it is unable to satisfy any of the tests; and

· the special circumstances affecting the business activity are outside the control of the operators of the business activity.

Individuals who do not meet the income requirement, but who can demonstrate their business is commercial, and has been affected by special circumstances, may be considered under the special circumstances limb of section 35-55 of the ITAA 1997.

For a business activity to be regarded as 'commercial' for the purposes of Division 35 of the ITAA 1997, four objective tests are provided, at least one of which must be satisfied. There are no other tests in Division 35. As a result, those tests are relevant to determining whether or not individuals who do not meet the income requirement are conducting a business activity that is 'commercial' for the purposes of Division 35.

Affected by 'special circumstances'

For the exercise of the Commissioner's discretion in regard to the special circumstances limb, the business activity must be affected by special circumstances. No exhaustive definition of 'special circumstances' is provided in the ITAA 1997. However, the term has received considerable judicial consideration in respect of other legislation.

In the case Community Services Health, Minister for v. Chee Keong Thoo (1988) 78 ALR 307; (1988) 8 AAR 245 Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation at ALR 324:

Those discretions are intended to be applied to a great variety of situations. In such a context, the core of the idea of 'special circumstances' is that there is something unusual or different to take the matter out of the ordinary course...

In the case Employment, Education, Training Youth Affairs, Department of v. Barrett (1998) 82 FCR 524; (1998) 52 ALD 499; (1998) 27 AAR 291 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed at FCR 530 that:

The word 'special' must be read in context. In normal parlance it signifies that the event or circumstances in question are out of the ordinary or normal course.

Tamberlin J went on to say:

The AAT observed in Re Beadle and Director-General of Social Security (1984) 6 ALD 1 at 3 (which was approved by the Full Court in Beadle v. Director of Social Security ) (1985) 60 ALR 225):

An expression such as 'special circumstances' is by its very nature incapable of precise or exhaustive definition. The qualifying adjective looks to circumstances that are unusual, uncommon or exceptional. Whether circumstances answer any of these descriptions must depend upon the context in which they occur. For it is the context which allows one to say that the circumstances in one case are markedly different from the usual run of cases. This is not to say that the circumstances must be unique but they must have a particular quality of unusualness that permits them to be described as special.

In the context of Division 35, where the income requirement is satisfied, special circumstances are ordinarily those affecting the business activity such that it is unable to satisfy a test and it would be unreasonable for the loss deferral rule to apply. Ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances. These fluctuations are expected to occur on a regular or recurrent basis when carrying on a business activity and affect all businesses within a particular industry. However, substantial unexpected fluctuations of a scale not regularly encountered previously may qualify on a case by case basis.

Paragraph 35-55(1)(a) refers to 'special circumstances' as including drought, flood, bushfire or some other natural disaster. However, the use of the word 'including' indicates that the type of circumstances to which the special circumstances limb of the discretion can potentially apply is broader than those which are natural disasters. For example, circumstances such as oil spills, chemical spray drifts, explosions, disturbances to energy supplies, government restrictions and illnesses affecting key personnel might, depending on the facts, constitute special circumstances of the type in question. 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. Some indicators of the effects on the business activity that could lead to the exercise of the discretion in regard to the special circumstances limb are:

· destruction of stock or equipment

· delays in ploughing, planting, harvesting etc

· delay in growth of crops

· inability of operator to perform duties

· loss of business opportunities

In the situation where a business activity would have failed to satisfy a test even if the special circumstances had not occurred, it is unlikely that the Commissioner would consider it to be unreasonable for the loss deferral rules to apply and therefore the Commissioner would be unlikely to exercise the discretion.

Where the business activity is carried on by an individual who does not satisfy the income requirement and this activity would have made a loss even if it had not been affected by special circumstances, it is also unlikely that it would be considered unreasonable for the loss deferral rules to apply and therefore the Commissioner is unlikely to exercise the discretion.

Outside the control of the operators of the business activity

The operators of the business activity must show that the special circumstances were outside their control. The concept of 'control' was discussed in Secretary, Department of Employment, Education and Youth Affairs v. Ferguson (1997) 76 FCR 426; (1997) 48 ALD 593; (1997) 147 ALR 295 for the purposes of subsection 45(6) of the Employment Services Act 1994 . At 76 FCR 438; 48 ALD 603; 147 ALR 306, Mansfield J said:

The expression in s45(6)(a) requires that the main reason for the failure was something that the person had within that person's control. The concept of 'control' in that context is one of fact, but I think it is intended to mean something which the person could have done something about.

And at 76 FCR 438, 48 ALD 603; 147 ALR 306:

It recognises the focus of the expression upon occurrences which the person concerned could not realistically prevent.

However, if the operators of the business activity fail for no adequate reason to adopt certain practices commonly used in their industry to prevent or reduce the effects of certain circumstances, such as for example pests or diseases, then that may point to the circumstances being within their control.

Similarly, the acquisition of a poorly run but promising business activity would generally be considered to be within the control of the business operator and as such would not, by itself, constitute special circumstances, even though the actions of the former operator may have been outside the control of the current operator.

In your particular situation you have stated that the reason your business made a loss in the 2009-10 income year and is expected to make a loss in the 2010-11 income year is because of the dominance and eventual collapse of a competitor as well as the Global Financial Crisis of 2008. You state that had these special circumstances not taken place, your business would have been profitable.

We do not consider that the collapse of the competitor and the Global Financial Crisis are special circumstances in the sense required by paragraph 35-55 (1)(a) of the ITAA 1997.

We do not consider that the increase in expenses resulted from the dominance and eventual collapse of a competitor or the Global Financial Crisis of 2008. We consider that the restructure of the business was the main reason why the business made a loss in the income year.

The reason for this, as you have stated, is that you wanted to segregate the license, the business and employees for the purposes of asset protection and, that there was a business plan to expand and acquire further competing businesses. You also stated that the restructure enabled you to be in a better position for funding the new acquisitions as the banks preference was to lend to a sole trader versus a company. We consider that this restructure resulted in the increased costs mentioned above.

It is also considered that the restructure of the business activity was not out of your control. As you have stated, a business decision was made to restructure the business . Once acquired, normal business decisions would have been made on matters such as staffing, loans, expenses and level of fees charged. None of these items would have been 'out of your control'.

In view of the above details, the difficulties experienced by you are not considered to be 'special circumstances' for the purposes of paragraph 35-55(1)(a) of the ITAA 1997.

As your business activity was not affected by 'special circumstances' in the sense required by paragraph 35-55 (1)(a) of the ITAA 1997 in the 2009-10 and 2010-11 income years, the Commissioner is therefore not satisfied that it would be unreasonable to apply the rule in section 35-10 of the ITAA 1997 in relation to your business activity for the 2007-08 income year.

Summary

The Commissioner will not exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the 2009-10 and 2010-11 income years on the basis that:

• It is not accepted that the collapse of a competitor, the Global Financial Crisis and the restructure of the business is a special circumstance in the sense in which this term is used in paragraph 35-55(1)(a) of the ITAA 1997.

This means that the rule in subsection 35-10(2) of the ITAA1997 will apply to defer to a future income year any loss that arose from your business for those years.

A deferred loss is not disallowed and will be deductible against any taxation profit from your business, or similar business activity, in future years.