Edited version of private ruling

Authorisation Number: 1011643479313

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Ruling

Subject: Non-Commercial Losses - Special Circumstances & Lead Time

Question 1

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) (special circumstances) to allow you to include any losses from your business in your calculation of taxable income for the 2009-10 income year?

Answer

No.

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 (lead time) to allow you to include any losses from your business in your calculation of taxable income for the 2009-10 income year?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

Your business commenced part way through the 2009-10 income year.

You purchased an asset to be used in your business. The use of that asset in your business was delayed for many months. You could not use the asset until after the peak season.

You currently run the business from your home office.

You will maintain your full time employment until such time as the business becomes financially self-sufficient.

You conservatively predict the business will generate assessable income over $20,000.

You have a business plan.

A website will form the core of your marketing strategy. To date the website is not operational. As it will take some time to have your website operational you intend to market your business via other means.

You did not pass any of the four tests under Division 35 of the ITAA 1997.

Your income for non-commercial loss purposes is less than $250,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 Paragraph 35-55(1)(a)

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

Income Tax Assessment Act 1997 Subsection 35-10(2)

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

Income Tax Assessment Act 1997 Section 35-10(4)

Income Tax Assessment Act 1997 Section 35-30

Income Tax Assessment Act 1997 Section 35-35

Income Tax Assessment Act 1997 Section 35-40

Income Tax Assessment Act 1997 Section 35-45

Reasons for decision

Division 35 of the ITAA 1997 prevents losses from non-commercial business activities (being conducted by an individual or a partner in a partnership) being offset against other assessable income in the year the loss is incurred. The loss is deferred unless:

· You satisfy the income requirement under section 35-10(2E) of the ITAA 1997 and pass one of the following four tests:

(a) at least $20,000 of assessable income in that year from the business activity (assessable income test)

(b) the business activity results in a taxation profit in three of the past five income years (profits test)

(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 (real property test), 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 (other assets test) or

· the Commissioner exercises his discretion (special circumstances or lead time) or

· you meet the exception test (can only be met if the activity is a primary production or a professional arts business and your assessable income from that year from other sources that do not relate to that activity is less than $40,000).

The income requirement under section 35-10(2E) of the ITAA 1997 is met if the sum of the following is less than $250,000:

(a) your taxable income for that year;

(b) your reportable fringe benefits total for that year;

(c) your reportable superannuation contributions for that year;

(d) your total net investment losses for that year.

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 (including the income test under subsection 2E), the discretion is exercised, or the exception applies.

Are you carrying on a business?

Your activities will only be subject to these provisions if it is carried on as a business. You stated in your private ruling application that your activity was carried on as a business. This ruling is made on the basis of accepting this claim.

Application of section 35-55 of the ITAA 1997 (Commissioner's discretion) to this arrangement

As your activity has commenced, and is carried on as a business, it is subject to the provisions in Division 35 of the ITAA 1997.

It appears from your application that you believe special circumstances affected your business. You have also indicated that you believe the nature of your activity affected your business. Both paragraph 35-55(1)(a) of the ITAA 1997 (special circumstances) and paragraph 35-55(1)(b) of the ITAA 1997 (lead time) will now be addressed.

Special Circumstances

Paragraph 35-55(1)(a) of the ITAA 1997 sets out the first arm of the Commissioner's discretion as follows:

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… if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

(a) the business activity was or will be affected in that or those income years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster;
Note: This paragraph is intended to provide for a case where a business activity would have satisfied one of the tests if it were not for the special circumstances.

Paragraph 35-55(1)(a) of the ITAA 1997 refers to 'special circumstances' outside of the control of the operators of the business activity. No exhaustive definition is given of 'special circumstances' but the paragraph does include drought, bushfire and other natural disasters.

The question of what constitutes 'special circumstances' has been judicially considered on many occasions. In the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation:

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…

Later, in the Federal Court Case of Secretary, Department of Employment, Education, Training & Youth Affairs v. Barrett and Another (1998) 82 FCR 524 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed 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 then quoted the following passage with approval from the AAT case of Re Beadle and Director-General of Social Security (1984) 1 AAR 362; (1984) 6 ALD 1:

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.

It can be seen that to determine what are 'special circumstances', we need to look at the context in which the phrase is used. Also, it is clear that 'special circumstances' will be something out of the ordinary or unusual. 'Special circumstances' in paragraph 35-55(1)(a) of the ITAA 1997 is used in the context of a situation occurring such that it would be unreasonable for the Commissioner to apply the loss deferral rule for a particular year or years. For this to be the case, it will not only be necessary that an event or situation has occurred which is of itself unusual, but that it has resulted in the business activity failing to pass a test. Clearly, if the business activity would not have passed a test even if the event or situation had not arisen, we cannot say that the business activity was affected by 'special circumstances' in the sense in which this term is used in paragraph 35-55(1)(a), as the Note to the paragraph indicates.

In Taxation Ruling TR 2007/6, the Commissioner provides guidance to taxpayers in what he considers to be special circumstances for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. Apart from drought, flood and bushfire which are specifically mentioned in the legislation, it may also include:

· earthquakes

· hailstorms

· an oil spill

· a chemical spray drift

· a gas plant explosion

· a power plant shutdown

· a water authority malfunction

· government authority restriction imposed on land use, or

· other events (for example, illness of the operator or employee(s)) which have significantly affected the ability of the operator to carry on the business activity.

In application to your case you have requested that the Commissioner exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 in the 2009-10 income year. The discretion is designed to allow for cases where unusual circumstances occurred to prevent businesses from meeting one of the four tests.

It is a normal part of business for that business to arrange its affairs so that assets, which are integral to its operations, are in place in a condition which will allow the business to earn assessable income. There is nothing unforeseeable or unusual about having to wait some time before your income-earning asset is in place in order for assessable income to be earned.

The Commissioner will therefore not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 as there is nothing special about the circumstances surrounding you having to wait some time for your asset to be delivered in an income-earning state.

Lead Time

By asking the Commissioner to consider using his discretion under paragraph 35-55(1)(b) of the ITAA 1997 it is assumed that none of the four tests were satisfied in the 2009-10.

As no test was satisfied in the 2009-10 income year, 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 business for that year, unless the Commissioner exercises an arm of the discretion under paragraph 35-55(1)(b) of the ITAA 1997.

Paragraph 35-55(1)(b) of the ITAA 1997 may be exercised for one or more income years where:

(a)        the business activity has started to be carried on, and for those years:

(i)      because of its nature it has not satisfied, or will not satisfy, one of the tests set out in Division 35 of the ITAA 1997, and

(ii)     there is an expectation that the business activity of an individual taxpayer will either satisfy one of the tests or produce a taxation profit within a period that is commercially viable for the industry concerned.

The note to this paragraph states that it 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. For example, an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

The type of feature contemplated by the phrase 'because of its nature', in the context in which it appears, is that referred to in the note quoted above. That is, that there is an inherent or innate feature of the activity resulting in an inability to produce income in the year of commencement and (in most cases) a number of years thereafter. This is borne out further by paragraph 1.51 of the Explanatory Memorandum for the New Business Tax System (Integrity Measures) Act 2000, which states:

This arm [paragraph 35-55(1)(b)] of the safeguard discretion will ensure that the loss deferral rule in section 35-10 does not adversely impact on taxpayers who have commenced to carry on activities which by their nature require a number of years to produce assessable income. Examples of activities which would fall into this category are forestry, viticulture and certain horticultural activities.

The note and the passage cited above do not support any view that the discretion should be exercised for any start-up activity that is yet, for example, to satisfy the assessable income test in section 35-30 of the ITAA 1997, simply because of the small scale on which it was started, or because a client base is being built up. Those sorts of constraints on being able to satisfy that test are far removed from the specific one referred to in the note and the Explanatory Memorandum.

You were unable to satisfy any of the four tests under Division 35 of the ITAA 1997 in 2009-10. You are currently only conducting your business on a limited basis as you are still employed full time in another occupation. Your main means of getting your corporate message to the general public, your website, is not operational. You are at the stage operating your business on a very small scale with limited means of advertising. These are two of the reasons which will prevent you from meeting the assessable income test. Those sorts of constraints on being able to satisfy the assessable income test are far removed from the specific examples referred to in the note and the Explanatory Memorandum.

The Commissioner's discretion will not be exercised as your business is in its early start up phase and is yet to satisfy any of the four tests under Division 35 of the ITAA 1997 simply because of the small scale on which it was being initially conducted and because a client base is being built up.

We do not consider that there is anything inherent in the nature of your business that prevented you from being able to satisfy one of the tests for the 2009-10 income year.

In conclusion, the requirements of paragraph 35-55(1)(b) of the ITAA 1997 have not been met. Consequently, you are not eligible for the Commissioner's discretion under paragraph 35-55(1)(b) of the ITAA 1997 for the 2009-10 income year.

As the Commissioner will not exercise his discretion under either paragraph 35-55(1)(a) or paragraph 35-55(1)(b) of the ITAA 1997 you are required to defer losses from your business in the 2009-10 income year.