Edited version of private ruling

Authorisation Number: 1011657537126

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Ruling

Subject: Non-Commercial Losses Special Circumstances & Lead Time

Question 1

Will the Commissioner exercise the discretion under 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 the calculation of your 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

You purchased two business assets.

You hired out those assets.

You could not hire the assets out to the general public because you had to promote the business, apply for and receive appropriate accreditations, address licensing issues and develop your website.

You made losses from this activity during the 2009-10 income year.

You did not pass any of the tests under Division 35 of the ITAA 1997 during the 2009-10 income year.

You passed the income requirement in the 2009-10 income year.

Relevant legislative provisions

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

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

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

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 (refer to paragraph 5 below)

· You meet the income requirement under subsection 35-10(2E) 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.

Generally, a 'loss' in this context is, for the income year in question, the excess of a taxpayer's allowable deductions attributable to the business activity over that taxpayer's assessable income from the business activity.

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 (and the income requirement is met), the discretion is exercised, or the exception applies.

Exception

Under subsection 35-10(4) of the ITAA 1997, there is an 'Exception' to the general rule in subsection 35-10(2) of the ITAA 1997 where the loss is from a primary production business activity or a professional arts business activity and the individual taxpayer has other assessable income for the income year from sources not related to that activity, of less than $40,000 (excluding any net capital gain).

Tests

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).

Income Requirement

You satisfy the income requirement for an income year if the sum of the following is less than $250,000:

· your taxable income for that year

· your reportable fringe benefits total for that year

· your reportable superannuation contributions for that year

· your total net investment losses for that year.

Are you carrying on a business?

Your activity will only be subject to these provisions if it is carried on as a business. You have 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.

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.

Before you could hire the assets out to the general public you had to address the promotion of the business, apply for and receive appropriate accreditations, address licensing issues and develop the website. When a new business is starting up it is normal for it to take some time to establish. It will take some time for you to establish a regular clientele and to be more widely known in the industry. The circumstances you found yourself in during the 2009-10 income year are not considered unusual or special and are not out of the ordinary for a newly-formed business.

The Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997.

Lead Time

Under paragraph 35-55(1)(b) of the ITAA 1997, the Commissioner's discretion can be exercised for an applicant who satisfies the income requirement, where the business activity satisfies the following conditions:

· the business activity has started to be carried on and, for that or those income years:

· because of its nature, it has not satisfied, or will not satisfy, one of the tests set out in section 35-30, 35-35, 35-40 or 35-45; and

· 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 either meet one of those tests or 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 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 satisfied the income requirement, however you were unable to satisfy any of the four tests under Division 35 of the ITAA 1997 in the 2009-10 income year. You purchased the assets and before you could hire them out to the general public you had to ensure you had the correct licences and accreditations. You also had to develop a website and promote the business. These sorts of constraints are normal for all businesses which are starting out and are far removed from the specific examples referred to in the note and the Explanatory Memorandum.

There is nothing inherent in the nature of the business which would warrant the Commissioner to exercise his discretion under paragraph 35-55(1)(b) of the ITAA 1997.

Division 41 deduction

A note to Subsection 35-10(2) of the ITAA 1997 states the rule (under subsection 35-10(2)) does not apply if your excess is solely due to deductions under Division 41.

The excess in your case consisted of deductions covered under Division 41 and other Divisions (for example: interest deduction is deductible under Division 8 of the ITAA 1997); the excess was not solely due the deductions under Division 41.

Conclusion

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 and your excess was not solely due to deductions under Division 41, the rule under subsection 35-10(2) of the ITAA 1997 will apply. You are therefore required to defer losses from your business in the 2009-10 income year.