Edited version of private ruling

Authorisation Number: 1011659897352

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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)(b) 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 income year?

No.

This ruling applies for the following period

1 July 2009 to 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You established a small retail business in the 2009-10 income year.

Your establishment costs included setting up a website.

You have also incurred other cost of sales expenditure.

You handle all aspects of the business.

You have earned a small amount of income (approximately $2,500) in the 2009-10 income year, resulting in a loss.

Your merchandise is now sold in over 10 stores in your state and online orders are increasing.

You have earned income from sales in the 2010-11 income year to date of approximately $500.

You expect to make a profit in the 2010-11 income year as you now have a stockpile of merchandise and you expect very few expenses.

You are seeking the Commissioner's discretion to claim your loss.

You have passed the income requirement (that is,. your income for non-commercial loss purposes is less than $250,000)

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 35-1

Income Tax Assessment Act 1997 subsection 35-55(1)

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

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

Reasons for decision

Summary

The Commissioner will not exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to include any losses from your business activity in your calculation of taxable income for the 2009-10 income year.

Detailed reasoning

Division 35 of the ITAA 1997 details special measures that apply to prevent losses from a non-commercial business activity carried out by an individual taxpayer being offset against other assessable income in the year in which the loss is incurred.

Under the measures, losses that cannot be offset against other income in the year in which they arise (quarantined losses) may be carried forward to be offset in a future year when there is a profit from the non-commercial activity (or against other income if certain criteria are satisfied or the Commissioner exercises his discretion).

From the 2009-10 income year, a taxpayer can only deduct a loss from a non-commercial activity if his/her "adjusted taxable income" for the relevant year is less than $250,000 and meets one of the four tests. "Adjusted taxable income" is the sum of taxable income, reportable fringe benefits, reportable superannuation contributions and total net investment losses, and is not reduced by excess deductions from a non-commercial business activity that are subject to Division 35 of the ITAA 1997.

The tests are as follows:

· assessable income test: the assessable income (including capital gains) for that year from the activity must be at least $20,000. If the business activity started or ceased during the year, this test is based on the taxpayer's "reasonable estimate" of the amount that would have been the assessable income if the activity had been carried on for the whole year. This may involve consideration of factors such as the cyclical nature of the business, any orders received or forward contracts, and industry trends

· real property test: the total reduced cost bases of real property or interests in real property used on a continuing basis in carrying on the activity (other than privately used dwellings and tenant's fixtures) must be at least $500,000

· other assets test: the total value of other assets (other than motor vehicles) used on a continuing basis in the activity must be at least $100,000, or

· profits test: the particular activity must have resulted in taxable income in at least three out of the last five income years, including the current year.

In your situation, your adjusted taxable income is less than $250,000 and you have not been able to meet any of the four tests.

Where you are unable to meet one of the four tests (and your adjusted taxable income for the year is less than $250,000), the Commissioner may exercise his discretion where he considers that deferral would be unreasonable because:

· the activity is affected by special circumstances outside the control of the taxpayer (for example, drought, flood, bushfire or other natural disasters such as earthquakes, pest plagues, hailstorms or diseases destroying live stock or crops), or

· the business activity has started and there is an objective expectation (based on evidence from appropriate independent sources, if available) that the activity will either meet one of the tests or will produce taxable income within a period that is commercially viable for the industry concerned. This may apply, for example, where there is necessarily a long lead-up time between the commencement of the activity and the production of assessable income. The business activity must have been unable to satisfy the tests "because of its nature", that is, having regard to some inherent feature in the activity (rather than to the peculiar way in which the taxpayer runs it)

There is no indication that special circumstances would apply to your activity and therefore the Commissioner could only consider whether he would apply his discretion under the "nature of the activity (lead time)" approach.

Paragraph 17 of Taxation Ruling TR 2007/6 deals with the exercise of the Commissioner's discretion and the meaning of 'because of its nature'. Paragraph 17 states that:

for the failure to satisfy one of the four tests to be 'because of its nature', the failure must be because of some inherent characteristic that the taxpayer's business activity has in common with other business activities of that type.

Paragraph 78 of TR 2007/6 states that:

the consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity and would not result in the requirements of subparagraph 35-55(1)(b)(i) being met.

The example at paragraph 139 of TR 2007/6 explains the taxpayer was new to the region and industry in which he chose to commence his business. He had no clientele. His funding and his advertising were limited, he kept his part time employment and he worked at his business when he could. He chose where his business premises were located and also his opening and closing times. He made losses each year and didn't satisfy any of the four tests.

The Commissioner's view on this example is found at paragraph 140 of TR 2007/6:

The inability of Andrew's business activity to satisfy any of the four tests is due to his personal business choices as to hours of business, location and advertising, not any inherent characteristics that affect clock repair businesses. Accordingly the requirement of subparagraph 35-55(1)(b)(i) is not met and the Commissioner would not exercise the discretion.

In your circumstances, your choice of the number of outlets used and the rate of merchandise sold contributed to the losses you incurred in the 2009-10 income year. In reference to the above paragraphs, you have not shown that the lead time is an inherent characteristic of your industry.

Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997. You cannot claim a deduction for your losses against other income in the 2009-10 year. You must defer the loss to a future year where the loss can be claimed against a profit from your business activity (or you meet a test or the Commissioner exercises his discretion).