Edited version of private ruling

Authorisation Number: 1011679265647

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Ruling

Subject: Non Commercial Losses

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act (ITAA 1997) to allow you claim losses from your activity in your calculation of taxable income for the 2009-10 income year?

No.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You built a vehicle for yourself. The vehicle generated a lot of interest from people wanting to purchase one from you.

You obtained prices for materials and estimated the work hours involved in constructing the vehicles. You established that there was a very strong likelihood that you would be able to make a substantial profit on the sale of the vehicles.

You started to manufacture the vehicles.

You commenced business in 2010.

You are currently building the first vehicle which will be used as a demonstration model (it will still be available for sale).

Subsequent vehicles will be built to the specifications of the purchaser.

You plan to sell one vehicle in 2011.

You intend to be making a profit by 2012.

You expect to meet the assessable income test in 2012-13.

You expect to meet the profits test in 2013-14.

You have set up a workshop on your five acre property to build the vehicles in.

You used $20,000 of capital to set up the activity.

You did not borrow money to set up the activity.

You advertise your business through word of mouth, and by travelling around in your own vehicle.

You keep a cash book, a job costing book for each project and records of your mileage.

You spend approximately 24 hours per week and 10 hours travel time on this venture.

The tasks that you undertake in relation to the activity are:

Purchasing materials

Travelling to purchase materials

Research and design

Construction of the vehicles

Construction and maintenance of the work area.

You spend 28 hours and eight hours of travel time on your other employment.

You do not employ other people.

You expect your venture to become profitable in the third year of operation.

You have an ABN.

Your building activity in relation to this venture has increased as your research time and work area preparation time has decreased.

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.

Carrying on a business

The question of whether you are carrying on a business is a question of fact and degree. There are no hard and fast rules for determining whether your activities amount to the carrying on of a business. The facts of each case must be examined. In Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548, Webb J said:

The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and, as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.

However, the courts have developed a series of indicators that you can apply to your circumstances to determine whether you are carrying on a business. Taxation Ruling TR 97/11 Income tax: Am I carrying on a business of primary production? summarises these indicators. No one indicator is decisive. The indicators must be considered in combination and as a whole.

Based on the information you supplied, your vehicle manufacturing can be said to have commenced as a business.

The Commissioner's discretion - lead time 

Under paragraph 35-55(1)(b) of the ITAA 1997, the Commissioner's discretion can be exercised where the business activity satisfies these requirements.

for an applicant who carries on the business activity who satisfies 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 satisfied, or will not satisfy, one of the tests set out in section 35-30, 35-35, 35-40 or 35-45 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 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 paragraph 35-55(1)(b) of the ITAA 1997 referred to the paragraph being 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 provides the example of the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income. 

Paragraph 17 of Taxation Ruling TR 2007/6 deals with the exercise of the Commissioner's discretion under this paragraph and the meaning of 'because of its nature'.

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 (see Federal Commissioner of Taxation v. Eskandari (2004) 134 FCR 569; 2004 ATC 4042; (2004) 54 ATR 695).

Paragraph 78 of TR 2007/6 states:

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, you will not pass the assessable income test until the 2012-13 income year, or the profits test until 2013-14 income year and will never pass the real property or other assets test. The timing of commencing business, the initial setup of the workshop and the travel expenses incurred and the fact that you work at the business part time all contributed to the losses incurred in the 2009-10 income year. Therefore, in reference to the above paragraphs, you have not shown that the lead time is an inherent characteristic of your industry.

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 income year.

You cannot claim a deduction for your losses against other income in the 2009-10 income year or future years. You must defer the loss to a future year, where you have met one of the four tests, met an exception or the Commissioner has exercised the discretion in your favour.