Edited version of private ruling

Authorisation Number: 1011711643018

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Non-commercial losses - Commissioner's discretion

Question 1

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your options/futures trading 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)(c) of the ITAA 1997 to allow you to include any losses from your options/futures trading 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 2007

Relevant facts

You conduct an activity of trading SPI futures and options with an annual turnover in excess of $200,000. The activity is conducted on a daily basis with the aid of your laptop computer, charting packages and up to date market data and prices.

You began trading futures and options in mid July 2007 for the sole purpose of making profits.

Your other income for non-commercial losses purposes is in excess of $250,000 in the 2009-10 income year.

You have closed your options/futures trading account and will never again trade, thus you will not be able to claim the loss against any future profits.

You have requested the Commissioner's discretion for the 2009-10 income year on the basis of 'the nature of the activity' and 'special circumstances'.

Reasons for decision

Summary

It is considered that there are no 'special circumstances' in the 2010 income year that would allow the Commissioner to grant a discretion under paragraph 35-55(1)(a) of the ITAA 1997 to include any losses from your options/futures trading business in your calculation of taxable income.

The Commissioner cannot exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 to include any losses from your options/futures trading business in the calculation of your taxable income for the 2009-10 year. It is considered that there is nothing inherent in this industry that 'because of its nature' prevents you from producing assessable income greater than the deductions attributable to it in a year.

Detailed reasoning

For the non-commercial loss rules to apply to an individual they have to be carrying on a business for taxation purposes. It is accepted that you are carrying on a business of options/futures trading.

The effect of the non-commercial losses legislation is to restrict the circumstances where a business loss can be offset against other income.

Prior to the 2009-10 income year if you could pass one of four tests, obtained the Commissioner's discretion or if an exception applied, the losses could be offset against your other income.

Changes were made to the operation of the non-commercial loss rules to apply for the 2009-10 and later income years to further restrict the circumstances where a business loss can be offset against other income with the introduction of an income requirement. To satisfy the income requirement for an income year the sum of the following has to be 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. For the purposes of calculating your taxable income you do not take into account any excess from the business activity affected by the non-commercial losses. You have provided information indicating that you do not meet the income requirement, therefore the new restrictions will apply to you for the 2009-10 income year.

Under these changes you do not have access to the four tests and the exception does not apply to you as your income from other sources exceeds $40,000. You are limited to getting the Commissioner's discretion. Previously there were two types of discretions referred to as 'special circumstances' and 'lead time' discretions. The 'special circumstances' legislation has had no changes, but with the 'lead time' legislation there is a new paragraph 35-55(1)(c) of the ITAA 1997, a new discretion for individuals who do not meet the income requirement. They no longer get access to the normal 'lead time' discretion at paragraph 35-55(1)(b) of the ITAA 1997.

Previously for an individual starting up a business, if you could show that because of the nature of your business you could not pass one of the four tests and there was an objective expectation that within a commercially viable period for that industry concerned, the business will either meet one of the tests or you could produce assessable income for an income year greater than the deductions attributable to it for that year, a discretion could be obtained. There is a note in the legislation that explains this further. It refers to business activities that have a lead time between the commencement of the activity and the production of any assessable income. For example the planting of hardwood forestry trees for harvest.

Special circumstances

You have asked the Commissioner to consider, under the umbrella of 'special circumstances', your circumstances where you have ceased trading and will never have profits to offset these losses in the future.

Section 35-55 provides that the Commissioner can decide that section 35-10 does not apply where he is satisfied that it is unreasonable for it to apply.

Paragraph 35-55(1)(a) provides that the Commissioner can exercise the discretion where certain special circumstances apply.

Paragraph 35-55(1)(a) refers to 'special circumstances' outside of the control of the operators of the business activity, including drought, bushfire and other natural disasters. However the list is not meant to be exhaustive. There are a range of other circumstances which may be considered as special.

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 is '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.

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.'

Paragraph 47 of Taxation Ruling TR 2007/6 explains that to qualify as special circumstances the circumstances must go beyond the normal or expected fluctuations in business, weather or market conditions. Ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity as well as trading downs and risks associated with running a business will not be considered to be special circumstances.

In your case, you have made a decision to cease your trading business and never trade again. This is not something that would be classed as 'special circumstances' in terms of the non-commercial losses legislation. You have made a business decision to stop trading. There is not some outside influence that is outside your control that has impacted on your business in this year.

It is considered that there are no special circumstances in the 2010 income year that would allow the Commissioner to grant a discretion under subsection 35-55(a)(1) to include any losses from your options/futures trading business in your calculation of taxable income.

New lead time discretion for individuals who do not meet the income requirement, applicable to the 2009 -10 income year and future years.

The new discretion has similar terminology, but the changes for the new discretion are that you no longer get access to the four tests under the discretion. You have to be able to show that you can produce assessable income for an income year greater than the deductions attributable to it for that year, within the commercially viable period for the industry concerned. The same note applies to this discretion. It is for those types of activities that have a lead time between the commencement of the activity and the production of assessable income. If the nature of your activity is that it will not produce assessable income in the early years, you would not be able to produce a profit.

Where the income requirement test is not met, there is only one discretion in the legislation that is applicable for a business starting up, that because of its nature there is lead time and this is shown at paragraph 35-55(1) (c).

In determining whether the Commissioner can grant a discretion the following information is considered.

Paragraph 35-55(1)(c) of the ITAA 1997 states "for an applicant who carries on the business activity who does not satisfy subsection 35-10(2E) (income requirement) for the most recent income year 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 produced, or will not produce, assessable income greater than the deductions attributable to it; 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 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)).

Note: Paragraphs (b) and (c) are 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 explanatory memorandum to this new legislation explains that individuals:

….must demonstrate that the reason they do not or will not make a profit is because of the nature of the business and not for some other reason which is peculiar to that individual's particular business.

The individual is required to establish objectively the commercially viable period for the industry concerned.

The phrase 'objective expectation' was discussed in the Administrative Appeals Tribunal case of Scott v. Commissioner of Taxation [2006] AATA 542; VS2005/31-33, where it was said:

…in determining a commercially viable period, the test is primarily an objective one based on independent sources. According to the Commissioner, this approach was taken by the Federal Court in Commissioner of Taxation v Eskandari (2004) 134 FCR 569 where Stone J said, at 581-582:

In some cases it may be a straight forward exercise to identify the industry in which the business activity takes place. Some industries are well-established and the basis for an ''objective expectation'' can readily be based on a comparison between the taxpayer's business and other businesses within that industry, particularly where businesses or business associations within the industry produce material such as annual reports or industry papers ...

Despite what Stone J said, Mr Scott contended that there were other circumstances which had to be taken into account when determining the commercially viable period expressed in the Olives Australia document. However, according to the Commissioner, this is impermissible because, as the Federal Court held in Eskandari, in most cases only objective material will be considered. It is only where, because of the nature of the industry, there is very little or no objective evidence that recourse may be had to the circumstances of the tax payer. That is not the case in the olive industry, which has been established for centuries. I agree with that submission. It seems to me that if it were permissible to take into account subjective considerations of each individual grower, there might be an almost infinitely variable period which could be described as the commercially viable period.

The sole reliance on objective evidence and the impermissibility of subjective considerations was further emphasised in the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 as follows:

2.30 The taxpayer is required to establish objectively that the business is commercial in nature and will become profitable in a commercially viable timeframe. Objective evidence from independent sources can include evidence from an individual or organisation experienced in the relevant industry, such as industry or regulatory bodies, tertiary institutions, industry specialists, professional associations, government agencies or other independent entities with a similar successful business activity. Evidence from independent sources can also include evidence from business advisers (such as business plans), financiers and banks.

2.34 For taxpayers that do not meet the income requirement, the Commissioner may exercise a discretion after an application by a taxpayer, where the Commissioner is satisfied that - based on evidence from independent sources - the business will produce assessable income greater than available deductions, in a timeframe that is considered commercially viable for the industry concerned.

2.35 The discretion is not intended to be available in cases where the failure to make a profit is for reasons other than the nature of the business, such as, a consequence of starting out small and needing to build up a client base, or business choices made by an individual that are not consistent with the ordinary or accepted practice in the industry concerned - such as the hours of operation, location, climate or soil conditions, or the level of debt funding.

Example 2.5

Tracey carries on a business of primary production from breeding and selling cattle. Their profit projections indicate that they do not expect to make a profit for six years.

Independent evidence provided by Tracey indicates the lead time period begins from the commencement of the activity and includes the time taken to raise females to a breeding age, allowing for the gestation period of those animals to finish, and finishes when the progeny have reached a saleable age. On the evidence provided, the period for a typical business activity of breeding and selling cattle to become commercially viable is no greater than three years. Therefore, Tracey will not be able to produce a tax profit within a period that is commercially viable for the industry concerned and the Commissioner will not be able to exercise the discretion to allow the losses.

Application to your situation

You have been conducting a business of options/futures trading on a daily basis since 1 July 2007. The nature of this type of activity is that it is possible to derive assessable income from the first day. You have argued that results vary for individuals and institutions with some making profits and others making losses.

We have to consider whether it is 'because of the nature' of the industry that there would be reasons that would prevent you from making a profit at the start of a business.

There is nothing inherent in the nature of the activity that would prevent you from making a profit in the third or earlier years of your activity. There is nothing inherent in the activity that prevents you from deriving assessable income from the start. You have stated that some parties will make a profit. You entered into the activity with the sole purpose of making profits.

It can be seen from the general discussions above that this is not the type of industry where it was envisaged that this discretion would apply. It does not exhibit any of the characters of these types of industries.

The Commissioner cannot exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 to include any losses from your options/futures trading business in the calculation of your taxable income for the 2009-10 year. It is considered that there is nothing inherent in this industry that 'because of its nature' prevents you from producing assessable income greater than the deductions attributable to it in a year.