Edited version of private ruling

Authorisation Number: 1011721683999

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Ruling

Subject: Non-commercial losses - Lead time

Question and answer

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 internet business in your calculation of taxable income for the income tax years ended 1 July 2009 to 30 June 2011 inclusive?

No

This ruling applies for the following period

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commenced on

1 July 2009

Relevant facts

You and your spouse have established an internet business.

You state this business venture commenced in 200X.

You provided a copy of your business plan.

You have completed the ATO Non-commercial losses - evidentiary checklist. You indicated that your income for non-commercial loss purposes was less than $250,000.

You provided an income and expenditure statement for the year ended 30 June 2010. This statement shows the income and expenses for the 2009-10 income year for the business.

You provided a copy of your balance sheet as at 30 June 2010. This balance sheet indicates that the assets which are used in carrying on your business activity are less than $100,000.

You did not provide any costings of future income years for your internet business.

You expect to breakeven within 12-24 months from commencement. You have not provided any details as to how you expect to achieve this.

You have supplied a letter from your business advisor. This letter confirms that your business advisor has reviewed your business plan.

You have not provided any evidence or independent industry information showing the period that is commercially viable for your particular industry.

You state that your business needs traffic and as there is no shopfront in a highly visible neighbourhood, the traffic must be generated by other means. Traffic for your business is generated by other means, namely in the online world as your business does not have a shopfront in a visible neighbourhood.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

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

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

Income Tax Assessment Act 1997 section 35-55

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

Reasons for decision

Carrying on a business

If an activity is not carried on as a business, and cannot reasonably be expected to produce assessable income, for example, it is carried on as a hobby, then you cannot claim general deductions in relation to it, regardless of the operation of Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997).

Whether a business is being carried on depends on the large or general impression gained (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all the indicators of carrying on a business, and no one indicator will be decisive (Evans v. Federal Commissioner of Taxation 89 ATC 4540; (1989) 20 ATR 922). These indicators are described in Taxation Ruling TR 97/11.

In your case, you have indicated in your application that your activity is carried on as a business. This ruling has, therefore, been determined on the basis of accepting your statement that you were carrying on a business via the internet to consumers who are interested in various market segments during the 2009-10 income year and will continue the business during the 2010-11 income year.

Overview of Division 35

Division 35 of the ITAA 1997 applies to losses from certain business activities for the income year ended 30 June 2001 and subsequent years.

Under Division 35 of the ITAA 1997, a loss made by an individual from a business activity will not be deductible in the income year in which it arises unless certain conditions are met. 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, the discretion is exercised, or the exception applies.

For 2009-10 and later income years an income requirement applies as per subsection 35-10(2E) of the ITAA 1997 where individual income for non-commercial loss purposes is less than $250,000.

You have indicated that your income for non-commercial loss purposes is less than $250,000. Therefore, you satisfy the income requirement.

Tests

In broad terms, the tests require:

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

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

(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, 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.

If a business does not pass any of these tests, losses must be deferred except in certain circumstances. 

These circumstances are where the Commissioner exercises the discretion under paragraph 35-55(1)(a) or 35-55(1)(b) of the ITAA 1997. If the Commissioner exercises the discretion an individual whose business activity has not passed any of the tests can offset that business loss against other assessable income in the year of that loss.

Application to your circumstances

You have stated that from the particular month in 200X, you have been conducting an internet business. You provided a copy of the profit and loss statement together with a copy of the balance sheet for the business. Information from these documents shows that you did not satisfy any one of the tests in the 2009-10 income year. Further, you did not provide any information regarding the income and expenditure for the 2010-11 income year or any projections for future years. You have requested the Commissioner exercise his discretion in relation to your non-commercial business losses.

Your business activities did not satisfy any of the four non-commercial loss tests in the 2009-10 income year.

Based on the information you have supplied with your private ruling application, we will consider the application of the Commissioner's discretion to your arrangement.

The Commissioner's discretion - special circumstances

Under paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner's discretion can be exercised where: 

· the business activity is affected by special circumstances such that it is unable to satisfy any of the tests; and  

· the special circumstances affecting the business activity are outside the control of the business activity.  

Taxation Ruling TR 2007/6 sets out the Commissioner's interpretation of the exercise of the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 53 of this Ruling. 

Special circumstances are ordinarily those affecting the business activity such that it is unable to satisfy a test and it would be unreasonable for the loss deferral rule to apply. Ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances. These fluctuations are expected to occur on a regular or recurrent basis and affect all businesses within a particular industry. 

Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to special circumstances outside the control of the business activity, including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of the paragraph. These events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affected the business activity.

The inability of your business activity to satisfy one of the four non-commercial loss tests was not due to special circumstances.

The Commissioner's discretion - lead time

In order to demonstrate that the objective expectation exists, a business operator should produce evidence showing that the business activity will satisfy one of the tests or produce a tax profit, showing the period within which a commercially viable business would do so. Preferably, this evidence will be documented at the time, and the evidence that the business activity will satisfy one of the tests or produce a tax profit within a certain time will be consistent with evidence from independent sources relating to activities of that type. Appropriate independent sources include industry bodies or relevant professional associations, government agencies, or other taxpayers conducting successful comparable businesses.

You have not produced any objective evidence to show that there is an inherent or innate characteristic preventing activities in the business of internet marketing from producing assessable income for any period of time: Federal Commissioner of Taxation v Eskandari [2004] FCA 8; 54 ATR 695 (Eskandari Case).

Taxation Ruling TR 2007/6 deals with the exercise of the Commissioner's discretion under subparagraph 35-55(1)(c)(i) of the ITAA 1997 and the meaning of 'because of its nature'. Paragraph 17 of TR 2007/6 states:

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 Eskandari Case).

For example, the discretion will not be available where the failure to make a profit is for reasons other than the nature of the business, such as starting out on a small scale, the hours of operation or the need to build a client base.

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.

The Commissioner considers that the inability of a business activity to satisfy any one of the non-commercial loss tests or make a tax profit on the basis that it is started on a small scale or there is a time frame in which to build the business or the limited amount of time able to be devoted to the activity is not the type of constraint intended for exercise of the discretion for lead time in paragraph 35-55(1)(b) of the ITAA 1997. This type of constraint on a business operation does not prevent it from producing assessable income quite soon after it has commenced.

In your case, you advised that the nature of your business contributed to the loss. You stated that your business needs traffic and as there is no shopfront in a highly visible neighbourhood, the traffic must be generated by other means. This traffic must be generated in the online world and this takes time and considerable effort.

The inability of your business activity to satisfy one of the four non-commercial loss tests was not due to lead time. Therefore, the Commissioner will not exercise the discretion in section 35-55 of the ITAA 1997 to allow you to offset the losses made from your online business against your other assessable income for purposes of calculating your taxable income for the 2009-10 and the 2010-11 income years.