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Ruling

Subject: Commissioner's discretion

Question:

Will the Commissioner exercise the discretion in section 35-55 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?

Answer: No.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You commenced your business activities in early 2010.

You were unable to produce a tax profit in the 2009-10 income year because your activities did not begin until the last quarter of the financial year.

Your business activities are never expected to meet the assessable income test, the real property test or the other assets test.

You expect to make a tax profit in the 2010-11 income year and in future years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 section 35-10

Income Tax Assessment Act 1997 section 35-30

Income Tax Assessment Act 1997 section 35-35

Income Tax Assessment Act 1997 section 35-40

Income Tax Assessment Act 1997 section 35-45

Income Tax Assessment Act 1997 section 35-55

Reasons for decision

Overview of Division 35

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. 

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 unless: 

· the exception in subsection 35-10(4) of the ITAA 1997 applies; or  

· one of the four tests is met; or  

· if one of the tests is not satisfied, the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

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).

In your case, your business activity is not a primary production business activity or a professional arts business activity, therefore, the exception contained in subsection 35-10(2) of the ITAA 1997 does not apply. 

Tests 

Division 35 of the ITAA 1997 sets out four tests to determine the commerciality of a business. These are contained in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) and 35-45 (other assets test) of the ITAA 1997. 

In broad terms, the tests require: 

· at least $20,000 of assessable income in that year from the business activity (section 35-30 of the ITAA 1997);  

· the business activity results in a tax profit in 3 of the past 5 income years (including the current year) (section 35-35 of the ITAA 1997);  

· 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  

· at least $100,000 of certain other assets (excluding cars, motor cycles and similar vehicles and real property that is taken into account for the real property test) used on a continuing basis in carrying on the business activity in that year (section 35-45 of the ITAA 1997).  

Your business activities did not satisfy any of the four non-commercial loss tests contained in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) and 35-45 (other assets test) of the ITAA 1997 in the 2009-10 income 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. 

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 guidelines on how the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997 may be exercised. 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 business 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.

In your case, the inability of your business activity to satisfy one of the four non-commercial loss tests was not due to special circumstances, as set out in paragraph 35-55(1)(a) of the ITAA 1997 

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 has started to be carried on but because of its nature it has not satisfied, or will not satisfy, one of the tests set out in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997; and  

· there is an objective expectation that within a period that is commercially viable for the industry concerned the activity will meet one of the tests listed above or produce assessable income for an income year greater than the deductions attributable to it for that year.  

TR 2007/6 sets out guidelines on how the Commissioner's discretion under paragraph 35-55(1)(b) of the ITAA 1997 may be exercised. The following has been extracted from paragraphs 70 to 104 of this Ruling. 

The discretion is provided to ensure that certain individuals who carry on genuine commercial businesses are not disadvantaged due to particular circumstances which prevent them from satisfying tests 1 to 4. 

This arm of the safeguard discretion will ensure that the loss deferral rule in section 35-10 of the ITAA 1997 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. The paragraph 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. Such activities have an inherent characteristic that cannot be overcome by conducting the business activity in a different way but only by changing the nature of the business. 

In your case, the nature of your business does not prevent it from producing assessable income quite soon after it has commenced. The inability of your business activity to satisfy one of the four non-commercial loss tests is due to the scale of the activity and was not due to lead time, as set out in paragraph 35-55(1)(b) of the ITAA 1997.

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 business activity against your other assessable income for purposes of calculating your taxable income for the 2009-10 income year.