Edited version of private ruling

Authorisation Number: 1011758588943

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Ruling

Subject: non commercial losses

Question 1

Will the Commissioner exercise his discretion under paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) in the 200X-Y financial year to allow you to deduct your losses from your retail business due to special circumstances?

Answer: No.

Question 2

Are you able to claim expenses in the following financial year after you have ceased carrying on a business?

Answer: Yes

This ruling applies for the following period

Year ended 30 June 2010

Year ending 30 June 2011

The scheme commenced on

1 July 2007

Relevant facts and circumstances

In the relevant financial year you established a retail store.

Trading commenced in the following financial year.

Sales decreased significantly in a latter year. You attribute this to several factors:

You made losses in three consecutive financial years.

The lease of your retail premises was due to expire in the 200X-Y financial year. You did not wish to default on the lease. You decided to continue trading to see if the impact of the various factors would reduce over time. You experimented with additional stock lines and offered additional service to enhance sales and to attract potential customers. You were unsuccessful and ceased trading in the 200X-Y financial year.

The majority of stock on hand at after you ceased trading was sent to auction. Most items were sold for less than 10% of original cost.

Your income from other sources is in excess of $250,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 35-10

Income Tax Assessment Act 1997 Section 35-55

Income Tax Assessment Act 1997 Paragraph 35-55(1)(a)

Reasons for decision

Division 35 of the ITAA 1997 applies to losses from certain business activities for the year ended 30 June 2001 and subsequent years. The provisions only apply to individuals who conduct a business activity as either a sole trader or partner in a partnership and made a loss from that business activity.

Section 35-10 of the ITAA 1997 was amended to include an income requirement that must be met (along with certain other tests), in order to include losses from a business activity in your taxable income calculation. The income requirement applies in relation to the 2009-10 financial year and later years.

You satisfy the income requirements under section 35-10(2E) of the ITAA 1997 if your income for non-commercial loss purposes is less than $250,000.

The Commissioner may exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 where special circumstances have prevented a taxpayer from making a tax profit, regardless of whether the income requirement is met or not.

You have not satisfied the income requirement as your relevant income exceeded $250,000 in the 200X-Y financial year. Therefore the loss from your activity will not be taken into account unless the Commissioner will exercise his discretion in section 35-55 of the ITAA 1997.

To apply the discretion in paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner should be satisfied that the business activity is affected in the relevant year by the special circumstances.

No exhaustive definition of 'special circumstances' is given in the legislation.

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.

In the context of Division 35 of the ITAA 1997, special circumstances are ordinarily those affecting the business activity such that it would be unreasonable for the loss deferral rule to apply. TR 2007/6 states at paragraph 47:

…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 when carrying on a business activity and affect all businesses within a particular industry.

You advised that your activities have been affected by the global financial crisis, extensive road works, the exit from the market of dealerships nearby, increased competition by cheaper alternatives here and abroad and a change in the Federal Government.

It is considered that a change in competitive forces, such as the availability of cheaper alternatives and the closure of nearby stores are a result of ordinary market fluctuations that affects all businesses within your industry, and are circumstances that might be reasonably expected to occur when carrying on a business activity. Also whilst we accept that the global financial crisis was not within your control, we consider the fluctuations to be a normal part of the share market and financial industry. Similarly we consider the change in government to be a normal occurrence and not unusual, uncommon or exceptional.

In most instances road works of a general and brief nature would not be considered to be special circumstances. However considering the duration and the extensive nature of the road works, the Commissioner accepts that the road works may be considered to be special circumstances out of your control that impacted on your assessable income for the 200W-X financial year and also 200X-Y income year.

However, the Commissioner must also be satisfied that the special circumstances prevented you from making a tax profit.

From the information you have provided, you have not shown that the road works prevented you from making a taxable profit in the 200X-Y financial year. In your first year of operation you incurred a loss when according to your feasibility analysis you expected to make a profit. This loss was not caused by road works, as they had not yet commenced. The loss could be attributed predominantly to the lower than expected mark-up achieved on goods and the low turnover of stock.

Your financial position actually improved in the 200W-X financial year when the road works were at their most extensive phase. Coupled with this was the finding that your turnover rate was actually higher in the period that the road works took place than in the preceding period.

A further indication that your losses were not predominantly due to the road works was the low price received for stock at auction with most stock selling for less than 10% of the original cost. This poor return at auction indicates a low demand for your goods not caused by road works.

Therefore, taking into account the above factors, the Commissioner will not exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 for the 200X-Y financial year as you have not proven that the road works prevented you from making a taxable profit.

Expenses incurred after the cessation of the business

Taxation Ruling TR 2001/14, at paragraphs 55 and 58, supports the view that the provisions of Division 35 of the ITAA 1997 apply where the business continues to be carried on. Claims for deductions for expenses incurred after the business has ceased are considered under section 8-1 of the ITAA 1997.

Section 8-1 of the ITAA 1997 allows a deduction for losses and outgoings which are incurred in the course of gaining or producing assessable income. However, no deduction is allowed where the losses or outgoings are capital, or are of a capital, private or domestic nature or another provision prevents the taxpayer from deducting it.

The fact that the expenses were incurred after the cessation of the business does not prevent the deduction from being allowable.

In Placer Pacific Management Pty Ltd v. FC of T 95 ATC 4459; (1995) 31 ATR 253 (Placer Pacific) the Full Federal Court had to consider the deductibility of expenses incurred subsequent to the sale and termination of a business. The Court stated that a deduction would not be denied merely because a business had ceased, nor because the expense was incurred in a year later than the income was derived. If the occasion for the business outgoing could be found in the business operations directed towards the gaining or producing of assessable income, that loss or outgoing would be deductible unless it was capital or of a capital nature.

In your situation, you operated a retail business which ceased trading. You incurred losses in relation to the business in the following financial year predominantly through the sale of remaining stock at a loss.  

As the stock was purchased as part of your normal income producing activities a deduction is allowable for the loss on the liquidation of that stock. From Placer Pacific, it can be seen that the fact that your business is no longer operating does not alter the deductibility of the expenses related to the production of assessable income in a prior year.

Accordingly, you are entitled to a deduction for the losses incurred in the following financial year under section 8-1 of the ITAA 1997.