Edited version of private ruling

Authorisation Number: 1011766193167

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Ruling

Subject: Non-commercial losses - Commissioner's discretion

Question

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

Answer

No.

This ruling applies for the following period

The year ended 30 June 2010

The scheme commenced on

01 July 2008

Relevant facts

Your 2009-10 income for non-commercial losses purposes is in excess of $XXX,000.

You have carried on a share trading business with the intention of making a profit since July 20XX. In the year ended 30 June 20XX, your turnover was in excess of $X million with in excess of 350 transactions, which resulted in a profit. This amount was included in your income in the 20XX tax return.

In the year ended 30 June 20XX, your turnover was in excess of $X million with in excess of 350 transactions, which resulted in a loss.

You have requested that the Commissioner exercise his discretion under section 35-55 of the ITAA 1997, because of the nature of this activity.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 35-10

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

Income Tax Assessment Act 1997 Subsection 35-55(1)

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

Reasons for decision

Summary

The Commissioner cannot exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 to include any losses from your share trading business activity in the calculation of your taxable income for the 2009-10 year as there is not anything inherent in the nature of trading activities that would prevent the activity from producing assessable income greater than the deductions attributable to it.

Detailed reasoning

For the non-commercial losses 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. 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 losses 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. If you do not meet this income requirement you do not get access to the four tests.

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 year.

Under these changes you do not have access to the four tests and you are limited to getting the Commissioner's discretion or one of the exceptions. You do not qualify for the exceptions as you are not in a relevant industry and your income is in excess of $40,000.

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 with 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.

Under the new discretion, you have to show that it is 'because of the nature' of the industry the assessable income will be less than the attributable deductions during the excluded years. If it can also be shown that assessable income will exceed attributable deductions in a commercially viable period then a discretion may be exercised.

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

The Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the income years in question where the business activity is affected by special circumstances outside the control of the operator of the business activity.

You have not asked the Commissioner to consider the special circumstances discretion and there does not appear to be any special circumstances applicable in this year.

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

There is no period of time from starting the activity to when it can start producing assessable income. The first trade could produce assessable income and that is the intention when entering into that trade. You have made a profit in the 2008-09 year of 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.

There will be traders that made profits in the 2009-10 income year and there will be traders who made losses in the 2009-10 income year. The results will be dependent on the individual decisions that each one made.

The share industry is volatile in nature and affected by many factors. The outcome of trades will depend on the knowledge and skills of the individuals, but there is nothing inherent in the industry that will prevent you from producing assessable income or producing assessable income in excess of the deductions attributable to that business activity in a year.

Most business activities will have a dependence on knowledge, skills and equipment to be successful and are affected by fluctuating prices, but there is nothing inherent in the nature of these activities similar to those suggested in the note. In these particular activities it is impossible to produce assessable income because it takes a period of time (lead time) to produce the output that is going to be sold or traded.

In reading some of the comments made about the new legislation and specifically this new discretion the explanation is somewhat abbreviated and it talks about where a taxpayer can demonstrate that their business activity is genuinely commercial, they can apply to the Commissioner to apply the losses against other income. They fail to mention that there has to be something inherent in the nature of your activity and you have to demonstrate that you can make a tax profit in a year for that activity within the 'commercially viable period' for the industry concerned.

The meaning of commercially viable period has not changed. The relevant paragraphs of Taxation Ruling TR 2007/6 Income tax: non-commercial losses: Commissioner's discretion, is still applicable.

The meaning is further clarified in the explanatory memorandum to the amended legislation through the examples. The meaning has not been expanded to include any other types of industries. The following example from the explanatory memorandum provides guidance in this respect:

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.

The Commissioner cannot exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 to include any losses from your share and derivative trading business activity in the calculation of your taxable income for the 2009-10 year as there is not anything inherent in the nature of trading activities that would prevent the activity from producing assessable income greater than the deductions attributable to it.