Edited version of private ruling

Authorisation Number: 1011782437877

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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 tourism facility in your calculation of taxable income for the 2009-10 to 2011-12 financial years?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2010
Year ended 30 June 2011
Year ended 30 June 2012

The scheme commenced on

1 July 2004

Relevant facts and circumstances

The arrangement that is the subject of this ruling is described below. The following documents have been relied upon to reach a decision:

· your application for private ruling; and

· further information we received.

Your income for non-commercial loss purposes in the income year before you lodged your application for a private ruling was greater than $250,000.

You commenced a business of operating a tourism facility in a particular year.

The tourism facility had to be started from scratch without the benefit of any proper tourism facility infrastructure in place.

The tourism facility is currently set up for personalised tour guides with the visitors at all times that take visitors around the facility with various stops on route.

The tours have always run in this format, that is, to date the tourism facility has only been open to group bookings or by appointment for personalised tours.

You believe changing to this format would potentially make the facility like so many others and that it is much more viable to run as a unique facility with a completely different experience for visitors.

The tourism facility is advertised to the public by various means including a website.

The tourism facility is currently being adapted to allow for a new opening entrance which will open it to the public in general without the need for an appointment.

The expected opening hours would be 9am to 5pm daily.

The idea behind opening to the public is that the visitors would come in and be able to gain access to a small area where there will be smaller exhibits, a canteen etc. This would be ideal for visitors who initially just want to spend a small amount of time at the tourism facility but gives them a choice to stay and take the longer tour that would leave at predetermined time slots such as every half hour. This longer guided tour would attract a premium ticket fee. You make reference to two other tourism facilities which use this concept of using a bus.

This newer concept of opening to the public would mean that passing travellers would not have to book and would not be required to wait more than half an hour for the main tour. An added benefit is that as numbers increase the ancillary spent on food, drinks and souvenirs would also increase.

The tourism facility is expanding its exhibits over time.

You anticipate that to break even your tourism facility would require annual visitors of approximately 11,000, which, according to your projections, will be ten years after the year in which the activity commenced.

You advise you intend to bring the venture to a breakeven point as quickly as possible as you have limited capital.

You advise that you have attempted to obtain independent evidence of the accepted 'commercially viable period' for your type of tourism facility but you have not been able to obtain any publicly available data on this.

You state that you expect the ATO 'can obtain further data on the lead times', but you believe that a ten year lead time 'is not unrealistic'.

You make reference to one other tourism facility which commenced with limited opening and you state they now have 120,000 visitors per annum and visitor numbers are still increasing.

You state that many of the tourism facilities in Australia that are similar to yours operate through non-profit or government organisations and that information from such sources will not assist in determining the accepted number of years before an activity becomes commercially viable. You advise that some are expected to be maintained and operated at a loss.

You were required to meet all of the standards and legislative requirements necessary to operate the tourism facility and obtain accreditation.

You have provided information from a government tourism report in 2010 of the approximate number of domestic overnight visitors, domestic day visitors and international visitors to the region.

You have provided information from your local council of the approximate number of vehicles to pass the tourism facility entrance each day.

You have provided visitor numbers to the tourism facility and tour income since commencement.

You have provided projections for your expected tourism facility income for the next five years.

You have estimated the income for the 2010-11 financial year to date (i.e. approximately eight months) based on the average number of visitors per month).

You advise that the numbers in April 2011 increased significantly without the facility being 'open' via the new entrance.

You state that the increased numbers are linked to promotional activities and give credibility to the projections you have provided.

Since early in the recent year you have advertised the tourism facility in a series of advertisements on prime television.

Visitors recently have come from surrounding areas, interstate and overseas.

Currently applications are waiting approval for acquisitions of new exhibits.

One of your planned exhibits will be unique in the region and will add to the attraction of the tourism facility.

You have provided a list of your current admission fees.

You have claimed losses from the business activity to date.

Rulee's opinion

You state that losses are expected to be incurred in operating the tourism facility up until the
2014-15 financial year because of the inherent or innate feature of your type of tourism facility operations.

Reasons for Decision

Summary

The Commissioner will not exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997 as you have not shown that the reason your activity is producing a loss is inherent to the nature of the business rather than peculiar to your situation.

Even if the losses were considered to be inherent to the nature of the business, the second condition that must also be met for the discretion to be exercised has not been satisfied. That is, the Commissioner is not able to conclude that your activity will make a tax profit within a commercially viable period for the industry concerned.

Detailed reasoning

For the 2009-10 and following income years there have been changes to the non-commercial losses legislation to limit the circumstances where business losses can be offset against other income.

The introduction of the income requirement test means that individuals with an adjusted taxable income for non-commercial loss purposes in excess of $250,000 for that year will not get access to the four tests. To be able to claim your losses in that year you have to be granted the Commissioner's discretion under section 35-55 of the ITAA 1997 or meet one of the exclusions.

Under paragraph 35-55(1)(c) of the ITAA 1997, the Commissioner's discretion can be exercised where the business activity satisfies the following requirements.

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 ending 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).

The note to paragraph 35-55(1)(c) of the ITAA 1997 refers to the paragraph being intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. It provides the example of the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income. 

Subparagraph 35-55(1)(c)(i) of the ITAA 1997

Taxation Ruling TR 2007/6 discusses the exercise of the Commissioner's discretion. With regards to the meaning of 'because of its nature', it states at paragraph 17:

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 Federal Commissioner of Taxation v. Eskandari).

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.

In your case you do not satisfy the income requirement as your income for non- commercial loss purposes is above $250,000.

In 2004 you opened the tourism facility for bookings. To date you have limited entrance to the tourism facility to bookings by appointment only. However, you intend to expand your clientele to include entrance/admission to the general public.

You explained the inherent or innate feature of your activity is the development of the tourism facility as you build visitor numbers and increase your exhibits.

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.

This example is of a taxpayer who satisfies the <$250,000 income requirement and consequently has access to the four tests. However, the principle it demonstrates is applicable to taxpayers who do not meet the <$250,000 income requirement. These taxpayers must therefore show that the inability of their activity to make a tax profit is due to the nature of the activity only and cannot be attributable to other reasons such as business choices.

In your case, your business model to date has excluded the general public from admission to the tourism facility without prior booking. Although this is to be remedied by the planned new opening entrance which will open the tourism facility to the public in general without the need for an appointment, this limitation contributed to the low visitor numbers that resulted in the losses incurred to date.

You identified that the tourism facility would require annual visitors of approximately 11,000 to break even. The tourism facility's annual visitor numbers to date have been less than a third of this number. These figures indicate that it was evident for some time that your business model which excluded the general public without prior booking was not likely to ever result in a profit. However, you have only recently decided to change your business model to one that is less restrictive to potential customers.

The limiting of clientele to booked clients only is not an inherent characteristic of your industry. We do not consider that the loss made in the 2009-10 financial year and the losses expected to be made in the 2010-11 and 2011-12 financial years are simply the result of the nature of the industry. Rather, it was your choice with regard to how the business was run that has contributed to the losses.

Therefore, the 'because of its nature' requirement contained in subparagraph 35-55(1)(c)(i) of the ITAA 1997 has not been satisfied.

Subparagraph 35-55(1)(c)(ii) of the ITAA 1997

Even if the 'because of its nature' requirement contained in subparagraph 35-55(1)(c)(i) of the ITAA 1997 was considered to have been satisfied, we do not believe that the requirement contained in subparagraph 35-55(1)(c)(ii) of the ITAA 1997 has been met.

This second condition is that there must be an objective expectation that the business activity will make a tax profit within a period that is commercially viable for the industry concerned.

You have provided projections that show that the activity is first expected to make a profit 10 years after commencement. Your income projections are based on increased visitor numbers expected when your tourism facility is made open to the public without bookings.

However, your visitor numbers in the 2010-11 financial year to date have fallen well short of your projected visitor numbers for that year. This casts doubt on whether your income projections can be used as a reasonable basis for calculating the period in which you expect your activity to become profitable.

It is also noted that the income you have predicted for the 2014-15 financial year is more than 7 times the income the tourism facility actually generated in the 2009-10 financial year. Even with the tourism facility becoming more accessible to the public, such an extreme increase in income appears to be quite optimistic.

Even if the 10 year period you have predicted for the tourism facility to reach profitability was accepted, you have been unable to provide objective evidence of the commercially viable period to make a tax profit for your type of activity. We acknowledge that you have attempted to obtain this information but were unsuccessful. However, without this information the Commissioner is not able to conclude that the 10 years you have predicted your activity will take to make a tax profit is within a period that is commercially viable for your industry. Your statement that a ten year lead time 'is not unrealistic' is not evidence of the commercially viable period to make a tax profit.

You have also stated that the ATO can obtain further information on lead times. However, it is not the ATO's role to gather evidence to support your application; section 35-55 of the ITAA 1997 places the onus on the taxpayer to provide sufficient information so that the Commissioner is satisfied that a discretion should be granted. This view is supported by the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No.2) Act 2009 which states: 'The individual is required to establish objectively the commercially viable period for the industry concerned.'

In your case, based on the information supplied, the Commissioner is not able to conclude that the tourism facility will make a tax profit within a commercially viable period for the industry concerned. That is, the second requirement in order for the discretion to be exercised has also not been met.

Conclusion

In order for the discretion under paragraph 35-55(1)(c) of the ITAA 1997 to be exercised, two requirements must both be met. In your case it is considered that neither requirement has been satisfied.

The Commissioner will not exercise the discretion for the 2009-10 to 2011-12 financial years. Consequently your losses from your tourism facility activity for these financial years must be deferred.