Edited version of private ruling

Authorisation Number: 1011899736090

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Ruling

Subject : Commissioner's discretion

Question

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 band activity in your calculation of taxable income for the 20XX-XXincome year?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Facts

You and your spouse have full time employment.

You and your spouse have been teaching your children the skills required to perform in a band.

You created a family band which focused on your children performing original songs written by your family.

Your goal is for your children to achieve highly successful and profitable music careers, not just in music sales and performing as a band, but also with merchandising of the band's brand.

You provided the various roles of the band members

You created a business plan in 20XX.

Initially your approach for the band was to be appealing to a certain age group.,. However your aim is for the band to progress to a different section of the population.

In 20XX you began writing and arranging songs for the band's first album, which continued into the 20XX-XX financial year. The band also prepared for performances.

The band's first performance was in late 20XX, and since then the band has performed on numerous occasions at schools, community groups and public venues,. The majority of these performances were at no charge. However for some performances you sold tickets to the general public for admission. You also sold the band's CDs leading up to and on the day of performances.

You have made monthly performance bookings with a local club for the 2011-12 financial year. You will receive a performance fee from these performances and the performances should generate CD sales.

Where you have charged a price for admission and the ticket sales have not been high enough to cover the venue hire, you have paid the difference yourself.

The total income earned by the band has been less than $X,000 to date.

What income the band has earned you have given to your children.

During the 20XX-XX financial year you will audition x musicians to join the band as you and your spouse intend on concentrating on managing the band.

You plan to obtain expert advice on matters such as contracts, insurance, occupational health and safety, compensation and liability, accounting and taxation, home/travel schooling, as well as forming a company.

You market the band and upcoming events on a case by case basis, with the method of advertising depending on the audience and venue.

The advertising has been effective in making the public aware of the band, and has led to subsequent bookings. However it has not been particularly effective in stimulating ticket sales.

You applied for an Australian Business Number in 20XX.

You purchased a business insurance policy in 20XX.

To date you have purchased in excess of $XX,000 worth of quality equipment (assets) for the band. However the assets do not equal or exceed $XXX,000 in value.

You have set a budget of $XXX,000 for the development of the band, which is expected to be consumed by 20XX.

You keep financial records for the band.

You estimate that you spend on average 42.5 hours per week on activities related to the band.

Your taxable income for non-commercial loss purposes will be under $250,000 for the 20XX-XXfinancial year.

You state that you run the band as a sole trader business.

Assumption

The band activity constitutes the carrying on of a business by you as a sole trader.

Reasons for decision

Summary

It is not considered that the failure of your activity to meet a test or make a tax profit in the 20XX-XXfinancial year was caused by the inherent nature of the activity. Also, the Commissioner is not satisfied that that you have demonstrated that your activity will meet a test or make a tax profit within a commercially viable period. Therefore, the Commissioner will not exercise his discretion under paragraph 35-55(1)(b) of the ITAA 1997 for the 20XX-XXfinancial year.

Detailed reasoning

For the 20XX-XXand later income years, Division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless (relevant to this division):

· you meet the income requirement and you pass one of the four tests (the $20,000 assessable income test, the profits test, the real assets test, or the other assets test)

· the exceptions apply

· the Commissioner exercises his discretion.

In your case, the income requirement is met but you do not pass any of the four tests. None of the exceptions apply in your situation. You have asked for the Commissioner to exercise a discretion as you contend that your business has not passed a test or made a tax profit due to the nature of your activity.

Under paragraph 35-55(1)(b) of the ITAA 1997, the Commissioner's discretion can be exercised for an applicant who satisfies the income requirement, where the business activity satisfies the following conditions:

· the business activity has started to be carried on and, for that or those income years:

· because of its nature, it has not satisfied, or will not satisfy, one of the tests set out in section 35-30, 35-35, 35-40 or 35-45; and

· 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 either meet one of those tests or 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 this paragraph states that it 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. For example, an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

The note indicates that the discretion is to cover business activities where it is not possible to earn assessable income for a certain initial period (for example, forestry or some agricultural business activities).

The note does not support any view that the discretion should be exercised for any start-up activity that is yet, for example, to satisfy the assessable income test because of business decisions made by the taxpayer, such as the scale on which it was started, or because a client base is being built up. Those sorts of constraints on being able to satisfy that test are far removed from the specific one referred to in the note.

In other words, the 'lead time' discretion will only apply to a business where every business in that industry at the same period after commencement would not be able to earn $20,000 in a year. If it was possible that another business in the same industry would be able to achieve this, then the discretion is not applicable for that industry. That is, where the individual circumstances of the business has an influence over whether the $20,000 assessable income test can be met then any failure to meet the test is not due to the inherent nature of the industry.

In your case, you operate a band as a sole trader. Your activity commenced in 20XX. You are requesting the lead time discretion for the 20XX-XX financial year.

The first requirement that must be met in order for the discretion to be granted is that we must conclude that it was the inherent nature of the business activity that prevented your activity from passing any of the tests or making a tax profit for the 20XX-XXfinancial year.

You chose to start a band that was focused on your young children performing original songs written by your family. It is considered that the fact your activity did not meet the $20,000 assessable income test in its third year of operation was influenced by your choices such as the type of band to operate, the market targeted, the type of music played, the band members selected and the schedule chosen to develop the band.

It is considered that it would not be impossible for a band in its third year of operation to earn $20,000 in assessable income. Even though many bands in their third year may not accomplish this, the fact that it is not impossible means that it is not the inherent nature of the activity that prevents a test being met.

We do not consider that your activity was prevented from meeting the $20,000 assessable income test in the 20XX-XXfinancial year by the inherent nature of the activity. The fact that the test was not met was influenced by the individual circumstances of your activity.

As the first requirement set out in paragraph 35-55(1)(b) of the ITAA 1997 has not been met, the discretion provided by this paragraph will not be exercised.

Even if the first requirement was met, it is not considered that the second requirement has been satisfied. The second criteria requires you to provide evidence to satisfy the Commissioner that your activity will meet a test or make a tax profit within a period that is commercially viable for the industry.

You have not provided any evidence that shows what the commercially viable period for the industry is. Also, you have merely stated that you expect your activity to be generating at least $100,000 per year by the end of the 2014-15 financial year. The amount of $100,000 appears to be a goal or expectation rather than a projection based on objective data. You have not shown how you have arrived at this figure or provided independent evidence that it is realistic.

Also, the financial estimates you have provided for your activity are based on the activity being operated as a sole trader and retaining all the revenue generated by the band. Your business plan does not show how the efforts of the other band members are accounted for with regards to the band's earnings whether it be by direct remuneration, or through an income/profit sharing arrangement. However, we also note that you plan to obtain advice on forming a company to operate the band. We do not see how predictions can be made regarding the income or profits your activity as a sole trader will achieve in the future where you have not accounted for the issue of remuneration or income/profit sharing with the other band members and there is a possibility that the band will be operated through a company rather than by you as a sole trader.

Therefore, even if the first requirement was met, the discretion in paragraph 35-55(1)(b) of the ITAA 1997 would not be exercised as the Commissioner is not satisfied that there is an objective expectation that your activity as a sole trader would meet a test or make a tax profit within a commercially viable period.

Other information

You have stated that your activity constitutes the carrying on of a business. You did not ask us to provide a ruling on this issue. Therefore, we have only ruled on your non-commercial loss query. This ruling is provided on the basis of your statement that your activity is a business.

The issuing of this ruling does not mean that the Commissioner accepts that your activity constitutes a business.

In your private ruling application you stated that you have invested quite heavily in your activity, with the plan being your children will launch successful music careers in the future. It appears that the intention behind the formation and continued operation of the band is not so that you can earn income as a sole trader but to assist your children in launching music careers from which they can earn income in the future.

Therefore, your operation of the band appears to be a private and domestic arrangement with your family rather than a business that you are carrying on in order for you to earn income as a sole trader. The fact that you plan to shortly obtain advice on forming a company to operate the band also lends weight to the belief that you are not undertaking the activity to earn business income as a sole trader.

Given the uncertainty regarding whether your activity constitutes a business, if you intend to claim losses from your activity we recommend that you request a further private ruling regarding this particular issue.