Edited version of private ruling

Authorisation Number: 1011905695946

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Ruling

Subject: Non-commercial losses - Commissioner's discretion

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your business in your calculation of taxable income for the 20XX-XX financial year?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2010
The scheme commenced on

01 July 1992

Relevant facts

The arrangement that is the subject of the ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

(a) the application for private ruling received X April 20XX and

(b) additional information dated X August 20XX

Your adjusted taxable income for non-commercial loss purposes is more than $250,000 in the 20XX-XX financial year.

You carry on a business selling collectibles (the business) with a number of outlets.

The business is carried on in partnership with your spouse.

You commenced the business more than fifteen years ago.

The business involves travel as you search for suppliers. You conduct exhibitions and promote your products on-line.

Your outlets are on tourist routes in order to sell your products.

You have repeat customers and you sell your products in Australia and overseas.

You train staff and employ qualified staff in order to maximise opportunities.

The business sells various products.

Information you have provided states that turnover and profits have been affected by the following:

(a) The global financial crisis (GFC) which affected Australian and overseas sales;

(b) Extreme weather events, which caused the business to close for a number of months (with repairs still outstanding). As a consequence, the records were destroyed, equipment needed replacing and damage occurred to one outlet collapsed resulting in significant write-offs of stock and equipment.

(c) The death of a key supplier

(d) Competition and changes to the trade for your products, including:
(i) other outlets being established within a couple of blocks of each other;
(ii) other companies have begun promoting similar products. These sales detract from the disposable art dollar otherwise available to your business;
(iii) other organisations which consider it to be corporately responsible to sponsor similar products;
(iv) over the years auction houses have greatly increased in number and in their marketing and selling of your type of product; and
(v) private collections of products such as yours.

(e) Statutory developments - the economic climate for your products has been made worse by statutory developments and the review into Australia's superannuation system in relation to self-managed superannuation funds which recommended that the acquisition of collectables be prohibited. This report caused an adverse reaction from your buyers as a significant section of your client base traditionally has been people who purchased collectibles for their superannuation schemes.

You also state that, to strengthen the business's role with some institutions and to gain credibility with members of potential buying communities, you have been embarking on a program of strategic donation or sale (at reduced prices) of institutional quality collectibles.

You have also elected to share some of the proceeds of some exhibitions with worthy causes or other charities.

During 20XX you found that running exhibitions internationally was potentially profitable, as there appeared to be a growing number of collectors outside Australia.

You managed to book exhibitions as a first phase in the 20XX-XX financial year and this resulted in a large percentage increase in sales.

This increase was the result of years of investing and carrying out research in different methods of advertising and test marketing in different markets. There were also various trips made to acquire collectibles.

There had been a decrease in sales from the 20XX-XX to 20XX-XX financial years.

There had been mild increases in the previous three years (of around four to six percent).

You planned to book exhibitions for future years but the GFC struck during the 2008-09 financial year and adversely affected sales.

For the six months to 31 December 2008 the turnover was significant.

For the six-month period from 1 January 2009 to 30 June 2009, occurring after the commencement of the GFC, turnover was down to one-third of the previous six months.

The turnover in the 20XX-XX financial year was similar to the 2008-09 financial year.

You state that, if the GFC had not hit, the turnover in the 2008-09 financial year should have been significantly higher.

In the 2008-09 financial year the business passed the assessable income test, the real property test and the other assets test for the purpose of the non-commercial losses.

After the GFC, you worked to minimise costs and investigated alternative strategies, closing down one outlet and choosing to exhibit in other outlets.

You state that, if the circumstances you describe as 'special circumstances' had not occurred, the turnover in the 20XX-XX financial year should have been significantly higher.

From the estimated figures you have provided, the lost sales income for the 20XX-XX financial year, due the 'special circumstances you describe, amounts to approximately $X million.

You expect the activity will show a profit by the 2011-12 financial year.

You expect the business's reputation and the growing economy in Asia will also enable sales to increase.

The business has never made a profit.

Relevant legislative provisions

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

Reasons for decision

For the 20XX-XX and later income years, Division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless:

· you meet the income requirement - section 35-10(2E) - and you pass one of the four tests - section 35-30, 35-35, 35-40, 35-45

· the exceptions contained in section 35-10 of the ITAA 1997 apply; or

· the Commissioner exercises his discretion under section 35-55 of the ITAA 1997.

In your situation, you do not satisfy the income requirement (that is, your taxable income, excluding your business losses, exceeds $250,000) and you do not come under any of the exceptions in section 35-10. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

The relevant discretion contained in paragraph 35-55(1)(a) may be exercised for the income year in question where your business activity is affected by special circumstances outside your control.

'Special circumstances' are those circumstances which are sufficiently different to distinguish them from the circumstances that occur in the normal course of conducting a business activity, including drought, flood, bushfire or some other natural disaster.

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. Taxation Ruling 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 GFC, extreme weather, the death of a supplier, increased competition and statutory changes.

Whilst we accept that it is open for you to argue that the global financial crisis constituted 'special circumstances' within the meaning of the term in this context, you have not provided evidence of a strong correlation between the GFC and your assessable incomes for the 2008-09 and 20XX-XX financial years.

We also accept that the extreme weather events of March 2010 were special circumstances beyond your control and that, in certain circumstances, the loss of a key supplier could be considered to be special circumstances as envisaged in the legislation.

However, it is considered that a change in competitive forces, such as the opening of nearby stores and new markets for your product, results in ordinary market fluctuations that affect all businesses within your industry, and are circumstances that might be reasonably expected to occur when carrying on a business activity.

Similarly we consider the change in statutory policy to be a normal business risk to all businesses in a particular industry and not unusual, uncommon or exceptional.

It is accepted in your case that some of the circumstances described constitute special circumstances outside your control. However, this in itself is not sufficient for the discretion to be exercised. The Commissioner must also be satisfied that the special circumstances prevented you from making a tax profit.

You claim that you would have made a profit in the 20XX-XX financial year, had the special circumstances you described not occurred.

You state that, if the circumstances you described as special circumstances had not occurred, the turnover in the 20XX-XX financial year should have been around $3 million.

This is based on an increase of around 35 percent in sales each year from the
20XX-XX financial year. We acknowledge that sales in the 2007-08 financial year had increased by around 35 percent on sales in the 20XX-XX financial year. You explained that this increase in sales had resulted from bookings of international exhibitions as a first phase. However, you had tried this previously but you had not been successful in a large way.

The level of increase on which you base your estimates of sales you should have earned, if not for special circumstances, has not resulted from any pattern of large increases in sales. Rather, there had been a decrease in sales from the 2005-06 to 20XX-XX financial years and significantly milder increases in the previous three years (of around four to six percent). In order to make a profit in the 20XX-XX financial year you would have required greatly increased sales, without the associated rise in costs. We do not consider this to be a realistic expectation, based on your historical figures and the fact that you were donating some products, selling some products at reduced prices and sharing some of the proceeds of some exhibitions with charities. We do not consider this to be normal commercial practice for a business that has never made a profit.

We also note that the business has not yet made a profit in any of the past years of trading.

However, the special circumstances you describe only affected several of those years. That is, your activity has made losses even in periods that were unaffected by special circumstances.

From the information provided, the Commissioner cannot be satisfied that if it were not for the special circumstances, your activity would have made a profit in the 20XX-XX financial year.

Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the 20XX-XX financial year on the basis that it is reasonable to conclude that a profit would still not have been made in the 20XX-XX financial year, had your activity not been affected by special circumstances.

This means that the loss from your activity cannot be taken into account in calculating your taxable income for the 20XX-XX financial year.