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Ruling

Subject: Non-commercial losses and the Commissioner's discretion

Question

Will the Commissioner exercise his discretion under section 35-55 of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from business activity in calculating your taxable income for the years ended 30 June 2010 and 30 June 2011?

Answer

No

This ruling applies for the following periods

Year ended 30 June 2010
Year ended 30 June 2011

The scheme commenced on

1 July 2009

Relevant facts and circumstances

You have written a book

You self-published the book and commenced selling it in the 200X-XX financial year. The first sales occurred within a month of the book being available for sale.

The number of books sold in the 2009-10 and 2010-11 financial years was less than the number required to break even. You do not expect to make a profit in the 2011-12 financial year.

You incurred losses from this activity in the 2009-10 and 2010-11 financial years.

When you commenced your activity you expected to make a tax profit in the 2011-12 financial year. However, due to changes in the publishing industry and the increase of eBook sales, you are unsure when you will make a tax profit.

You are currently writing a second book and have other books planned. These will be sold as hard copies and/or eBooks.

You have not provided evidence from independent sources as to the commercially viable period for your industry as that type of information is scarce.

You state that risks are inherent in the industry and vary from one book project to the next.

Your income for non-commercial loss purposes is more than $250,000.

This ruling has been prepared on the basis that your book writing and selling activities are being conducted as a business.

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 Section 35-55

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

Reasons for decision

Summary

The Commissioner will not exercise the discretion within section 35-55 of the ITAA 1997 to allow you to offset the losses made from your business activity against your other assessable income for the purposes of calculating your taxable income for the 2009-10 and 2010-11 financial years. You have not provided sufficient evidence that you will make a tax profit in a period that is commercially viable for your industry.

Detailed reasoning

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 a 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 year ended 30 June 2010 and later years.

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

Under paragraph 35-55(1)(c) of the ITAA 1997, the Commissioner's discretion can be exercised where:

... 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) [of the ITAA 1997]).

The note to paragraph 35-55(1)(c) of the ITAA 1997 referred 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.

Before the Commissioner can consider exercising the discretion you must be able to show that the reason your business activity is producing a loss is inherent to the nature of the business and is not peculiar to your situation as stated in subparagraph 35-55(1)(c)(i) of the ITAA 1997. 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, a consequence of starting out on a small scale, the hours worked or the need to build a client base.

Taxation Ruling TR 2007/6 outlines how the Commissioner's discretion under paragraph 35-55(1)(c) of the ITAA 1997 may be exercised. The following has been extracted from paragraphs 70 to 104 of this Ruling.

The discretion is provided to ensure that certain individuals who carry on a genuine commercial business are not disadvantaged due to particular circumstances which prevent them from satisfying any of the four non-commercial loss tests.

The aim of the safeguard discretion is to ensure that the loss deferral rule in section 35-10 of the ITAA 1997 does not adversely impact on taxpayers who have commenced to carry on activities which by their nature require a number of years to produce assessable income. Examples of activities which could fall into this category are forestry, viticulture and certain horticulture activities. Such activities have an inherent characteristic that cannot be overcome by conducting the business activity in a different way but only by changing the nature of the business.

The Commissioner also needs to be satisfied that there is an objective expectation that the business activity will satisfy a test or produce a tax profit in some future income year falling within a period that is commercially viable for the industry concerned. If the business activity is not expected to satisfy a test or produce a tax profit within this period then the discretion will not be exercised.

In your case you do not satisfy the income requirement as your income for non-commercial loss purposes is above $250,000. You have researched and written a book which became available for sale during the 2009-10 financial year and are planning to publish other books in electronic and hard copy formats in the future.

You have not provided any objective evidence to show that there is an inherent or innate characteristic preventing activities in the business of publishing and selling books from producing assessable income for any period of time: FC of T v Eskandari [2004] FCA 8, 54 ATR 695.

Whilst it is accepted that there was a time period between when you commenced writing the book and when it was published, assessable income was produced almost immediately.

You have stated you are unsure as to when you will make a tax profit from your business activity.

As you are unsure when you will make a tax profit, the Commissioner is unable to determine if a tax profit will be made in a period that is commercially viable for your industry.

Therefore, the Commissioner will not exercise the discretion in section 35-55 of the ITAA 1997 to allow you to offset the losses made from your business activity against your other assessable income for the purposes of calculating your taxable income for the 2009-10 and 2010-11 financial years.