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Ruling

Subject: Commissioner's discretion

Questions:

1. 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 activities in the calculation of your taxable income for 2010-11 and 2011-12 financial years?

Answer: No.

2. Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to include any losses from your business activities in the calculation of your taxable income for 2010-11 and 2011-12 financial years?

Answer: No.

This ruling applies for the following periods

Year ended 30 June 2011

Year ending 30 June 2012

The scheme commenced in

1 July 2010

Relevant facts

You commenced your business activity, of selling products on the internet for an overseas based entity on a commission basis, in the 2010-11 financial year.

The agreement was that you would direct potential customers to the overseas based website to purchase the products and you would receive a commission on sales made.

You wrote about the products on a few related forums and advertised on a free advertising web-site.

You registered your business name and applied for an Australian business number.

You designed your own Australian based website to direct potential Australian customers to the site where they could buy the products. You incurred expenses setting up the website.

In the 2011-12 financial year, you were informed by the overseas based entity that no sales had been made as a result of your site and no commission income was derived.

The overseas based entity has now shut down their website and, as a result, your business has ceased.

Your income for non-commercial loss purposes was below $250,000 in the 2010-11 financial year and you expect this will be the case in the 2011-12 financial year as well.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Division 35

Income Tax Assessment Act 1997 - Subsection 35-10(4)

Income Tax Assessment Act 1997 - Subsection 35-30

Income Tax Assessment Act 1997 - Subsection 35-35

Income Tax Assessment Act 1997 - Subsection 35-40

Income Tax Assessment Act 1997 - Subsection 35-45

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

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

Reasons for decision

Under Division 35 of the ITAA 1997, a loss made by an individual from a business activity will not be deductible in the financial year in which it arises unless certain conditions are met. Losses that cannot be taken into account in a particular year of income, because of subsection 35-10(2) of the ITAA 1997, can be applied to the extent of future profits from the business activity, or are deferred until one of the tests is passed, the discretion is exercised, or the exception applies. 

Under the rule in subsection 35-10(2) of the ITAA 1997 a loss made by an individual from a business activity will not be taken into account unless: 

· the exception in subsection 35-10(4) of the ITAA 1997 applies; or  

· you satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 and one of the four tests is met; or  

· if you do not satisfy the income requirement or if one of the tests is not met, the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

Your business activity is not a primary production activity or a professional arts business activity. Therefore, the exception contained in subsection 35-10(2) of the ITAA 1997 does not apply.

Your income for non-commercial loss purposes is less than $250,000 and therefore you satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997. However, your business activity has not satisfied any of the four non-commercial loss tests contained in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) and 35-45 (other assets test) of the ITAA 1997 in the 2010-11 and 2011-12 financial years. 

The Commissioner's discretion - special circumstances 

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

· the business activity is affected by special circumstances such that it is unable to satisfy any of the tests; and  

· the special circumstances affecting the business activity are outside the control of the business activity.  

Taxation Ruling TR 2007/6 sets out the interpretation of the exercise of the Commissioners discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 53 of this Ruling. 

Although not limited to natural disasters, paragraph 35-55(1)(a) refers to special circumstances outside the control of the business activity, including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of the paragraph. These events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affected the business activity. 

However, the use of the word 'including' indicates that the type of circumstances to which the special circumstances limb of the discretion can potentially apply is broader than those which are natural disasters. For example, circumstances such as oil spills, chemical spray drifts, explosions, disturbances to energy supplies, government restrictions and illnesses affecting key personnel might, depending on the facts, constitute special circumstances of the type in question.

In your case, your business activity failed to meet any of the four tests due to a lack of interest in the product you were offering. This is not considered to be 'special circumstances' within the meaning of paragraph 35-55(1)(a) of the ITAA 1997.

Therefore, the Commissioner is unable to exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 to allow you to offset the losses from your business activities against your other assessable income for purposes of calculating your taxable income for the 2010-11 and 2011-12 financial years.

The Commissioner's discretion - lead time 

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

· the business activity has started to be carried on but because of its nature it has not satisfied, or will not satisfy, one of the tests set out in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997; and  

· there is an objective expectation that within a period that is commercially viable for the industry concerned the activity will meet one of the tests listed above or produce assessable income for an income year greater than the deductions attributable to it for that year.  

Taxation Ruling TR 2007/6 sets out guidelines on how the Commissioner's discretion under paragraph 35-55(1)(b) of the ITAA 1997 may be exercised.

The discretion is provided to ensure that certain individuals who carry on genuine commercial businesses are not disadvantaged due to particular circumstances which prevent them from satisfying one of the tests. 

This arm of the safeguard discretion will 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. The paragraph 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. 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. 

In your case, the nature of your business does not prevent it from producing assessable income quite soon after it has commenced. The inability of your business activity to satisfy one of the four non-commercial loss tests was not due to lead time, as set out in paragraph 35-55(1)(b) of the ITAA 1997.

Therefore, the Commissioner is unable to exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to offset the losses from your business activities against your other assessable income for purposes of calculating your taxable income for the 2010-11 and 2011-12 financial years.