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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 the 2009-10 to 2012-13 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 the 2009-10 to 2012-13 financial years?

Answer: No.

This ruling applies for the following periods

Year ended 30 June 2010

Year ended 30 June 2011

Year ending 30 June 2012

Year ending 30 June 2013

The scheme commenced on

1 July 2009

Relevant facts

You commenced your business activities in 2007.

In the first two years, your activities produced no income but incurred losses of over $X.

You established an e-commerce website and engaged the services of a public relations and marketing agent.

You invested more then $X in the production of the product and related products.

In 2008, you rented a shop; on a three year contract with a 12 month opt out option.

After X months you informed your landlord you would not be continuing the lease after 12 months.

In X months, your business produced less than $X in income and incurred losses of more than of $X.

The shop closed after 12 months

In the 2009-10 financial year, your business produced less than $X in income and incurred losses of almost $X.

You do not expect sales to improve over the next 12 months. Your plan is to continue networking and gaining exposure until there is a general shift in consumer confidence.

You have stated that you believe the affects of the global financial crisis (GFC) on consumer spending is the cause of your business losses and the GFC will continue to affect your business activities until the 2013-14 financial year.

Your income for non-commercial loss purposes in the 2009-10 and 2010-11 financial years was less than $250,000 and you expect that this also be the case for the 2011-12 and 2012-13 financial years.

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, 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 2009-10 and 2010-11 financial years and you expect this will be the case in the 2011-12 and 2012-13 financial years as well. 

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, you believe the continuing affects of the GFC on consumer spending has prevented your business from passing any of the four tests in the 2009-10 and 2010-11 financial years and will continue to do so until the 2013-14 financial year.

The GFC might constitute 'special circumstances' in some circumstances depending on the facts of the cases. Changes in consumer confidence and spending can and does occur for many reasons, including increases in official interest rates and seasonal pressures. A drop in consumer confidence and spending itself is not considered to be 'special circumstances' within the meaning of paragraph 35-55(1)(a) of the ITAA 1997.

In your case, you currently have no outlet for your products, other than via a website, and in the 2009-10 financial year your sales totalled less than $X.

The Commissioner is not satisfied that your activities were affected by special circumstances in the 2009-10 and 2010-11 financial years.

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 2009-10 to 2012-13 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 following has been extracted from paragraphs 70 to 104 of this Ruling. 

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. 

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.

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 2009-10 to 2012-13 financial years.