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Ruling

Subject: Non-commercial losses - Commissioner's discretion - lead time

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 business activity in your calculation of taxable income for the years ended 30 June 2011 and 2012?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commenced on

1 July 2010

Relevant facts

Your business activity consists of operating a hire car service catering for functions like weddings, debutants and tours.

For the first six months your income was nil and you forecast that your annual income will be approximately $15,000.

You state your business activity has never satisfied, and currently does not satisfy any of the tests set out in section 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) or 35-45 (other assets test) of the ITAA 1997.

You have forecast that you can make a profit in the 2012-13 income year.

Your adjusted taxable income for non-commercial losses purposes is less than $250,000.

Relevant legislative provisions

Income tax Assessment Act 1997 Section 35-30

Income tax Assessment Act 1997 Section 35-35

Income tax Assessment Act 1997 Section 35-40

Income tax Assessment Act 1997 Section 35-45

Income tax Assessment Act 1997 Section 35-55

Reasons for decision

Summary

The Commissioner will not exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997 in relation to your business activity for the years ended 30 June 2011 and 2012 as:

· the Commissioner is not satisfied that it is because of the nature of your business activity, that it has not yet satisfied one of the tests set out in section 35-30, 35-35, 35-40 or 35-45.

You have forecast that you will make a profit in the year ended 30 June 2013. The exercise of the Commissioner's discretion is not necessary in a year that you make a profit.

Detailed reasoning

Division 35 Overview

Division 35 applies to losses from certain business activities for the income year ended 30 June 2001 and subsequent years. Under the rule in subsection 35-10(2), a 'loss' made by an individual (including an individual in a general law partnership) from a business activity will not be taken into account in an income year unless:

· the 'Exception' in subsection 35-10(4) applies; or

· you meet the income requirement and one of four tests in sections 35-30, 35-35, 35-40 or 35-45 is met; or

· if one of the tests is not satisfied, the Commissioner exercises the discretion in section 35-55.

Generally, a loss in this context is, for the income year in question, the excess of a taxpayer's allowable deductions attributable to the business activity over that taxpayer's assessable income from the business activity.

Losses that cannot be taken into account in a particular year of income, because of subsection 35-10(2), can be applied to the extent of future profits from the business activity, or are deferred until you meet the income requirement and one of the tests is passed, the discretion is exercised, or the exception applies.

Exception

Under subsection 35-10(4), there is an 'Exception' to the general rule in subsection 35-10(2) where the loss is from a primary production business activity or a professional arts business activity and the individual taxpayer has other assessable income for the income year from sources not related to that activity, of less than $40,000 (excluding any net capital gain).

On the facts given, the exception in subsection 35-10(4), has no relevance for the purpose of this ruling.

Tests

In broad terms, if you meet the income requirement (adjusted taxable income for NCL purposes less than $250,000) the tests require:

(a) at least $20,000 of assessable income in that year from the business activity (section 35-30);

(b) the business activity results in a taxation profit in 3 of the past 5 income years (including the current year) (section 35-35);

(c) at least $500,000 of real property, or an interest in real property, (excluding any private dwelling) is used on a continuing basis in carrying on the business activity in that year (section 35-40); or

(d) at least $100,000 of certain other assets (excluding cars, motor cycles and similar vehicles) are used on a continuing basis in carrying on the business activity in that year (section 35-45).

In the context of Division 35, a taxation profit for the income year in question is where the amount of assessable income from the business activity for that year, is greater than the sum of the deductions attributable to it for that year (apart from the operation of subsection 35-10(2)).

Application of section 35-55 (Commissioner's discretion) to this arrangement

As your business activity has commenced, and is carried on as a business, it is subject to the provisions in Division 35 of the ITAA 1997. Information provided with the application for this Private Ruling indicates you pass the income requirement and that your hire of vintage cars activity is yet to pass one of the tests or produce a taxation profit, and is unlikely to do so in the income years ended 30 June 2011 to 30 June 2012. Specifically, it appears that your business activity will not produce assessable income of at least $20,000 on a full years trading and projections indicate it will produce a taxation profit in the year ended 30 June 2013.

As no test seems likely to be satisfied for the income years ended 30 June 2011 and 30 June 2012 the rule in subsection 35-10(2) will apply to defer to a future income year any loss that arises from your business activity for those years, unless the Commissioner exercises an arm of the discretion under paragraphs 35-55(1)(a) or (b).

The first arm of the discretion in paragraph 35-55(1)(a) relates to 'special circumstances' applicable to the business activity, and has no relevance for the purposes of this Private Ruling.

The second arm of the discretion in paragraph 35-55(1)(b) may be exercised where:

(i) the business activity has started to be carried on; and

(ii) because of its nature it has not yet met one of the tests set out in Division 35; and

(iii) there is an expectation that the business activity of an individual taxpayer will either pass one of the tests or produce a taxation profit within a period that is commercially viable for the industry concerned.

The 'Note' to paragraph 35-55(1)(b) states:

This 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. 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.'

It has been accepted based on the information you have supplied that you started carrying on your business activity, and that it is yet to pass one of the four tests. However, it is not accepted that it is because of the nature of your activity that it is yet to have passed one of the tests.

The type of feature contemplated by the phrase 'because of its nature', in the context in which it appears, is that referred to in the 'Note' quoted above. That is, that there is an inherent or innate feature of the activity resulting in an inability to produce income in the year of commencement and (in most cases) a number of years thereafter. This is borne out further by paragraph 1.51 of the Explanatory Memorandum for the New Business Tax System (Integrity Measures) Act 2000, which states;

'This arm [paragraph 35-55(1)(b)] of the safeguard discretion will ensure that the loss deferral rule in section 35-10 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 would fall into this category are forestry, viticulture and certain horticultural activities.'

The Note and the passage cited above do 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 in section 35-30, simply because of the small 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 and the Explanatory Memorandum.

We do not consider that there is anything inherent or innate in the nature of your business activity which means that it has not yet been able to satisfy one of the tests. In particular, we think your activity is of a type that is able to produce assessable income quite soon after its commencement. We believe it is because a client base is being built up that is the major reason why it will not pass the assessable income test or make a profit for the income years ended 30 June 2011 and 2012, and not its inherent nature.

Therefore the Commissioner will not exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 in relation to your business activity for the years ended 30 June 2011 and 2012.