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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 2010-11 financial year?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

01 July 2009

Relevant facts

The arrangement that is the subject of the private 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:

§ your letter and the application for private ruling and

§ additional information you provided in your email and attachments.

You commenced your business as a sole trader.

You were working on certain projects that were subsidised by a Government program (the program).

The program ceased and the main source of your income also ceased.

You are also a qualified in another trade and decided to turn your business towards that activity.

You passed the assessable income test in your first year of trading (the 2009-10 financial year).

In the 2010-11 financial year, you have grossed less than $5,000 from the activity new to the business and no income from your original work activity.

You state that you did not cease your original work activity and your lack of work in this area was because there was no longer a demand for it.

You have purchased technical equipment, trade journals, tools and applied for extra qualifications and training in order to steer the business in a new direction.

Your business has always been part-time in nature.

You have also worked either part or full-time as an employee for another business.

You are looking to expand the business and you may consider making the business your main income-producing activity.

Your income for non-commercial loss purposes for the 2010-11 financial year was less than $250,000.

Relevant legislative provisions

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

Reasons for decision

Are you carrying on a business?

Your activity will only be potentially subject to these provisions if it is carried on as a business. You have stated in your private ruling application that your activity was carried on as a business. This ruling is made on the basis of accepting this claim.

Non-commercial loss

For the 2009-10 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 satisfy the income requirement (that is, your taxable income, excluding your business losses, does not exceed $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.

Paragraph 35-55(1)(a) of the ITAA 1997 provides that the Commissioner can exercise the first arm of this discretion where certain special circumstances apply. Special circumstances in this context are those outside the control of the business operator, including those such as drought, flood, bushfire or some other natural disaster, that have materially affected that activity.

Further, having special circumstances in itself is not sufficient for the discretion to be exercised. The Commissioner must also be satisfied that the special circumstances prevented you from passing a test.

No exhaustive definition of 'special circumstances' is given in the legislation.

Tamberlin J 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 Government's withdrawal of the program in early 2010. However, the cessation of the program mainly affected the 2009-10 income year.

Example 8 at paragraph 130 of TR 2007/6 describes the situation where Sam operated a bluetail fishing business which satisfied the assessable income test in 2003 and was expected to satisfy this test in the 2004 financial year. A local environment protection authority placed a temporary restriction on fishing in Sam's fishing grounds for the 2004 financial year which resulted in Sam's business making a loss in that year.

In this case the Commissioner would exercise the discretion in paragraph 35-55(1)(a) of the ITAA for special circumstances. The loss of business due to the restriction on fishing would be special circumstances which were outside Sam's control. The business activity was expected to have satisfied a test if not for these special circumstances and consequently the Commissioner would be satisfied that it would be unreasonable for the loss deferral rule in section 35-10 to apply. As a result, Sam is able to offset his business losses against his other assessable income in the 2004 financial year.

However, in your case the special circumstances occurred during the 2009-10 financial year.

Further, the establishment of a new activity or new direction within the business or a decision to run a business part-time are factors that may relate to any business and are not considered to be special circumstances as described by the taxation legislation or TR 2007/6.

Whilst we accept that it is open for you to argue that the withdrawal of the program constituted 'special circumstances' within the meaning of the term in this context in the 2009-10 financial year, we are not satisfied that special circumstances materially affected your ability to pass a test in the 2010-11 financial year.

Rather, it was your choice with regard to how the business was run, specifically that it was run on a part-time basis and the fact that you added an activity and obtained extra qualifications, that prevented you from meeting a test.

In your case, the Commissioner cannot be satisfied that if it were not for special circumstances, your activity would have made a profit or satisfied a test in the 2010-11 financial year.

Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the 2010-11 financial year.

This means that the loss from your activity cannot be taken into account in calculating your taxable income for the 2010-11 financial year. These losses will need to be deferred until a future income year where one of the four tests is met or there is a profit from the activity.