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Ruling

Subject: Non-commercial business losses

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 holiday accommodation activity in your taxable income for the 2011-12 financial year to 2016-17 financial year?

Answer: No

This ruling applies for the following period

Year ended 30 June 2017

Year ended 30 June 2016

Year ended 30 June 2015

Year ended 30 June 2014

Year ended 30 June 2013

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You currently run a farm.

You plan to begin a holiday accommodation activity which is aimed at providing a reliable income stream in future years to offset the potential negative effects of climate change on your current horticultural activities.

You state that holiday accommodation is in high demand during the summer months, as there is a shortage of accommodation in town.

You advise that the holiday accommodation building is currently in the planning stage and you expect construction to begin in the 2011-12 financial year. You advise that you will finance the construction of the building through savings and other business income, rather than taking out a loan. For this reason, you expect construction of the building to take approximately five to seven years.

The holiday cottage will be fully self-contained and located near your own residence. It can accommodate a family with 3-4 children.

You do not expect to ever meet the assessable income test, the profits test, the real property test or the other assets test.

Your have provided a business plan detailing the region, information about the accommodation and, a 10 year financial projection from 2011-12 to 2021-22. The financial projection shows;

· the accommodation will be rented for approximately 12 weeks a year.

· you expect your first income from the activity in the 2016-17 financial year and your first tax profit in the 2017-18 financial year.

· you have included a deduction for capital works at 2.5% from 2011-12 to 2021-22.

· you have not allowed for any ongoing expenses.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 Subsection 35-10(2)

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

Income Tax Assessment Act 1997 Subsection 35-10(2E)

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 Paragraph 35-55(1)(b)

Income Tax Assessment Act 1997 Section 43-30

Reasons for decision

Summary

The Commissioner will not exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997 for lead time for the holiday accommodation activity for the period 2011-12 to 2016-17. This is because your failure to pass any on the non-commercial business loss tests is due to the way you have chosen to finance, and therefore conduct the activity, and is not inherent to the nature of the business.

Detailed reasoning

If an activity is not carried on as a business, and cannot reasonably be expected to produce assessable income, for example, it is carried on as a hobby, then you cannot claim general deductions in relation to it, regardless of the operation of Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997). 

In your case, you have indicated in your application that your activity was carried on as a business. This ruling has, therefore, been determined on the basis of accepting your statement that you were carrying on a business that commenced during the 2011-12 financial year.

Non-commercial losses

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, you state that your business activity will not satisfy 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 for the period from 2011-12 to 2016-17 financial years. 

Commissioner's discretion

You have requested that the Commissioner exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997 for 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 non-commercial loss 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 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. 

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. 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 reason your business activity is expected to produce a loss over the next several years is that you have chosen to progressively finance the construction works for the holiday accommodation building from your savings and other business income, rather than taking out a loan. The commencement of each various stage of construction will occur only after you accumulate sufficient funding for that stage.

As a result of your funding choices, you estimate the construction time frame will be up to seven years. This considerably exceeds what would be considered a standard time for the construction of a similar building. In situations where a taxpayer has secured appropriate funding from the commencement of the construction, it is considered they will have the construction of the building completed in a significantly shorter period, thereby allowing the activity to return a tax profit earlier than your predicted time frame.

As such, any loss incurred for the activity will be due to the way you conduct your business activity and is not inherent in the nature of the business. Therefore, the Commissioner will not exercise his discretion under paragraph 35-55(1)(b) of the ITAA 1997 to allow you to deduct a loss in the 2011-12, 2012-13, 2013-14, 2014-15, 2015-16 and 2016-17 financial years. Accordingly, under Division 35 of the ITAA 1997, your losses must be deferred in these years.