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Ruling

Subject: Commissioner's discretion - special circumstances

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 wholesale product franchise 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

1 July 2010

Relevant facts

You entered a franchise agreement to market a wholesale product within a defined area.

Under the terms of the franchise agreement, you were required to purchase the product from the company along with point of sale materials.

You had some initial sales of less than $2,000 before issues arose regarding the product.

The parent company went into voluntary administration on at the end of the financial year.

You continued to make sales of the product in the 2011-12 financial year.

You valued your trading stock at 30 June 2011 at less than $20,000.

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

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)

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 activities have 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 financial year. 

The Commissioner's discretion - special circumstances 

Where the income requirement is satisfied, the Commissioner's discretion, under paragraph 35-55(1)(a) of the ITAA 1997, can be exercised where a business activity is affected by special circumstances, outside the control of the operators, such that it is unable to satisfy any of the tests.

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

Special circumstances are ordinarily those affecting the business activity such that it is unable to satisfy a test and it would be unreasonable for the loss deferral rule to apply. 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 and affect all business within a particular industry. 

Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 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.

In your case, a few months after entering into your franchise agreement issues arose that were outside of your control. During this time you made sales of less than $2,000. The parent company went into administration at the end of the financial year.

While these conditions were outside your control, they are not considered to be 'special circumstances' for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. The product could still be sold up to 30 June 2011, and beyond as you made sales in the 2011-12 financial year.

Additionally, given the inherent flaw of the product and lack of any supporting evidence, the Commissioner is not satisfied that you would have passed the assessable income test, but for the circumstances.

Therefore, the Commissioner is unable to exercise the discretion available in paragraph 35-55(1)(a) of the ITAA 1997 in relation to your activities for the 2010-11 financial year.