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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) (lead time) to allow you to include any losses from your services activities in your calculation of taxable income for the 2010-11 income year?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

01 January 2011

Relevant facts

You have commenced a business of providing services. You are in the process of building up the business.

You will advertise through various communication channels to attract clients.

You have not derived any income for the year ended 30 June 2011, but have incurred expenses.

You have forecast a profit for the year ended 30 June 2012.

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

Relevant legislative provisions

Income Tax Assessment Act 1997 Paragraph 35-55(1)(b).

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

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

Income Tax Assessment Act 1997 Section 35-30.

Income Tax Assessment Act 1997 Section 35-35.

Income Tax Assessment Act 1997 Section 35-45.

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

Summary

We do not consider that there is anything inherent in the nature of your business activity that prevented you from being able to satisfy one of the tests in the 2010-11 income year. You are in the process of building up your clients in this time.

Consequently, the Commissioner will not exercise his discretion for lead time for the 2010-11 income year. Any losses from your activity will need to be deferred to a future year.

Detailed reasoning

Division 35 of the ITAA 1997 prevents losses of individuals from non-commercial business activities being offset against other assessable income in the year the loss is incurred. The loss is deferred.

The deferred losses may be offset in later years against profits from the activity. The losses may also be offset against other income if the income requirement and one of the tests are satisfied, or if the Commissioner exercises a discretion (special circumstances or lead time).

Division 35 sets out an income requirement and a series of tests to determine whether a business activity is treated as being non-commercial.

Income Requirement

The income requirement applies to the 2010-11 and following years and you will satisfy the income requirement if the sum of the following is less than $250,000 in the income year:

§ Your taxable income for that year

§ Your reportable fringe benefits total for that year

§ Your reportable superannuation contributions for that year, and

§ Your total net investment losses for that year

Tests

In broad terms, the tests require:

(a) at least $20,000 of assessable income in that year from the business activity

(b) the business activity results in a taxation profit in three of the past five income years

(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, 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.

Are you carrying on a business?

Your activities will only be subject to these provisions if it is carried on as a business. You 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.

Application of the Commissioner's discretion (lead time) to this arrangement

As your activities have commenced, and are carried on as a business, they are subject to Division 35 of the ITAA 1997.

It is assumed that none of the four tests were, or will be, satisfied in the 2010-11 year.

As no test was, or will be satisfied, for the 2010-11 income year losses in this income year are to be deferred to a future income year, unless the Commissioner exercises one of the two discretions. The special circumstances discretion is not applicable to your situation and will not be considered further.

The lead time discretion may be exercised for one or more income years where:

(a)        the business activity has started to be carried on; and for those years:

(i)      because of its nature it has not satisfied, or will not satisfy, one of the tests, and

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

The note to this paragraph states:

Note: 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.

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 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.

You satisfy the income requirement in the 2010-11 income year as your adjusted taxable income will be under $250,000 for that income year. This ruling is based on the assumption that you were unable to satisfy any of the four tests outlined above in 2010-11 income year.

You have not derived any income in the 2010-11 income year. We do not consider that there is anything inherent in the nature of your business activity that prevented you from being able to satisfy one of the tests in the 2010-11 income year. You are in the process of building up your clients in this time.

Consequently, the Commissioner will not exercise his discretion for lead time for the 2010-11 income year. Any losses from your activity will need to be deferred to a future year.