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Ruling

Subject

Non-Commercial Losses - Special circumstances and lead time

Question 1

Will the Commissioner exercise the special circumstances or lead time discretion in subsection 35-55(1) of the Income Tax Assessment Act 1997 (ITAA 1997) with respect to the 2010-11 financial year?

Answer

No.

Question 2

Will the Commissioner exercise the special circumstances or lead time discretion in subsection 35-55(1) of the ITAA 1997 with respect to the 2009-10 financial year?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commenced on

1 July 2009

Relevant facts

You conduct a plantation business.

The business commenced several years ago.

Over the years your business has been affected by various circumstances including frost and personal circumstances which meant that you, and a family member who also worked in the business, were required to spend time away from the business.

You also believe that the Global Financial Crisis (GFC) has affected the business by depressing both the value of the shares that you owned that underpinned the development of the business and the demand for your products.

In response to a previous Tax Office review, you provided a reply in early in the 2009-10 financial year detailing the then current status of your business. This reply included the following information:

You had a substantial amount of stock ready for market which would provide a gross income of approximately $50,000.

You forecast gross sales revenue of approximately $25,000 for the 2009-10 financial year.

You forecast gross sales revenue of approximately $30,000 for the 2010-11 financial year.

You provided your original profit and loss forecasts from your initial business plan.

Your income for non-commercial loss purposes was greater than $250,000 in the 2009-10 financial year.

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

Your business meets the real property test.

Relevant legislative provisions

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

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

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

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

Reasons for decision

2010-11 financial year

You have advised that your income for non-commercial loss purposes in the 2010-11 financial year was less than $250,000 and that your business meets the real property test.

As you meet the <$250,0000 income requirement, you have access to the four non-commercial loss tests for the 2010-11 financial year. As your business meets one of these four tests you are not required to defer your business loss in this financial year.

As you are not required to defer your business loss for the 2010-11 financial year, there is no requirement for the Commissioner to exercise a discretion with respect to that year.

2009-10 financial year - Special circumstances discretion

You have applied for the Commissioner's discretion - special circumstances, with regard to your loss for the 2009-10 financial year, as your other income is in excess of $250,000 and you do not have access to the four non-commercial loss tests.

The Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for a financial year where the business activity is affected by special circumstances outside the control of the operators of the business activity and the Commissioner considers that it would be unreasonable to require the loss to be deferred.

Taxation Ruling TR 2007/6 states that for those individuals who do not meet the <$250,000 income requirement, the Commissioner considers that it would be unreasonable to require a loss to be deferred where but for the special circumstances, the business activity would have made a profit in that year.

Paragraph 35-55(1)(a) of the ITAA 1997 refers to 'special circumstances' outside of the control of the operators of the business activity, including drought, bushfire and other natural disasters. However the list is not meant to be exhaustive. There are other circumstances which may be considered as special.

Paragraph 47 of TR 2007/6 explains that to qualify as special circumstances the circumstances must go beyond the normal or expected fluctuations in business, weather or market conditions.

You contend that your business activity was affected by various circumstances.

A number of the circumstances you have referred to are not considered special circumstances for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. For example, the GFC is not considered to be special circumstances in your case. Your planned reliance on the sale of shares to finance the development of the business was a business choice you made. Therefore, the drop in share prices is not considered to be a special circumstance that would be taken into account for the purposes of the Commissioner's discretion. Also, the general drop in consumer confidence and spending across the entire economy in the years after the GFC are not considered to be special circumstances.

Even if all of the circumstances you refer to above were considered to be special circumstances, this would not be sufficient for the discretion to be exercised. The Commissioner must also be satisfied that your activity would have made a profit but for the special circumstances.

Your original profit and loss forecasts from your initial business plan show that for the 2009-10 financial year you expected to make a small profit profit from sales of $120,000. Your actual sales income for that financial year was less than $1,000 and your expenses were greater than predicted which resulted in a substantial loss.

You contend that if the circumstances you have mentioned had not occurred, your expenses would not have increased and you would have achieved your sales target which means that you would have achieved your projected profit.

Your original profit and loss forecasts show that even if your expenses had stayed at the level you expected, you would only make a profit in the 2009-10 financial year if you achieved sales of approximately $110,000 to $120,000.

Therefore, before the Commissioner can exercise the special circumstances discretion, he must be satisfied that if special circumstances had not occurred, you would have achieved that level of sales.

Most of the circumstances you refer to impacted either on the expenses or on the supply side of the business, that is, the stock levels available for sale. It is noted that the information you supplied to the Tax Office in early in the 2009-10 financial year stated that:

You had a substantial amount of stock ready for market which would provide a gross income of approximately $50,000.

You forecast gross sales revenue of approximately $25,000 for the 2009-10 financial year.

You forecast gross sales revenue of approximately $30,000 for the 2010-11 financial year.

All of the circumstances that affected the stock levels of the business occurred well before this information was provided so would have been taken into account in the information you supplied.

Even though early in the 2009-10 financial year, you had a level of stock ready for sale that was worth approximately $50,000 in sales revenue, you made less than $1,000 in sales revenue in the 2009-10 financial year and approximately $10,000 in the 2010-11 financial year.

There is no doubt that some of the circumstances you referred to affected the stock levels of your business. However, if these circumstances had not occurred, that is, you had achieved the stock levels you originally expected, it is still not considered that you could have generated sales of $120,000 per year.

If you had sold all or most of the stock you had available, then it could be accepted that it was the lack of stock which prevented you from achieving your projected sales figure of $120,000. However, if you could not sell all the stock you actually had (which could have generated approximately $50,000 in sales) then it cannot be accepted that you would have sold more than twice that level of stock if you had it.

All of the above indicates that it appears there is not sufficient demand for your products to enable your business to generate a profit. Even if all of the circumstances you mentioned which increased your expenses and reduced the level of your stock had not occurred, it is still considered that you would not have achieved a profit in the 2009-10 financial year. Therefore, the Commissioner will not exercise the special circumstances discretion for that year.

2009-10 financial year - Lead time discretion

For taxpayer's who do not meet the <$250,0000 income requirement, paragraph 35-55(1)(c) of the ITAA 1997 the lead time discretion may be exercised for the income year in question where:

it is in the nature of your business activity that there will be a period before a tax profit can be produced

and

there is an objective expectation your business activity will produce a tax profit within the commercially viable period for your industry.

The note to paragraph 35-55(1)(c) of the ITAA 1997 refers to the paragraph being intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. It provides the example of the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income. 

It is accepted that your business has a lead time before a tax profit can be achieved.

However, before the lead time discretion can be exercised, there must be an objective expectation your business activity will produce a tax profit within the commercially viable period for your industry.

You commenced your business several years ago. Since that time you have consistently produced substantial tax losses. Early in the 2009-10 financial year, after all the circumstances you considered to hamper your business had occurred, you predicted that you would make sales in the 2009-10 and 2010-11 financial years of $25,000 and $30,000 respectively. Your actual sales figures for these two years were less than $1,000 and approximately $10,000.

You now predict that you will achieve sales of approximately $100,000 for the 2011-12 financial year. Based on the past sales performance of the business and the shortfalls between your previous projections and the actual achievements, we cannot accept that the dramatic increase in sales that you have forecast is realistic.

Your business has already been in operation for several years and based on the actual figures you have provided it is does not appear that your business will achieve a profit in the near future. It is not considered that you have shown that there is an objective expectation that your business will produce a tax profit within a commercially viable period for your industry.