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Authorisation Number: 1012269446673

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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 the 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

1 July 2010

Relevant facts

You operated a business which you commenced in partnership with another person.

Neither partner wished to be involved in the day to day running of the business so a manager was appointed.

You are seeking the Commissioner's discretion for special circumstances due to:

· a temporary massive downturn in the industry sector wide;

· the fact that the manager didn't have the required skill to keep the business viable; and

· a dispute regarding the high rent which ended up with the business being locked out of the premises by the landlord.

As a result of these factors the business ceased.

The partners went into the business venture solely to earn assessable income.

Your income for non-commercial loss purposes is more than $250,000.

You also made a loss in the 2009-10 financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 35-55

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

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

Reasons for decision

Summary

The Commissioner is not satisfied that the events that you have listed that impacted on your business during the 2010-11 financial year are special circumstances for the purposes of the non-commercial losses provisions.

Therefore, the Commissioner will not exercise his discretion in the 2010-11 financial year and the loss in that year is to be deferred.

Detailed reasoning

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 satisfy the income requirement and you pass one of the four tests

· the exceptions apply, or

· the Commissioner exercises his discretion.

In your situation, you do not satisfy the income requirement (that is your taxable income, reportable fringe benefits and reportable superannuation contributions but excluding your business losses, exceeds $250,000) and you do not come under any of the exceptions. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

The relevant discretion may be exercised for the income year in question where your business activity is affected by special circumstances outside your control.

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 a range of other circumstances which may be considered as special.

For individuals who do not satisfy the income requirement, the business activity must have been materially affected by the special circumstances, causing it to make a loss. In this context, the Commissioner may exercise this discretion for the income years in question where, but for the special circumstances:

· your business activity would have made a tax profit; and

· the activity passes at least one of the four tests or, but for the special circumstances, would have passed one of the four tests.

Paragraph 47 of Taxation Ruling 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. Ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity as well as trading downturns and risks associated with running a business will not be considered to be special circumstances.

The question of what constitutes 'special circumstances' has been judicially considered on many occasions.

In the Federal Court Case of Secretary, Department of Employment, Education, Training & Youth Affairs v. Barrett and Another (1998) 82 FCR 524, 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.'

It can be seen that to determine what is 'special circumstances', we need to look at the context in which the phrase is used. 'Special circumstances' in paragraph 35-55(1)(a) of the ITAA 1997 is used in the context of a situation occurring such that it would be unreasonable for the Commissioner to apply the loss deferral rule for a particular year or years.

The operators of the business activity must also show that the special circumstances were outside their control. The concept of control was discussed in Secretary, Department of Employment, Education and Youth Affairs v. Ferguson (1997) 76 FCR 426; (1997) 48 ALD 593; (1997) 147 ALR 295 for the purposes of subsection 45(6) of the Employment Services Act 1994 . At 76 FCR 438; 48 ALD 603; 147 ALR 306, Mansfield J said:

'The expression in s45(6)(a) requires that the main reason for the failure was something that the person had within that person's control. The concept of "control" in that context is one of fact, but I think it is intended to mean something which the person could have done something about.'

Application to your circumstances

Whilst we accept that the fluctuations in the market sector or economic downturns are not within your control we consider them to be normal risks to the industry. They affect all businesses within the industry and are not something unexpected.

On the other hand, the incompetence of a manager in your employ is within your control as you as owner had a responsibility to oversee the day to day activities of your business (including your employees). The risk of employing incompetent staff is a normal risk of business.

Dealings involving the rental of premises, and any disputes arising from these dealings, are also regarded as normal business activities/risks.

The Commissioner does not consider that fluctuations in the market sector, managerial ineptitude or disputes regarding the rental of business premises constitute special circumstances within the meaning of paragraph 35-55(1)(a) of the ITAA 1997.

As your business activity was not affected by special circumstances in the sense required by paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner will not exercise his discretion in the 2010-11 financial year.