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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 operate a business which you commenced many years ago as a sole trader.

Your income for non-commercial loss purposes is more than $250,000 due to a one-off substantial capital gain derived due to the sale of an investment rental property during the 2010-11 financial year.

Your activity passed the assessable income test and the profits test in the 2010-11 financial year.

You state that you incurred a business loss due to an economic downturn of surrounding neighbouring shops (resulting in shop vacancies) and the opening of a new shopping centre nearby.

Traditionally, you have generally derived profits from trading in this location, apart from a minor loss in 2008-09.

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 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 economic downturns are not within your control we consider them to be normal risks to businesses. They affect all businesses within an area or sector and are not something unexpected.

In your case, you made a one off capital gain in the 2010-11 financial year. Making this capital gain did not affect your business, causing it to make a loss. Instead it caused you to fail the income requirement under subsection 35-10(2E) of the ITAA 1997. This is not considered to be 'special circumstances' for the purposes of paragraph 35-55(1)(a) of the ITAA 1997.

While we appreciate your situation, there is no other discretion available to the Commissioner in Division 35 of the ITAA 1997 that would allow you to claim your losses in the circumstances you describe.

The Commissioner does not consider that economic downturns or one-off capital gains constitute special circumstances within the meaning of paragraph 35-55(1)(a) of the ITAA 1997.