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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 any losses from your business in your calculation of taxable income for the 2010-11 to 2012-13 financial years?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commenced on

1 July 2010

Relevant facts

You borrowed funds to purchase income producing assets from a company (X Co) and associated management agreements from an associated company (Y Co).

The purpose of the purchase was to generate profit from the income producing assets.

You were provided with documentation from X Co stating that the sale transaction was completed successfully and that the management agreement with Y Co would commence.

Every month you received statements from Y Co detailing the income earned from the assets and payment of your proceeds commenced as expected.

You expected that the business would produce a profit after two years.

In late 2011 both X Co and Y Co were placed into voluntary administration.

The administrators subsequently revealed that on the date you transferred the purchase price for the assets X Co was not in possession of the assets that were purportedly sold to you.

X Co had never held title to the assets and was therefore unable to legally pass title to you.

The monthly payments were based on fabricated transaction data.

Relevant legislative provisions

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

Reasons for decision

Summary

The Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 to allow you to apply your business losses against your assessable income in the 2010-11 to 2012-13 financial years.

This is because your activity had not yet actually commenced as a business, therefore you will not have any deductible business loss to which the non-commercial loss rules could apply.

Detailed explanation

Business losses from activities that do not meet any of the four tests under Division 35 of the ITAA 1997, or the exception in subsection 35-10(4) of the ITAA 1997, will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997, unless the Commissioner exercises a discretion under section 35-55 of the ITAA 1997 that it would be unreasonable to defer the loss.

In order for Division 35 to apply, a taxpayer must have commenced business. In determining when a business commences, there are three indicators that must be present before it can be said that a business has commenced. These are:

· purpose, intention and decision;

· acquisition of a business structure; and

· commencement of business operations

We must examine the above indicators in light of the characterisation of your business activity. In Goodman Fielder Wattie Ltd v. Federal Commissioner of Taxation 29 FCR 376; (1991) 22 ATR 26; 91 ATC 4438, Hill J stated:

Critical to the resolution of the present controversy, is the characterisation of the business activity itself which is said to have commenced. It was conceded properly by the applicant that if the business claimed to be carried on by it was to be characterised as one of manufacturing and selling monoclonal antibody products, then that business did not commence until around November 1982...

For example, for a primary production activity involving the planting and cultivating of trees, then the planting of the trees could be seen as the commencement of that business. Alternatively, if your business activity is characterised as a trading activity, involving conducting services in return for a fee, the business would generally be considered to have commenced once you begin conducting the services for a fee.

The information which you have provided indicates that your intended business activity is best characterised as a trading activity. Your intention was to purchase the assets and to receive income from the assets.

Purpose, intention and decision:

The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity. This is developed by researching the proposed business and, in some instances, by experiment. This process culminates in a final decision on whether to commence business. However, not all businesses commence in such an orderly manner.

It is clear from the information you have provided that you had decided the form of that business and had shown some commitment to it by investing in the (purported) acquisition of major capital assets.

Acquisition of a business structure:

For a business activity to commence, an appropriate business structure should be in place. As to what this structure will consist of, and its size, this will be a question of fact and degree, and depend on the nature of the business activity. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity.

In Calkin v. CIR [1984] 1 NZLR 440 Richardson J said at 446-447:

'Clearly it is not sufficient that the taxpayer has made a commitment to engage in business: he must first establish a profit-making structure and begin ordinary business operations.'

In your case, the company that purportedly sold the assets to you had never held title of the assets and was therefore unable to legally pass title to you, so you had not actually acquired the business assets needed to commence your business activity.

Commencement of Business Operations:

As noted by Brennan J in Inglis v. Federal Commissioner of Taxation (1979) 10 ATR 493; 80 ATC 4001, the level of activity is important in deciding whether a business is being carried on.  Brennan J stated at ATC 4004-4005;  ATR 496-497 that:

'The carrying on of a business is not a matter merely of intention.  It is a matter of activity.  Yet the degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the supposed business is being conducted.

In your case, you had not begun ordinary business operations. It has been revealed that the vendor did not have legal title to be able to sell the assets and that the management company paid you monthly payments based on fabricated transaction data.

We consider that, up to this point, your activities were preliminary to the carrying on of your intended business. The costs associated with the establishment of a trading entity are capital in nature as they relate to the structure of the business rather than the daily activities from which the business gains its assessable income (see Federal Commissioner of Taxation v. Maddalena 71 ATC 4161; (1971) 2 ATR 541.

As we do not consider that you got to the point where you had commenced business, your circumstances cannot be considered special circumstances which prevented your 'business' from meeting a test. Rather, our impression is that there were circumstances, including the failure to legally acquire the assets and the fabricated transaction data, which prevented the bona fide commencement of your intended business.

Therefore, although the circumstances may have been beyond your control, you were not actually carrying on a business nor did you have any deductible business loss to which the non-commercial loss rules could apply.