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Ruling

Subject: Non-commercial losses - Commissioner's discretion

Question:

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include losses from your business in the calculation of your taxable income for 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 commenced a business in the 2005-06 financial year.

Your first product was available for sale in 2005 and was distributed in all states and gained media coverage. The business would have produced a small profit had it not been for promotional expenses.

Subsequent products have been available for sale.

You reported a small profit in 2010 and a loss in all other years since 2005-06.

You have also won several prizes for other products.

You attribute your losses in the 2010-11 financial year to the cost of producing your product in Australia and the poor performance of the distributor.

In the 2010-11 income year, you earned over $40,000 in other income.

You expect that your activity will make a profit in the 2014-15 financial year.

Relevant legislative provisions

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

Reasons for decision

Summary

The Commissioner will not exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to offset the losses made from your business activities against your other assessable income for purposes of calculating your taxable income for the 2010-11 to 2012-13 financial years.

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

· the exceptions apply

· the Commissioner exercises his discretion.

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

The Commissioner's discretion - lead time 

The relevant 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.

In your case, you have indicated in your application that your activity is carried on as a business. This ruling has, therefore, been determined on the basis of accepting your statement that you are carrying on a business.

Taxation Ruling TR 2007/6 outlines how the Commissioner's discretion under paragraph 35-55(1)(b) of the ITAA 1997 may be exercised.  

The purpose of this discretion is to ensure that the loss deferral rule in section 35-10 of the ITAA 1997 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. The 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. Such activities have an inherent characteristic that cannot be overcome by conducting the business activity in a different way but only by changing the nature of the business. 

In order to demonstrate that the objective expectation exists, a business operator should produce evidence showing that the business activity will satisfy one of the tests or produce a tax profit, showing the period within which a commercially viable business would do so. Preferably, this evidence will be documented at the time, and the evidence that the business activity will satisfy one of the tests or produce a tax profit within a certain time will be consistent with evidence from independent sources relating to activities of that type. Appropriate independent sources include industry bodies or relevant professional associations, government agencies, or other taxpayers conducting successful comparable businesses. 

The Commissioner considers that the inability of a business activity to satisfy any one of the non-commercial loss tests or make a tax profit on the basis that you need time to make a name for yourself (or your product) in the market place is not the type of constraint intended for exercise of the discretion for lead time in paragraph 35-55(1)(b) of the ITAA 1997. This type of constraint on a business operation does not prevent it from producing assessable income quite soon after it has commenced.

Also, the poor performance of the distributor would be considered to be part of a normal business risk.

You have not produced any objective evidence to show that there is an inherent or innate characteristic preventing a business of your type from producing assessable income for any period of time: F C of T v Eskandari [2004] FCA 8; 54 ATR 695. On the contrary, some products in your industry are successful soon after they are available for sale.

Therefore, the Commissioner will not exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to offset the losses made from your business activities against your other assessable income for purposes of calculating your taxable income for the 2010-11 to 2012-13 financial years. You must defer the losses to a future year where the loss can be claimed against a profit from your business activity.