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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 activity in your calculation of taxable income for the years ended 30 June 2011 and 2012?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You satisfy subsection 35-10(2E) of the ITAA 1997 as you did not earn more than $250,000 in the 2010-11 financial year.

You state that you commenced a business and this ruling is made on the basis of accepting this claim.

You engaged a company to produce an item for your business. You were initially advised that your item would be completed in a number of months. When the item was received it was tested and found to be faulty which led to you engaging another company to produce the item.

You have yet to launch the item on the market.

You receive payments from a government department and in the relevant year you expected these payments to be increased and you factored this increase into your financial business plan. The payments were not increased until the subsequent year.

Relevant legislative provisions

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

Reasons for decision

For the 2009-10 and later financial 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, none of the exceptions would apply and although you satisfy the income requirement, you do not meet any of the four tests in the financial years under consideration. Your losses are therefore subject to the deferral rule, unless the Commissioner exercises his discretion.

Paragraph 35-55(1)(a) of the ITAA 1997 sets out the Commissioner's discretion as follows:

The Commissioner may decide that the rule in section 35-10 does not apply to a business activity for one or more income years if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

(a) the business activity was or will be affected in that or those income years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster;

Note: This paragraph is intended to provide for a case where a business activity would have satisfied one of the tests if it were not for the special circumstances.  

Paragraph 35-55(1)(a) of the ITAA 1997 refers to 'special circumstances' outside of the control of the operators of the business activity. No exhaustive definition is given of 'special circumstances' but the paragraph does include drought, bushfire and other natural disasters.

The question of what constitutes 'special circumstances' has been judicially considered on many occasions. In the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation:

Those discretions are intended to be applied to a great variety of situations. In such a context, the core of the idea of 'special circumstances' is that there is something unusual or different to take the matter out of the ordinary course

Later, in the Federal Court Case of Secretary, Department of Employment, Education, Training & Youth Affairs v. Barrett and Another (1998) 82 FCR 524 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed that:

The word 'special' must be read in context. In normal parlance it signifies that the event or circumstances in question are out of the ordinary or normal course.

Tamberlin J then 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 is clear that 'special circumstances' will be something out of the ordinary or unusual. '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.

In your circumstances

The failure of the company to produce the item and the timing of the government payment are not considered to be special circumstances outside your control for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. In terms of paragraph 13 of Taxation Ruling TR 2007/6, such circumstances are those circumstances which are sufficiently different to distinguish them from the circumstances that occur in the normal course of conducting a business activity. Ordinarily, special circumstances are those which have materially affected the business activity, causing it to not satisfy any of the four tests in Division 35.

In terms of paragraph 14 of Taxation Ruling TR 2007/6 special circumstances are specifically defined to include drought, flood, bushfire or some other natural disaster. In the case of other events, failure for no adequate reason to adopt practices commonly used in an industry to prevent or reduce the effects of certain circumstances may point to those circumstances not being outside the control of the operator.

There is a commercial risk taken by you operating this or any business. Engaging a company to produce any item or product is considered to be a normal commercial business process and the outcome of that engagement is considered to be a normal commercial business risk. Unfortunately in your case that outcome was less than satisfactory.

Also the timing of the decision to increase your government payment is a culmination of administrative processes that are considered not to be special circumstances for the purposes of paragraph 35-55(1)(a) of the ITAA 1997 but rather a result of a normal administrative process.

In view of the above, it is not accepted that the failure of company to produce the item or the timing of the government payment was sufficiently unusual to constitute special circumstances and that it prevented the activity from passing the assessable income test in section 35-30 of the ITAA 1997. Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997.