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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 (ITAA 1997) to allow you to include any losses from your business activity in your calculation of taxable income for the relevant financial year?

Answer No

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 April 2007

Relevant facts

Your income for non-commercial loss purposes for the relevant income year was more than $250,000.

You purchased some land parcels to subdivide and develop.

Since the commencement of the business you have had plans prepared for these properties and have subdivided, sold and settled some blocks of land.

You have incurred expenses such as bank interest on loans, council rates and land tax in addition to the subdivision costs.

You claim that you were affected by special circumstances due to the unforeseeable decline in the property market as a result of the global financial crisis (GFC) and that had it not occurred you would have generated a profit.

You purchased some property in a high market and its market value is now lower than its cost, based on offers you have received.

When assessing the viability of the project you allowed for a percentage drop in property prices for corrections in the market and consumer confidence.

You expect to ride out the downturn in the market and develop the land and make a tax profit when the market improves.

You have received independent advice that from the height of the market prices have dropped significantly on what builders and developers were paying for sites.

Relevant legislative provisions

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

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

Reasons for decision

Summary

The Commissioner cannot be satisfied that your land development activity would have made a profit in the relevant financial year if it were not for the GFC. Consequently, the Commissioner will not exercise the discretion in relation to your activity.

Detailed reasoning

The Commissioner will not exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the relevant financial year on the basis that we are not satisfied that it is reasonable to conclude that a profit would have been made in the relevant financial year, had your activity not been affected by special circumstances.

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

· the exceptions apply

· 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 contained in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the financial year in question where the Commissioner is satisfied that:

· an event has occurred that would be considered special circumstances (in terms of the relevant legislation) for your business activity and this event was outside your control; and

· the impact of these special circumstances prevented your business activity from making a tax profit in the year you are seeking the discretion.

'Special 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, including drought, flood, bushfire or some other natural disaster.

No exhaustive definition of 'special circumstances' is given in the legislation.

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.

In the context of Division 35 of the ITAA 1997, special circumstances are ordinarily those affecting the business activity such that it would be unreasonable for the loss deferral rule to apply. TR 2007/6 states at paragraph 47:

…ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances. These fluctuations are expected to occur on a regular or recurrent basis when carrying on a business activity and affect all businesses within a particular industry.

You advised that your activities have been affected by the GFC.

Whilst we accept that it is open for you to argue that the GFC constituted 'special circumstances' within the meaning of the term in this context, you have not provided evidence of a strong correlation between the GFC and your assessable income for the relevant financial year.

Even if it was accepted in your case that the GFC constituted special circumstances in the context of the legislation, this in itself is not sufficient for the discretion to be exercised. The Commissioner must also be satisfied that the special circumstances prevented you from making a tax profit.

You claim that you would have made a profit in the relevant financial year, had the special circumstances you described not occurred, however you have not demonstrated this to our satisfaction.

You merely advise that you have received advice from independent sources that prices in the property market have dropped by a certain percentage from the height of the market when you bought some of your property and that you are only receiving offers that are less than cost. You have not provided any estimates of what the turnover or expenses in the relevant financial year would have been, if the circumstances you described as special circumstances had not occurred.

You have also not provided any details of your subdivision costs or your losses to date.

From the information provided, the Commissioner cannot be satisfied that if it were not for the GFC, your activity would have made a profit in the relevant financial year. You have not demonstrated any history of profitable land development activities from which we could compare your profit-making ability in this industry in pre-GFC years.

Rather than it being the GFC that prevented you from making a profit, we consider it was your choice with regard to how the business was conducted, including your decision to postpone the subdivision, development and sale of Block Two.

Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the relevant financial year on the basis that we are not satisfied that it is reasonable to conclude that a profit would have been made in the relevant financial year, had your activity not been affected by special circumstances.