Edited version of your private ruling

Authorisation Number: 1012586655590

Ruling

Subject: non-commercial losses - Commissioner's discretion - lead time

Question

Will the Commissioner exercise his discretion under paragraph 35-55(1)(c ) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from a project management business, in calculating your taxable income for the years ended 30 June 2010 to 30 June 2015?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on

1 July 2002

Relevant facts

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· Private Ruling Application form

· Private Ruling letter and attachments

· Copy of Project Management Agreement

· Further information provided

You do not satisfy the less than $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You entered into a project management agreement with an associated entity to provide services in relation to a development.

You received an annual fee and made an annual claim for expenses incurred in providing the services. You operated on a cash accounting basis.

The period of time to get approvals for development were very lengthy due to the nature of the project.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 35-10(1)

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

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

Income Tax Assessment Act 1997 Paragraph 35-55(1)(c )

Reasons for decision

Summary

There is nothing inherent in a project management business activity that would stop it from producing assessable income for any extended period of time from the commencement of the activity. Your agreement commenced in the year ending 30 June 200X and you have requested the discretion for a period seven years later.

Therefore, the Commissioner is unable to exercise the discretion available in accordance with paragraph 35-55(1)(c) of the ITAA 1997 in relation to your project management business for the 2009-10 to 2014-15 financial years.

Detailed reasoning

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 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 financial years 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

· there is an objective expectation your business activity will produce a tax profit within the commercially viable period for your industry.

This discretion is intended to cover a business activity where there is an inherent period of time between the commencement of the activity and the production of assessable income. For example, (as per the note in the legislation) an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

For the discretion to be applied there needs to be an inherent or innate feature of the activity resulting in an inability to make a profit in the year of commencement and (in most cases) a number of years thereafter. Further examples that fall into this category are forestry, viticulture and certain horticultural activities. There is clearly a period of time where income cannot be derived due to the very nature of the business (product has to be grown before it is available for sale) and you cannot conduct the business in a different manner, that would enable income to be earned in this initial period of the business activity.

Stone J in Eskandari (Federal Commissioner of Taxation v. Eskandari; (2004) 134 FCR 569; [2004] FCA 8; 2004 ATC 4042; (2004) 54 ATR 695) confirmed this view when considering whether the Commissioner's discretion should be exercised in regard to losses incurred in a migration consultancy business. When looking at the type of activities referred to by the note in the legislation and the explanatory memorandum, Stone J stated at FCA 31:

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.

The discretion is not intended to be available where the failure to make a tax profit is for other reasons.

The non-commercial loss (NCL) rules apply to separate identifiable business activities. We have to determine that a business is being carried on and what the actual separate business activity consists of, to apply the NCL rules.

You have entered into a project management agreement to provide services during the planning and construction phase of the project. You have agreed that you are carrying on a business of providing project management services. You have stated that:

the intention of all parties, at the time of signing the agreement, and all subsequent time, is for the Project Manager to proceed with the project to a point where the project is complete.

You have interpreted 'complete' to mean a point where it can commence trading.

We cannot find any clauses in the agreement that supports this claim, but it is not relevant to the outcome of this ruling. Your source of income for the business activity of providing management services is payments from the Principal, during the development/construction phase, not from the operation of the project.

Under the agreement you are entitled to be paid a fee for services and reimbursement of expenses within 30 days of issuing an invoice to the Principal. In each of the years you have been paid a fee and have disclosed this in your income tax return.

You have also stated:

The Project manager has been maintaining a ledger of all costs in relation to the project. The ledger has been provided to the Principal on an annual basis and the Project Manager has treated these annual ledgers as a claim of reimbursement costs. The Principal has raised the total of this ledger in its accounts as a creditor.

The Principal has made payments of these reimbursements when it has cash available. The Project Manager has been relying on Clause 7 of the agreement, which allows it to charge interest on late payments, beyond the terms established in Clause 6.2 of the Agreement.

For the income tax years ended 30 June 200X, to 200Y (inclusive) the taxpayer elected to be a Simplified Tax System (STS) taxpayer and has utilised the concessions provided by Div 328 and has recorded the income of the activity on a cash basis.

For the later income tax years the taxpayer is a Small Business Entity and has continued to record the business income on a cash basis.

You have been paid a fee on an annual basis for the project management services and have made an annual claim for reimbursement for expenses incurred in providing these services. The amounts of reimbursement have been claimed but not paid by the entity. You have not declared the income as you have chosen to account for income on a cash basis. Your loss is due to your choice of accounting method and the fact that you have not demanded payment from an associated entity in which you and your family members hold all the units.

This is not something that is generally common to businesses providing project management services. They would normally make claims for payments on a regular scheduled basis as per their agreement and demand payment.

There is nothing inherent in a project management business activity that would stop it from producing assessable income for any extended period of time from the commencement of the activity. Your agreement commenced a number of years ago.

Therefore, the Commissioner is unable to exercise the discretion available in accordance with paragraph 35-55(1)(c) of the ITAA 1997 in relation to your project management business for the relevant financial years.