Edited version of private advice

Authorisation Number: 1012624450800

Ruling

Subject: deductions

Question 1

Are you allowed to include losses produced in the 2006-07 financial year from your business activity in your calculation of taxable income for the 2007-08 to the 2013-14 financial years?

Answer

No.

Question 2

Are you entitled to a deduction for the expenses you incurred in travel and accommodation between home and work?

Answer:

No.

Question 3

Are you entitled to claim a deduction of the interest charged on your investor repayment loan?

Answer:

No.

This ruling applies for the following periods:

Year ended 30 June 2007

Year ended 30 June 2008

Year ended 30 June 2009

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ending 30 June 2014

The scheme commenced on

1 July 2006

Relevant facts and circumstances

You are not an artist however you opened a retail business in the 2006-07 financial year. You ceased this business in the 2007-08 financial with losses. You took out a loan to repay those who invested in your business.

The business did not pass any of the tests however you meet the income requirement of Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997).

Due to competition and lack of trade in the area in which you opened the café you incurred losses.

In the 2011-12 financial year you commenced employment. On your own time you travel for rostered work.

When you travel you carry your tools of cutting boards and knives which weigh approximately 30kg. There is no secure area at the workplace that these tools can be stored.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 35-1

Income Tax Assessment Act 1997 subsection 35-55(1)

Income Tax Assessment Act 1997 subsection 35-55(2)\

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

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

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Prior to the 2009-10 financial year Division 35 of the ITAA 1997 deferred business losses unless:

• the exceptions applied,

• you passed one of the four tests, or

• the Commissioner exercises the discretion.

For the 2009-10 and later income years the income requirement was added to these provisions.

The exceptions

The exceptions provide that the rule in subsection (2), (2A) or (2B) of section 35 of the ITAA 1997 does not apply to a business activity for an income year if:

(a) the activity is a primary production business, or a professional arts business; and

(b) your assessable income for that year (except any net capital gain) from other sources that do not relate to that activity is less than $40,000.

Subsection 35-10(5) of the ITAA provides that a professional arts business is a business you carry on as:

(a) the author of a literary, dramatic, musical or artistic work; or

(b) a performing artist; or

(c) a production associate.

In your situation you do not meet the requirements of the exceptions as business is a retail business and you are not an author, performing artist or a production associate as defined within Division 35 of the ITAA 1997.

Four tests

You satisfy the income requirement however you did not meet any of the four tests in the years of income under consideration. The remaining consideration before business losses may be utilised is if the Commissioner's discretion is exercised either under paragraphs 35-55(1)(a) or (b) of the ITAA 1997.

Commissioner's discretion paragraph 35-55(1)(a) (special circumstances)

Under paragraph 35-55(1)(a) of the ITAA 1997 the relevant discretion may be exercised for the income year in question where:

the business activity was or will be affected in the excluded years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster;…

Paragraph 47 of Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion (TR 2007/6) explains that to qualify as special circumstances the circumstances must go beyond the normal or expected. Ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity as well as trading downs and risks associated with running a business will not be considered to be special circumstances.

In view of the above, the Commissioner's discretion in respect of special circumstances will not be exercised for the 2007-08 to the 2013-14 financial years.

Commissioner's discretion paragraph 35-55(1)(b) (lead time)

Under paragraph 35-55(1)(b) of the ITAA 1997 the relevant discretion may be exercised for the income year in question where:

• it is in the nature of the business activity that there will be a period of time before it can be expected to pass one of the four tests

• there is an objective expectation your business activity will produce a tax profit or meet one of the four tests within a 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, 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.

The note in paragraph 35-55(1)(b) of the ITAA 1997 does not support any view that the discretion should be exercised for any start-up activity that is yet, for example, to satisfy the assessable income test in section 35-30 of the ITAA 1997, simply because of the small scale on which it was started, or because a client base is being built up.

Paragraph 17 of TR 2007/6 deals with the exercise of the Commissioner's discretion under this subparagraph and the meaning of 'because of its nature'

For the failure to satisfy one of the four tests to be 'because of its nature', the failure must be because of some inherent characteristic that the taxpayer's business activity has in common with other business activities of that type (see Federal Commissioner of Taxation v. Eskandari).

Paragraph 78 of TR 2007/6 states;

The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity and would not result in the requirements of subparagraph 35-55(1)(b)(i) being met.

The example at paragraph 139 of TR 2007/6 explains the taxpayer was new to the region and industry in which he chose to commence his business. He had no clientele. His funding and his advertising were limited, he kept his part time employment and he worked at his business when he could. He chose where his business premises were located and also his opening and closing times. He made losses each year and didn't satisfy any of the four tests.

The Commissioner's view on this example is found at paragraph 140 of TR 2007/6;  

The inability of Andrew's business activity to satisfy any of the four tests is due to his personal business choices as to hours of business, location and advertising, not any inherent characteristics that affect clock repair businesses. Accordingly the requirement of subparagraph 35-55(1)(b)(i) is not met and the Commissioner would not exercise the discretion.

In your circumstances the size, scale and location of your business contributed to the losses incurred in the 2006-07 financial year. In reference to the above paragraphs you have not shown that the lead time is an inherent characteristic of your industry therefore the Commissioner will not exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997 and your losses are deferred under subsection 35-10(2).

Paragraph 55 of Taxation Ruling TR 2001/14 Income tax: Division 35 - non-commercial business losses states, that any amount deferred under subsection 35-10(2) will only be deductible in a subsequent year if the business activity that gave rise to this amount, or one 'of a similar kind', is carried on in that subsequent year. Therefore in your case if a business similar to a retail indigenous art and café is never carried on again, the entitlement to deduct the amount will be lost.

Travel

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

Paragraph 77 of Taxation Ruling TR 95/34 Income tax: employees carrying out itinerant work - deductions, allowances and reimbursements for transport expenses provide that; a deduction is generally not allowable for the cost of travel by an employee between home and their normal workplace as it is considered to be a private expense. The cost of travel between home and work is generally incurred to put the employee in a position to perform duties of employment, rather than in the performance of those duties.

However, there are situations where it has been accepted that travel by employees from home to work is deductible. These situations include:

• where the employment can be construed as having commenced at the time of leaving home, for example a doctor on call

• where you travel between home and shifting places of work, that is, an itinerant occupation,

• the transportation of bulky equipment in some circumstances.

In your case you travel on your own time to commence work and therefore have not commenced work prior to leaving your home. You do not have a shifting place of work as you travel to the one work-site.

Bulky equipment

A deduction may be allowable for home to work travel if the transport costs can be attributed to the transportation of heavy, bulky or cumbersome equipment, rather than to private travel between home and work.

A deduction is not allowable if the equipment is transported to and from work as a matter of convenience or personal choice.

A deduction is not allowable if a secure area for the storage of equipment is provided at the workplace.

The question of what constitutes 'bulky equipment' must be considered according to the individual circumstances in each case.

In Case 43/94 94 ATC 387 (Case 43/94), a flight sergeant with the Royal Australian Air Force was denied a deduction for the cost of transporting his flying suit and other items used for work purposes.  These items were carried in:

• a duffle bag measuring 75 cm long x 55 cm wide x 50 cm deep (0.1925 m³) and weighing 20 kilograms when packed,

• a suit bag which weighed 10 kg when packed, and

• a briefcase sized navigational bag which contained charts, work manuals and study materials.

It was held that the mode of transporting the items was simply a consequence of the means adopted by the taxpayer to convey him to work.  It was considered that the duffle bag was not of sufficient size or weight to impede facile transport.

You carry tools weighing approximately 30 kg. Your situation is comparable to the facts in Case 43/94 and therefore your tools are not considered to be bulky.

The travel expenses you have incurred are not considered to be as a result of your income earning activities. The expenses are incurred by you in putting yourself in a position where you can perform your duties, rather than in the performance of your duties. Therefore you are not entitled to a deduction for the travel expenses you incur.

Accommodation

Generally accommodation and food expenses incurred by an employee who lives away from home to carry out the duties of his employment will not be deductible. Expenses of this nature have been found to be private or incurred before or after the activity of earning assessable income.

This is supported by the decision in Federal Commissioner of Taxation v. Toms 89 ATC 4373; (1989) 20 ATR 466, where the Federal Court held that expenses incurred in relation to accommodation near the work place while maintaining a family residence in another location were not an allowable deduction as they were considered to be private expenses.

Accordingly, the accommodation expenses you incurred are private and domestic in nature. They are not incurred during the actual performance of your work - that is during the production of assessable income. Therefore you are not entitled to a deduction for these expenses.

Loan

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature. 

Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith considers the deductibility of interest. Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criteria. Where borrowed funds are used to acquire an income producing asset (for example, a rental property), the interest on the borrowed moneys is considered to be incurred in gaining or producing assessable income.

In your situation, the borrowings were used to repay a private debt and not for an income producing purpose.

As the loan amount was used for a non-income producing purpose, the interest incurred is not an allowable deduction under section 8-1 of the ITAA 1997.