Edited version of private advice

Authorisation Number: 1012651384237

Ruling

Subject: Non-commercial losses - Commissioner's discretion - over $250,000 - special circumstances

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 property development business in your calculation of taxable income for the 2012-13 financial year?

Answer

Yes

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2010

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:

• A letter

• Application for a private ruling on the Commissioner's discretion for non-commercial business losses

• Attached copies of contracts of sale, loan facility agreement, letters from bank, quotations from builders and ASIC Form.

You are a partner in a property development business.

The plan was to acquire land, construct units or apartments or townhouses and sell them for a profit.

You submitted an application to council to construct an apartment building for the purpose of sale. The application was rejected by council.

You consulted an architect, then came up with the proposal to construct townhouses. Plans were submitted to council and were approved.

You pre-sold some of the townhouses. Pursuant to the sale contract, the sales were subject to and conditional upon the townhouses being constructed and a Plan of Subdivision being registered by a certain date.

After obtaining the pre-sales, the bank approved a loan facility for the project. The loan was sufficient to cover all the construction costs.

You entered into building contracts with a builder for the construction of the townhouses. The time to complete the construction of the townhouses was within one year from the date the contracts were entered into.

You were concerned that the builder was not going to meet the deadline. It was later discovered that the invoices the builder submitted to the bank for payment, wrongly stated that the subcontractors had been paid, which was required, when in fact they had not been so paid.

The purchases of the pre-sold townhouses required the refund of their deposits as the conditions had not been met.

The builder stopped working on the property as they were in financial difficulties.

Quantity surveyors were engaged to ascertain how much of the building works were completed and what additional work was required and how much it would cost to complete to complete each of these townhouses.

A building consultant was engaged to see if any of the completed building works were defective. The cost to rectify all defects in the partially constructed townhouses was established.

An administrator was appointed to the building company. At the same time you lodged a claim with the insurer that domestic builders are required to insure with, in relation to defects.

No further work could be completed on the construction of the project until the insurer had completed their assessment. Also the new builder could not commence until they could get insurance for work to be completed. The project was at a standstill. It was estimated that it would require a further substantial sum to complete the project. That meant another 12-18 months of interest payments to the bank.

You entered into a contract to sell the property to a builder who could complete construction and sell the completed townhouses.

Your other income for non-commercial losses purposes is in excess of $250,000 in the 2012-13 financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 35-1

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

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

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

Reasons for decision

Summary

The Commissioner is satisfied that your activities would have made a profit in the 2012-13 financial year had it not been affected by these special circumstances. Therefore, the Commissioner will exercise the discretion available for the 2012-13 financial year.

Detailed reasoning

Section 35-1 of the ITAA 1997 provides that an income requirement must be met (along with certain other tests), in order to include losses from a business activity in your taxable income calculation. If the income requirement is not met, the Commissioner may exercise discretion to allow the inclusion of the losses.

A person will satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 if their income for non-commercial loss purposes is less than $250,000.

In your case, you do not satisfy the income requirement as your income for non-commercial loss purposes is above $250,000 in the 2012-13 financial year.

The Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the financial year where the business activity is affected by special circumstances outside the control of the operators of the business activity.

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. For those individuals who do not satisfy the income requirement, special circumstances are those which have materially affected the business activity, causing it to make a loss.

Taxation Ruling TR 2007/6 sets out the Commissioner's interpretation on the exercise of the discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 53 of this ruling:

Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to special circumstances outside the control of the business activity, including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of the paragraph. These events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affected the business activity. 

However, the use of the word 'including' indicates that the type of circumstances to which the special circumstances limb of the discretion can potentially apply is broader than those which are natural disasters. For example, circumstances such as oil spills, chemical spray drifts, explosions, disturbances to energy supplies, government restrictions and illnesses affecting key personnel might, depending on the facts, constitute special circumstances of the type in question.

In your case, the external builder you had engaged to build your townhouses, went into administration. You were prevented from engaging another builder until the insurer had completed their assessment, as there were defects in the work already completed. This prevented the completion and sale of any of the townhouses in the 2012-13 financial year. The sale of the pre-sold townhouses did not go ahead as the completion time condition of the contract had not been met. These circumstances are similar to the effects of the illness of key personal in a business as you were required to try to find an alternate builder to complete the project and overcome a number of issues due to the failure of the builder. The costs have increased greatly due to the extra interest expenses incurred with increased loans and the extension in time of the loans.

It is accepted that these conditions were outside your control and are 'special circumstances' for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. However, before the Commissioner can exercise the discretion you must be able to show that it was the special circumstances that caused your activities to make a loss.

You have stated that had the builder not reneged on its obligations under the contract, had not been placed in administration, and had not stopped work on the property, the townhouses would have been constructed on time, the pre-sales would have been completed, the other townhouses sold, and a profit made. Further, importantly, the bank would not have required further payments and pre-payments of interest.

The Commissioner is satisfied that your activities would have made a profit in the 2012-13 financial year had it not been affected by these special circumstances.

Therefore, the Commissioner will exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(a) of the ITAA 1997 for the 2010-11 financial year.