Edited version of private advice

Authorisation Number: 1012683961875

Ruling

Subject: Non-commercial losses

Question

Will the Commissioner exercise his discretion to allow you to include any losses from your business activity in the calculation of your taxable income for the 2013-14 financial year?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2014

The scheme commenced on:

1 July 2013

Relevant facts and circumstances

You commenced a new business (in partnership) during the 2013-14 financial year.

You do not meet the income requirement contained in subsection 35-10(2E) of the Income Tax Assessment Act 1997 (ITAA 1997).

Your business did not meet any of the business tests for non-commercial losses.

Your business made a net loss in the 2013-14 financial year.

You believe the failure in meeting any of the business tests, especially the assessable income test, was attributable to the fact that you had only just started to sell your product and that you were only in operation for a small period of your peak selling time.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 35-1

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

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

Income Tax Assessment Act 1997 Section 35-55

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

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

Reasons for decision

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 his discretion to allow the inclusion of the losses.

A taxpayer 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 for the 2013-14 financial year.

If you don't meet the income requirement, the Commissioner may exercise discretion to allow you to offset your loss if:

• special circumstances occurred that were outside your control (paragraph 35-55(1)(a) of the ITAA 1997), or

• due to the nature of the activity, there is

• a lead time before the business will make a tax profit; and

• an objective expectation, based on independent evidence, that it will make a profit in a time that is considered commercially viable for that industry (paragraph 35-55(1)(c) of the ITAA 1997).

Special circumstances

The Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for a 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 of the exercise of the Commissioner's 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. 

Ordinary market fluctuations that might reasonably be predicted to affect the business activity would not be considered special circumstances (paragraph 47 of TR 2007/6).

In your case, it is not accepted that your circumstances constitute special circumstances in the way this term is used in the legislation. While there is a peak selling period for your product, this is considered to be an ordinary market fluctuation for your industry. Accordingly, the Commissioner will not exercise the discretion under paragraph 35-55(1)(a) of the ITAA 1997.

Lead time

In order to exercise the discretion contained in paragraph 35-55(1)(c) of the ITAA 1997, the Commissioner must be satisfied there is an objective expectation, based on evidence from independent sources, that your business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period.

For the Commissioner to exercise this discretion you must be able to show that the reason your business activity is producing a loss is inherent to the nature of the business and is not peculiar to your situation. For example, the discretion will not be available where the failure to make a profit is for reasons other than the nature of the business such as, a consequence of starting out on a small scale, the hours worked or the need to build a client base.

We do not consider that there are factors inherent to the nature of your business that would cause you to make a loss. We consider that the reason your business failed to make a profit is peculiar to your situation, due, in part, to the timing and the scale on which the business activity commenced and the need to build up a client base.

Accordingly, the Commissioner will not exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997.

Conclusion

As the Commissioner will not exercise the discretions under paragraph 35-55(1)(a) or paragraph 35-55(1)(c) of the ITAA 1997 the losses from your business activity cannot be used in the calculation of your taxable income for the 2013-14 financial year; they must be deferred until your business activity produces a profit, or you meet the income requirement and one of the four business tests.