Edited version of your written advice

Authorisation Number: 1012806660771

Ruling

Subject: NCL Commissioner's discretion - 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 business activity in your calculation of taxable income for the 2013-14 financial year?

Answer:

Yes.

This ruling applies for the following period

Year ended 30 June 20XX

The scheme commenced on

1 July 2013

Relevant facts

Your business has commenced.

Your other income for NCL purposes is less than $250,000.

You were impacted by special circumstances in the 20XX income year. Had it not been for an event, you would have earned assessable income in excess of $20,000 in that year.

You have provided information which evidences the special circumstances.

Relevant legislative provisions

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

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

Income Tax Assessment Act 1997 Section 35-30

Income Tax Assessment Act 1997 Section 35-35

Income Tax Assessment Act 1997 Section 35-40

Income Tax Assessment Act 1997 Section 35-45

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

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Non-commercial losses

Individuals who make a net loss from a business activity may, under certain circumstances, claim that loss by offsetting it against their income from other sources.

Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997) provides for the treatment of losses that are incurred from a non-commercial business activity for a particular year of income. Division 35 of the ITAA 1997 sets out a number of tests that must be satisfied by a taxpayer in order for losses incurred from one business activity to be deducted against income from a separate activity. If the rules are not satisfied, the taxpayer will not be eligible to deduct losses against other income and the loss will only become deductible in a year the non-commercial business activity generates a profit or assessable income greater than $20,000.

It is important to remember that the application of the non-commercial loss measures needs to be determined on a year by year basis for a particular activity. As a consequence, each year the taxpayer must determine whether at least one of Division 35 of the ITAA 1997 tests is met, in order for losses to be deductible against their other income.

Carrying on a business activity

For the non-commercial loss rules to apply, a taxpayer must be able to demonstrate that a business is being carried on. Whether an activity amounts to the carrying on of a business is a question of fact, not law. The facts of each case must be considered in order to determine if a business activity exists.

In your case, we need to first determine if a business activity existed at the time of the event, and if so, then examine the non-commercial loss provisions for the 2013-14 income year.

Section 995-1 of the ITAA 1997 defines the term business to include any profession, trade, employment, vocation or calling but does not include occupation as an employee. This definition provides some guidance to the meaning of business but is neither exhaustive nor determinative of whether a business is being carried on. As a result, it is necessary to refer to common law for further guidance.

However, there is no one case that sets out a comprehensive list of all the criteria to be used to determine whether a taxpayer is carrying on a business. Instead, examination of the various court decisions shows that the courts have held that consideration of the following is useful to determine if a business is being carried out:

• whether there is significant commercial purpose or character

• the intention of the taxpayer

• repetition and regularity of the activity

• whether the activity is of the same kind and carried on in a manner that is characteristic of the industry

• whether the activity is planned, organised and carried on in a businesslike manner;

• the size, scale and permanency of the activity and

• whether the activity is better described as a hobby, a form of recreation or a sporting activity.

The above list is merely indicative. There is no one indicator that is decisive, nor is the above list exhaustive. In addition, the commencement date of the business activity is also a question of fact, not law.

In order to determine the commencement date of the business, the large and general impression gained from objectively viewing the activity must be considered. Guidance on the commencement date is provided in Taxation Ruling TR 2001/14 Income Tax: Division 35 non-commercial losses. Paragraph 98 of TR 2001/14 states that for a business activity to have commenced a person must have:

• made a decision to commence the business activity

• acquired the minimum level of business assets to allow that business activity to be carried on and

• actually commenced business operations.

In your circumstances, you made a decision to commence business activity as you have a business plan. You acquired the minimum level of business assets for your activity. You actually commenced business operations at the time of the event, even though you did not generate any income.

Considering all the indicators in combination and as a whole, it is accepted that you were carrying on your business activity during the 20XX income year.

Overview of Division 35

Under Division 35 of the ITAA 1997, a loss made by an individual from a business activity will not be deductible in the income year in which it arises unless certain conditions are met. Losses that cannot be taken into account in a particular year of income, because of subsection 35-10(2) of the ITAA 1997, can be applied to the extent of future profits from the business activity, or are deferred until one of the tests is passed, the discretion is exercised, or the exception applies. 

Under the rule in subsection 35-10(2) of the ITAA 1997 a loss made by an individual from a business activity will not be taken into account unless: 

• the exception in subsection 35-10(4) of the ITAA 1997 applies; or  

• one of the four tests is met; or  

• if one of the tests is not satisfied, the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

Exception 

Under subsection 35-10(4) of the ITAA 1997, there is an exception to the general rule in subsection 35-10(2) of the ITAA 1997 where the loss is from a primary production business activity or a professional arts business activity and the individual taxpayer has other assessable income for the income year from sources not related to that activity, of less than $40,000 (excluding any net capital gain). The exception does not apply in your situation as your business activity is not a primary production business or a professional arts business activity. 

Tests 

Division 35 of the ITAA 1997 sets out four tests to determine the commerciality of a business. These are contained in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) and 35-45 (other assets test) of the ITAA 1997. 

In broad terms, the tests require: 

• at least $20,000 of assessable income in that year from the business activity (section 35-30 of the ITAA 1997);  

• the business activity results in a tax profit in 3 of the past 5 income years (including the current year) (section 35-35 of the ITAA 1997);  

• at least $500,000 of real property, or an interest in real property, (excluding any private dwelling) is used on a continuing basis in carrying on the business activity in that year (section 35-40 of the ITAA 1997); or  

• at least $100,000 of certain other assets (excluding cars, motor cycles and similar vehicles and real property that is taken into account for the real property test) used on a continuing basis in carrying on the business activity in that year (section 35-45 of the ITAA 1997).  

Your business activity did not satisfy any of the four non-commercial loss tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 in the 2013-14 income year.

If a business does not pass any of these tests, losses must be deferred except in certain circumstances. 

These circumstances are where the Commissioner exercises the discretion under paragraph 35-55(1)(a) or 35-55(1)(b) of the ITAA 1997. If the Commissioner exercises the discretion an individual whose business activity has not passed any of the tests can offset that business loss against other assessable income in the year of that loss. 

The Commissioner's discretion - special circumstances 

Under paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner's discretion can be exercised where: 

• the business activity is affected by special circumstances such that it is unable to satisfy any of the tests; and  

• the special circumstances affecting the business activity are outside the control of the business activity.  

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

Special circumstances are ordinarily those affecting the business activity such that it is unable to satisfy a test and it would be unreasonable for the loss deferral rule to apply. 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 and affect all business within a particular industry. 

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. 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.

Your circumstances

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. You satisfy this criterion as events such as bush fires 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 which is what happened in your case. Your business activity was badly affected by bush fire which destroyed your entire property.

Had it not been for the event, you would have earned at least $20,000 for the 20XX income year had you continued your activity and would have passed at least the assessable income test in section 35-30 of the ITAA 1997. Thus the inability of your business activity to satisfy one of the four non-commercial loss tests was due to special circumstances, as set out in paragraph 35-55(1)(a) of the ITAA 1997.

Therefore, the Commissioner will exercise his discretion and you will be able to offset the losses made from your business activity against your other assessable income for purposes of calculating your taxable income for the 20XX income year.