Edited version of your written advice

Authorisation Number: 1012994914773

Date of advice: 14 April 2016

Ruling

Subject: Commissioner's discretion for lead time for a retail business

Question 1

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses in relation to the product in your calculation of taxable income for the 20XX-YY and 20YY-ZZ financial years?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 20YY

Year ending 30 June 20ZZ

The scheme commences on

1 July 20XX

Relevant facts and circumstances

Your business is an online based retail store.

You have created a detailed business plan that outlines all of your research into the market and projections for the future.

You commenced your market research in 20XX.

You registered your business name in 20XX.

You registered for GST in 20XX.

You ordered stock for your business which arrived to you in 20YY.

Your website was fully functional and open to the public by 20YY and was officially launched in 20YY.

Prior to the official launch of your website you marketed your product extensively.

Relevant legislative provisions

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

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

Income Tax Assessment Act 1997 paragraph 35-10(3)

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

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Summary of reasons for decision

The Commissioner will not exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997 because, on the facts provided:

• the business activity did not commence until you had stock to sell; and

• the Commissioner is satisfied that the retail activity is an activity that can produce income soon after its commencement and therefore the activity does not have lead time.

Therefore, the Commissioner's discretion in paragraph 35-55(1)(b) does not apply to your activity.

Given that your business had not commenced until around June 20YY and you do not satisfy any of the tests in Division 35 of the ITAA 1997 in the 20YY-ZZ income year, the rule in subsection 35-10(2C) of the ITAA 1997 will apply to defer to a future income year any loss that arises from your retail activity for those years. A deferred loss is not disallowed and will be deductible against any taxation profit from your retail activity, or similar business activity, in future years.

If your retail activity, or similar activity should satisfy an exception or satisfy the income requirement and one of the other tests in Division 35 of the ITAA 1997 in any given year, then the whole of the deferred loss will be deductible in that year.

Detailed reason

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 satisfy the income requirement and you pass one of the four tests

• the exceptions apply

• the Commissioner exercises his discretion.

However, for this division to apply, you must be carrying on a business.

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

The case of Evans v. Federal Commissioner of Taxation 89 ACT 4540; (1989) 20 ATR 922 stated that whether or not an activity amounts to carrying on business for taxation purposes is a question of fact. There is no exhaustive or determinative definition which can be applied to determine this matter. The facts of each case must be examined. In Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548, Webb J said:

The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.

When does a business activity commence?

The actual date of commencement of a business activity is a question of fact (Goodman Fielder Wattie Ltd v. FC of T 91 ATC 4438; (1991) 22 ATR 26) (Goodman Fielder Wattie).

For a business activity to have commenced a person must have:

• purpose, intention and decision to commence the business activity

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

• actually commenced business operations (Calkin v. CIR [1984] 1 NZLR 440).

We must examine the above indicators in light of the characterisation of your business activity.

In Goodman Fielder Wattie, Hill J stated at 4,447:

'Critical to the resolution of the present controversy, is the characterisation of the business activity itself which is said to have commenced. It was conceded properly by the applicant that if the business claimed to be carried on by it was to be characterised as one of manufacturing and selling monoclonal antibody products, then that business did not commence until around November 1982...'

For example, if your business activity is characterised as a primary production activity, involving the planting and cultivating of trees, then the planting of the trees could be seen as the commencement of that business. Alternatively, if your business activity is characterised as the manufacturing and selling of a product, the business would generally be considered to commence once you have manufactured and began selling the product.

In your case it is considered that the business activity you intend to carry on is characterised as retail, the selling of a product. We can now consider the indicators set out above to determine whether this business activity has commenced.

Purpose, Intention and Decision

The intention and purpose of a taxpayer in engaging in an activity is relevant to when a business commences. However, an intention to commence a business will not determine that the business activity has actually commenced.

The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity. This is developed by researching the proposed business and, in some instances, by experiment. This process culminates in a final decision on whether to commence business. However, not all businesses commence in such an orderly manner.

It is clear from the information you have provided that you have researched your proposed business activity, decided on the form of that business and have committed yourself to it.

Acquisition of a minimum level of business assets to allow that business activity to be carried on

Most business activities have a structure that provides the framework of the business. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity.

In Calkin v. CIR [1984] 1 NZLR 440 Richardson J said at 446-447:

Clearly it is not sufficient that the taxpayer has made a commitment to engage in business: he must first establish a profit-making structure and begin ordinary business operations.

For a business activity to commence, an appropriate business structure should be in place and begin ordinary business operations.

As to what the business structure will consist of, and its size, will be a question of fact and degree, and will depend on the nature of the business activity.

Your activity is the selling of a product to the general public via a website. You have sourced suppliers and purchased your beginning stock in 20YY. From the date of the purchase of this stock it could be considered that you have the minimum level of business assets to commence your business activity.

Commencement of Business Operations

As noted by Brennan J in Inglis v Federal Commissioner of Taxation (1979) 10 ATR 493; 80 ATC 4001, the level of activity is important in deciding whether a business is being carried on. Brennan J stated at ATC 4004-4005; ATR 496-497 that:

The carrying on of a business is not a matter merely of intention. It is a matter of activity. Yet the degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the supposed business is being conducted.

In Hadlow and FC of T [2002] AATA 1250; (2002) 2002 ATC 2294; (2002) 51 ATR 1197 the Small Taxation Claims Tribunal considered the amounts incurred by a taxpayer to research and develop a book. The question for decision was whether the activities were merely preparatory and preliminary or whether the activity had reached a stage where it was able to be characterised as a business.

In concluding that the activity was not carried on as a business in the relevant years, member Mowbray stated at paragraph 26:

Clearly Mr Hadlow has the subjective intention to carry on a business, but that is not sufficient. There must be business activity. There is a real question whether the activities to date are merely preparatory or preliminary (see Goodman Fielder Wattie at 4447), and whether the project has reached the stage where it is able to be characterised as a business. There has been much activity but the concept of business does not equate with being busy (Goodman Fielder Wattie at 4447; 386; 339)

Mr Hadlow has researched, undertaken travel, and visited museums, libraries and farms in pursuit of a particularly interesting topic. He has expended money but has made no sales, received no advances nor signed any contracts.

It is accepted that you have gone beyond merely having an intention to engage in business and there has been some activity. For example, you have created a business plan that shows your research into the industry and purchased product for sale on your website. However, you are operating a retail store and your stock was not ready for sale until around 20YY. This means that you would have been unable to sell any products and your business would not have commenced until you had items to sell to the public.

The systematic and regular transactions from which you will produce revenue as part of your business operations, that is, customers actually purchasing your product, has not commenced. Further the creation of the website, building relationships with suppliers and market research of competitors and products being supplied are considered to be activities that are preliminary to the commencement of business.

Therefore your activities prior to you having stock to sell to the public are considered preliminary to the carrying on of your intended business and are directed at constructing or establishing a business structure. As such you are not considered to be carrying on a business until 20YY.

Lead time

The Commissioner's discretion in paragraph 35-55(1)(b) of the ITAA 1997 reads -

The Commissioner may, on application, decide that the rule in subsection 35-10(2) does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

(b) for an applicant who carries on the business activity who satisfies subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made - the business activity has started to be carried on and, for the excluded years:

(i) because of its nature, it has not satisfied, or will not satisfy, one of the tests set out in section 35-30, 35-35, 35-40 or 35-45; and

(ii) there is an objective expectation, based on evidence from independent sources (where available) that, within a period that is commercially viable for the industry concerned, the activity will either meet one of those tests or will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of 35-10(2) and (2C)).

The Note to paragraph 35-55(1)(b) of the ITAA 1997 states that the particular paragraph is intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income.

It has been accepted based on the information you have provided that you commenced business from 20YY when you had stock available for purchase.

You have not provided independent evidence of the lead time for your industry. However, we do not consider that there is anything inherent or innate in the nature of your activity that results in a period of time between when the activity commences and when it first produces assessable income. In particular, we think retail activity is an activity that is able to produce assessable income quite soon after its commencement. We believe it is because your business activity didn't commence until 20YY was the major reason why your activity did not pass the assessable income test for the 20XX-YY and 20YY-ZZ income years.

In view of the above the discretion in paragraph 35-55(1)(b) has not been exercised for your business activity.