Edited version of your written advice

Authorisation Number: 1051484715361

Date of advice: 25 February 2019

Ruling

Subject: Commissioner’s discretion for non-commercial losses

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 20XX-XX financial year?

Answer

No

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You do not satisfy the <$250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997 for the 20XX-XX financial year.

You carry on a business of money lending which made a loss in the 20XX-XX financial year.

You commenced business operations many years ago and your business has had a history of profits over a long period.

You submit that you were affected by the following circumstances in the 20XX-XX financial year and request that the Commissioner consider them to be special circumstances for the purposes of the Commissioner’s discretion:

● A loan issued to one of your clients defaulted to the point that it had to be fully written off as an unrecoverable bad debt. As a result you lost $XXX,XXX.

● This contributed to your decision to sell an asset that you had held for many years, and the resulting capital gain is the only reason that you failed the income requirement.

You expect to return to profit in the 2018-19 financial year and also be profitable in future financial years.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 35-10(1)

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

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

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

Reasons for decision

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, or

● the Commissioner exercises his discretion.

In your situation, you do not satisfy the income requirement (that is your taxable income, reportable fringe benefits and reportable superannuation contributions but excluding your business losses, exceeds $250,000) and you do not come under any of the exceptions. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

The relevant discretion may be exercised for the financial year in question where your business activity is affected by special circumstances outside your control.

‘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, including drought, flood, bushfire or some other natural disaster.

For individuals who do not satisfy the income requirement, the business activity must have been materially affected by the special circumstances, causing it to make a loss. In this context, the Commissioner may exercise this discretion for the income year(s) in question where, but for the special circumstances:

● your business activity would have made a tax profit; and

● the activity passes at least one of the four tests or, but for the special circumstances, would have passed one of the four tests.

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.

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.

However, ordinary economic or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances.

In your case, you sold an asset during the 20XX-XX financial year in order to compensate for the unrecoverable bad debt that was written off (relating to your client’s unpaid / defaulted loan). The fact that you sold the asset did not directly affect your business, causing it to make a loss. Instead it caused you to fail the income requirement under subsection 35-10(2E) of the ITAA 1997. This is not considered to be ‘special circumstances’ for the purposes of paragraph 35-55(1)(a) of the ITAA 1997.

You have also requested that the Commissioner exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 in the 20XX-XX financial year on the grounds of special circumstances, due to a loan issued to one of your clients having defaulted to the point that it had to be fully written off as a large unrecoverable bad debt.

To determine what are 'special circumstances', we need to look at the context in which the phrase is used. Also, it is clear that 'special circumstances' will be something out of the ordinary or unusual.

The question of what constitutes 'special circumstances' has been judicially considered on many occasions. One example of this was in the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, where Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation:

Those discretions are intended to be applied to a great variety of situations. In such a context, the core of the idea of 'special circumstances' is that there is something unusual or different to take the matter out of the ordinary course…

The question that now must be addressed is whether your situation as described is considered special circumstances.

A review of the information provided confirms that the Commissioner will not exercise the discretion, as the defaulted loan (to the point where it had to be fully written off as an unrecoverable bad debt) does not constitute special circumstances, but rather is a standard risk of carrying on a business within your particular industry, and also is not a circumstance which is either unusual or out of the ordinary.

Your circumstances would be no different to other lending businesses operating within that industry, who would all face the same business risk of a potential loan write off / bad debt occurring.

As such it is not accepted that these circumstances constitute special circumstances in the way this term is used in the legislation.

While we appreciate your situation, there is no other discretion available to the Commissioner in Division 35 of the ITAA 1997 that would allow you to claim your losses in the circumstances you describe.

Therefore, the Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the 20XX-XX financial year.