Edited version of private advice

Authorisation Number: 1051616765226

Date of advice: 16 December 2019

Ruling

Subject: Non-commercial losses - lead time

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your travel photography business in your calculation of taxable income for the X income years?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

Year ending 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2022

The scheme commences on:

1 July 2015

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You do not satisfy subsection 35-10(2E) of the ITAA 1997. That is, your income for non-commercial loss purposes is more than $250,000.

Your business activity is based in Australia.

You describe your activities as a Professional Travel Photographer.

You have established and maintained a dedicated website that offers images for sale and details your travel photography business activity. In addition you have established social media accounts including Facebook and Instagram dedicated to your travel photography business activity.

You have infrastructure in place which includes a dedicated back account, complete back-up system, photo processing functionalities and image management systems.

You have invested in professional equipment including camera bodies, lenses, tripods, flash units, filters and accessories and a drone. You hold dedicated business equipment insurance.

You have invested in marketing including the development of brand logo, business cards, adhesive stickers, brochures, flyers and business stamps.

You have been accepted by a camera company into their professional group. You met the required criterion by substantiating that you owned professional equipment and was using that equipment to generate income.

You have received income from the sales of Photography Images and Services in each year. Since commencement on one occasion you have exceeded $20,000 in sales meeting the requirements of assessable income test. Images have been sold and shipped within Australia and Internationally.

You have travelled extensively to capture images for your image library. You currently have over X images in your photographic library.

Every trip you have taken has been a dedicated photographic tour/workshop/assignment. You have worked with or under a professional travel photographer and established photographic mentors from whom you have learnt.

You have furthered your development through online tutorials and programs.

You have entered photographic competitions and have exhibited your work.

You have responded to special order requests to fit out a building. Other opportunities have seen requests for use of your images in publications and flyers.

You spend a period each year travelling to build your image library and develop your skills. You currently operate two businesses.

You have provided assistance to other tour groups when requested by the provider.

You have arranged to conduct a photography tour with a number of participants in a country in the future. You have made a business decision not to charge the participants on this tour because you want to use this as a gauge of how you can best run workshops.

You have indicated that you have implemented a staggered/stepped approach to allow you to:

·  amass an extensive portfolio of images that can be offered as a stock imagery. Your plan in this regards is to place images on a platform however, you do not want to do this on a piecemeal basis. You have the opinion that you would have more success with selling stock imagery if you have an expansive portfolio of offer.

·  progressively identifying organisations and potential purchasers for targeted approaches, particularly focusing on your niche.

·  commence running workshops in the future you see workshops to include tours.

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)(c)

Reasons for decision

Summary

The lead time discretion 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. Lead time normally applies to agricultural activities where for example, a fruit tree takes time between the planting of the tree and the production of any fruit, such that there will be no assessable income for a number of years.

In the case of a professional travel photography business, there is nothing inherent in the activity that requires a lead time. You have achieved assessable income since the commencement of the business activity. Meeting the requirements of the assessable income test with greater than $20,000 assessable income achieved in a year of operation. This suggests that your activity does not have a lead time.

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 the calculation of taxable income. The 'income requirement' is set out in subsection 35-10(2E) of the ITAA 1997. 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.

The Commissioner's discretion in subsection 35-55(1) 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:

(c)for an applicant who carries on the business activity who does not satisfy 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 produced, or will not produce, assessable income greater than the deductions attributable to it; 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 produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C)).

The meaning of 'because of its nature'

For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is producing a tax loss in a year, is because of something inherent to the nature of the business and not something 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.

Paragraph 17 of Taxation Ruling TR 2007/6 deals with the exercise of the Commissioner's discretion under this subparagraph and the meaning of 'because of its nature':

For the failure to satisfy one of the four tests to be 'because of its nature', the failure must be because of some inherent characteristic that the taxpayer's business activity has in common with other business activities of that type (see Federal Commissioner of Taxation v. Eskandari).

Where the activities failure to satisfy a test or produce a tax profit is because of such an inherent characteristic, the requirement will be met for any income year within the period from the time the business activity starts to the end of the last income year in which that characteristic still affects the activity's ability produce a tax profit.

Where the initial period has passed, any continuing failure to produce a tax profit will be for reasons outside of subparagraph 35-55(1)(c)(i) of the ITAA 1997, and the discretion will not be exercised.

The note under paragraph 35-55(1)( c) states:

Paragraphs (b) and (c) are intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. For example, an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

Paragraph 1.51 of the EM comments:

This arm of the safeguard discretion will ensure that the loss deferral rule does not adversely impact on taxpayers who have commenced activities which by their nature require a number of years to produce assessable income. Examples of activities could fall into this category are forestry, viticulture and certain horticultural activities.

Stone J in Eskandari confirmed this view when considering whether the Commissioner's discretion should be exercised in regard to losses incurred in a migration consultancy business. When looking at the type of activities referred to by the note and the EM, Stone J stated at FCA 31:

Such activities have an inherent characteristic that cannot be overcome by conducting the business activity in a different way but only by changing the nature of the business.

Therefore, the phrase 'because of its nature' refers to inherent characteristics of the type of business activity being conducted by the taxpayer, which are common to any business activity of that type. These inherent characteristics must be the reason why the activity is unable to produce a tax profit. The discretion is not intended to be available where the failure to produce a tax profit, is for other reasons.

The decision in Eskandari has been sighted and further clarified in two latter AAT cases, after the change in legislation for the $250,000 income test. These cases are:

Hefner v. FC of T 2013 ATC 10-319; [2013] AATA 407 (Judgement date 18 June 2013)

This involved a cattle stud business activity that commenced 1 February 2009. The following paragraphs are extracts from the case.

15. I would add I am satisfied the evidence establishes a stud can begin selling its output within about five years, even though its products will not command premium prices until eight to ten years after establishment. The delay in achieving profitability after the five year mark appears to be attributable to financing costs.

16. The Commissioner points out the decision-maker must address the matters in both limbs of the test in s 35-55(1)(c) ). Those limbs require that the decision-maker be satisfied:

(i) the business will not become profitable in the period under review (ie, before 30 June 2017) because of its nature: and

(ii) there is independent evidence that justifies an objective expectation that the business will produce assessable income within the period that is commercially viable for the industry concerned.

17. The taxpayer is unable to satisfy the test contained in the first limb, which makes it unnecessary to consider the issues in the second limb. The evidence establishes a stud could become profitable in advance of 30 June 2017; indeed, depending on the cost structure of the operation, it could become profitable as early as five years after establishment (although I accept it probably would not generate maximum profits until sometime later). The key variable is financing costs. If those costs are high - because the operation is funded wholly or partly by debt - then it will take longer for the operation to turn a profit. But the operation does not have to be financed by debt. The fact most businesses are financed at least partly by debt does not suggest a debt is an "inherent feature that the taxpayer's business has in common with business activities of that type": see

Commissioner of Taxation v Eskandari [2004] FCA 8 at [32] per Stone J.

A stud business could be conducted in a different way, in the sense that alternative financing arrangements are at least theoretically available. There is nothing inherent in the business activities which demand that they be financed for that debt.

Case 1/2013; [2013] AATA 3; 2013 ATC 1-050; 87 ATR 355

A vineyard was purchased in 2008. It started with the small existing vineyard, which became the first two blocks in 2009, additional blocks were subsequently planted. Staggered planting was a common practice in the industry.

Evidence was given - which appears to be widely accepted - that vines take around 5 years to mature. They start producing fruit after 3-4 years but they do not reach their peak until 5 years after planting.

The following paragraphs are extracts from the case.

15. Can it be said the business 'because of its nature... will not produce... assessable income greater than the deductions attributable to it' during the 9 year period contended for by the taxpayer? The answer to that was clear enough from Mr Greaves's evidence - in particular, from his question to Ms Ford about whether it was possible to have the vineyard up and running within 5 years. He said it was. I accept he thought it was commercially prudent to approach the development in a more gradual way, and he may well be right. But that is not the test. I am required to look at whether the failure to produce sufficient assessable income during a given year of income was a "result of some inherent feature that the taxpayer's business activity has in common with activities of that type". See Federal Commissioner of Taxation v Eskandari 134 FCR 569 at [32] per Stone J.

16. Vines can be planted and become productive within 5 years. The applicant has chosen to take a more gradual approach. No one quibbles with the wisdom of her decision, and I am told it is common practice in the industry. But she is unable to satisfy the first leg of the test in s 35-55(1)(c ). In those circumstances, it would not be reasonable to exercise the discretion in her favour.

These cases clarify the application of the law for the new discretion for the over $250,000 taxpayers who may get a discretion under 35-55(1)(c). In particular these clarify the application of 35-55(1)(c)(i) and the meaning of 'because of its nature'. We are still looking at that essential period of time when 'because of its nature' the business activity cannot derive any assessable income. For breeding activities it is that period of time that it takes to produce offspring that can potentially be sold. If it is a crop, it is that period of time that it takes the crop to grow until it produces its first normal full crop. This period of time cannot be extended by the way a person commences their business activity, for example by staggered starts, and it cannot take into account such things as developing a reputation or improving quality.

Paragraph 78 of TR 2007/6 states;

The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity and would not result in the requirements of subparagraph 35-55(1)(b)(i)being met.

The example at paragraph 139 of TR 2007/6 explains the taxpayer was new to the region and industry in which he chose to commence his business. He had no clientele. His funding and his advertising were limited, he kept his part time employment and he worked at his business when he could. He chose where his business premises were located and also his opening and closing times. He made losses each year and didn't satisfy any of the four tests.

The Commissioner's view on this example is found at paragraph 140 of TR 2007/6;

The inability of Andrew's business activity to satisfy any of the four tests is due to his personal business choices as to hours of business, location and advertising, not any inherent characteristics that affect clock repair businesses. Accordingly the requirement of subparagraph 35-55(1)(b)(i) is not met and the Commissioner would not exercise the discretion.

Application to your situation

In your case, you do not meet the income requirement in subsection 35-10(2E) of the ITAA 1997 as your income for the purposes of paragraph 35-55(1)(c) of the ITAA 1997 is more than $250,000. Therefore you need the Commissioner's discretion to claim the loss incurred in that income year.

Your photography business activity will only be subject to the non-commercial losses provisions if it is carried on as a business. If your activity is not carried on as a business (or has not yet started to trade), and cannot reasonably be expected to produce income, then you cannot claim general deductions in relation to it, regardless of the operation of Division 35 of the ITAA 1997.

Based on the information provided, it is considered that you are carrying on a photography business.

The note to paragraphs (b) and (c) of subsection 35-55(1) of the ITAA 1997 does not support the view that the discretion should be exercised for any activity that is unable to produce a profit because of the small scale on which it was started, or because a client base is being built up but rather for those business activities that have a lead time between the commencement of the activity and the production of any assessable income.

You have indicated that you have implemented a staggered or stepped approach providing time to build up your business to amass an extensive portfolio of images that can be offered as stock imagery. You will progressively identify organisations and potential purchasers of your images for targeted approaches.

You have an expectation to commencing running workshops in the future. You have arranged to conduct a photography tour which will take place in a country in the future. You have made a business decision not to charge the participants on this occasion because you want to use this as a gauge of how you can best run workshops. You see that the delay in conducting such an activity will allow you the opportunity for detailed planning and execution to offer a tour that is unique and appealing for specific reasons.

The process of setting up of the building and implementing your business structure and plan is not considered an inherent feature for lead time.

In your case your business activity is Travel Photography. There is no generally accepted commercially viable period for Travel Photography or Photography generally as supported with your contact with a Professional Photography organisation. You state that the time that one can take to produce income from can be varied from one year to eight years. You have stated the factors affecting the commercially viable period for a Travel Photography activity are unique to your situation which are dependent on your ability to amass an extensive portfolio of images, identifying potential purchasers and commencing to conduct workshops. They are subjective and impermissible considerations, as affirmed in the cases of Eskandari and Scottand cannot be used as determinative factors in this private ruling.

In your circumstances, it is reasonable to conclude that the part-time basis on which you conduct your activities due to your commitment to your full-time professional business contributes to the losses incurred in the relevant income years. As you have outlined in case study number one, it could be possible for other photographers who concentrate solely on their photography business to produce a profit in a shorter timeframe.

You have not shown that the reason that you have not met a test or made a profit is due to a lead time (of between one to eight years) is an inherent characteristic of the industry. We do not consider that there is anything inherent or innate in the nature of your business activity that would prevent you earning assessable income. This is confirmed where you have been able to satisfy one of the tests in the third year of operation, namely the assessable income test. You have shown your activity is of a type that is able to produce assessable income quite soon after its commencement this has been evidenced in your own financial statements.

Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997 and you cannot claim a deduction for your losses against other income in the 20XX-XX to 20XX-XX income years. You must defer these losses to a future year where you meet a test or make a profit from your business activity.