Edited version of private advice

Authorisation Number: 1051624038009

Date of advice: 8 January 2020

Ruling

Subject: Non Commercial Losses

Question

Will the Commissioner exercise the discretion in subsection 35-55(1) 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 year ended 30 June 2019?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2019

The scheme commences on:

1 July 2018

You are a sole trader in a professional arts business.

You are seeking a Commissioner's discretion based on lead time, and you believe it will be 2 years before your activity becomes commercially viable.

You started your business on the 1 July XXXX.

You are currently employed full time and earned more than $40,000.

You will leave your employment in early XXXX.

You have worked part time in the professional arts business in the year XXXX.

You meet the income requirement; that is your Taxable income, Reportable fringe benefits, Reportable super contributions, and Total net investment losses for the income year ended 30 June 2019 is less than $250,000.

The professional arts business has a number of assets with a purchase price of less than $100,000.

The professional arts business does not have any interest in any real property that is uses on a continuing basis in carrying on its activity.

The professional arts business income for XXXX was $X,XXX.

You provided a Profit and Loss statement, that shows for the XXXX income years an amount of $XX,XXX is included for assets written off and small business pool depreciation.

Assumption

You are carrying on a business.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 35-10

Income Tax Assessment Act 1997 subsection 35-10(4)

Income Tax Assessment Act 1997 subsection 35-10(5)

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)(b)

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

Reasons for decision

Summary

·        As per Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997) you will need to defer the non-commercial loss from the professional arts business as:

·        Although you are a professional arts business, your personal assessable income for the year ended 30 June 2019 will be greater than $40,000;

·        Although you do satisfy the income requirement, the professional arts business does not pass one of the four tests i.e. assessable income test, profits test, real property test or other assets test; and

·        The Commissioner will not exercise his discretion. The discretion is only available where the activity has an inability to produce income in the year of commencement. The failure pass one of the four tests for reasons other than the nature of the business, such as, a consequence of starting out small is not supported by Taxation Ruling TR 2006/7 Income tax: non-commercial business losses: Commissioner's discretion. Further the professional arts business is of a type that is able to produce assessable income quite soon after its commencement.

Detailed reasoning

Carrying on a business

If an activity is not carried on as a business, and cannot reasonably be expected to produce assessable income, for example, it is carried on as a hobby, then you cannot claim general deductions in relation to it, regardless of the operation of Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997).

Taxation Ruling TR 2005/1 Income tax: carrying on business as a professional artist, provides guidance on the principles to be applied in determining whether an artist is carrying on business as a 'professional artist'.

It states that common law has identified a number of indicators that are relevant in determining whether a taxpayer's activities constitute the carrying on of a business. The question whether a taxpayer's activities should be characterised as a business is primarily a matter of general impression and degree (Ferguson ATR 884; ATC 4271). As noted in the Federal Court decision in Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922, no single indicator is determinative; rather all of the indicators must be considered. Whether a business is being carried on is based on the overall impression gained after looking at the activity as a whole and the intention of the taxpayer undertaking it.

In your case, you have indicated in your application that your activity is carried on as a business. This ruling has, therefore, been determined on the basis of accepting your statement that you were carrying on a business.

Overview of Division 35

For the year ended 30 June 2010 and later years, Division 35 of the ITAA1997 will apply to defer a non-commercial loss from a business activity unless:

·        the exceptions in subsection 35-10(4) applies

·        you satisfy the income requirement and you pass one of the four tests in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) or 35-45 (other assets test), or

·        the Commissioner exercises his discretion.

Exception - Professional arts business

In subsection 35-10(4) of the ITAA 1997 it is outlined that the rule in subsection 35-10(2) of the ITAA 1997 does not apply to a business activity for an income year if:

a) the activity is a primary production business, or a professional arts business, and

b) your assessable income for that year (except any net capital gain) from other sources that do not relate to that activity is less than $40,000.

Subsection 35-10(5) of the ITAA 1997 says

A professional arts business is a business you carry on as an:

a)               The author of a literary, dramatic, musical or artistic work; or

b)               A performing artist; or

c)               A production associate

Note the expression "author" is a technical term from Copyright law. In general, the "author" of a musical work is its composer and the "author" of an artistic work is the artist, sculptor or photographer who created it.

Your business is a professional arts business.

However, your assessable income for the year ended 30 June 2019 will be greater than $40,000; therefore the exceptions do not apply.

Four Tests

Division 35 of the ITAA 1997 requires the deferral of losses unless you satisfy the income requirement and you pass one of the four tests in sections 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) or 35-45 (other assets test) in the ITAA 1997.

·        Income requirement - To be eligible to offset your loss, you must first determine if you meet the $250,000 income requirement. You meet this requirement where the sum of four elements (your Taxable income, Reportable fringe benefits, Reportable super contributions, and Total net investment losses) is less than $250,000.

·        Assessable income test - to pass the assessable income test, assessable income from your business activity during the financial year must be at least $20,000. Assessable income includes ordinary income and statutory income.

·        Profits test - Your business will pass the profits tests if it has made a tax profit in three out of the past five years (including the current year).

·        Real property test - You will pass the real property test if real property of at least $500,000 in value is used in your business activity on a continuing basis.

·        Other assets test - You will pass the other assets test if the value of the 'other assets' (plant or equipment, trading stock, leased assets, and trademarks, and similar rights) you use in your business on a continuing basis is at least $100,000.

'Other assets' do not include real property, cars motor bikes or similar vehicles.

In the year ended 30 June 2019 you have said that you meet the income requirements - that your income was less than $250,000. However, there is no evidence that you have met any of the other tests. The professional arts business assessable income was $X,XXX to satisfy the assessable income test the income needed to be at least $20,000.

The professional arts business commenced on 1 July XXXX, and has therefore not made a profit for three out the past five years. To satisfy the profits test the professional arts business needed make a profit for three out of the past five years. To satisfy the real property test the professional arts business must own real property of at least $500,000, the professional arts business does not own any real property.

You have valued your equipment at the purchase price. The value of your equipment is less than $100,000. For the purposes of the 'other assets' test, the value of assets is the written down value of the asset. The professional arts business has included an amount of $XX,XXX as written off assets or depreciation, in its profit and loss statement, and this deduction should be included in the value of your assets for the purposes of the 'other assets' test. As a result the professional arts business does not have 'other assets' to the value of at least $100,000 and does not satisfy the 'other assets" test.

Your losses are therefore subject to the deferral rule, unless the Commissioner exercises his discretion.

Commissioners discretion

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 satisfy one of the four tests and

˗                  an objective expectation, based on independent evidence, that it will meet one of the four tests in a time that is considered commercially viable for that industry (paragraph 35-55(1)(b) of the ITAA 1997).

The note to section 35-55 of the ITAA 1997 states the discretion under paragraph 35-55(1)(b) of the ITAA 1997 is intended to cover a business activity where there is an inherent period of time between the commencement of the activity and the production of any assessable income (emphasis added). 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.

For the discretion to be applied there needs to be an inherent or innate feature of the activity resulting in an inability to produce income in the year of commencement and (in most cases) a number of years thereafter. Further examples that fall into this category are forestry, viticulture and certain horticultural activities.

Taxation Ruling TR 2007/6 states that the 'lead time' discretion provided for paragraph 35-55(1)(b) of the ITAA 1997 is available for a business activity if there is an initial period from when the activity commenced where the nature of the activity prevents one of the four tests from being met.

TR 2007/6 does not support any view that the discretion should available where the failure to make meet the test is for reasons other than the nature of the business, such as, a consequence of starting out small and business choices made by an individual that are not consistent with the ordinary or accepted practice in the industry concerned - such as the hours of operation, location, climate or soil conditions, or the level of debt funding.

In your case, based on the information provided, we do not consider that there is a lead time between the commencement of your activity (professional arts business) and the production of any assessable income as a professional arts business in its first year of operation. Therefore, we do not consider that there is anything inherent or innate in the nature of your business activity that it has not yet been able to satisfy one of the tests. The professional arts business is of a type that is able to produce assessable income quite soon after its commencement, as you have demonstrated.

Therefore, the Commissioner will not exercise his discretion under subsection 35-55(1) of the ITAA 1997 for the year ended 30 June 2019.