Edited version of private advice

Authorisation Number: 1051850226702

Date of advice: 2 August 2021

Ruling

Subject: Commissioner's discretion - non-commercial losses - special circumstances

Question

Will the Commissioner exercise his discretion under 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 the calculation of your taxable income for the year ended 30 June 20XX?

Answer

No.

This ruling applies for the following period

Income year ended 30 June 20XX

The scheme commences on:

1 July 2019

Relevant facts and circumstances

You are carrying on a business as a sole trader.

You do not satisfy the income requirement set out in subsection 35-10(2E) of the ITAA 1997 as your income in the income year ended 30 June 20XX is over $250,000.

You commenced trading as a sole trader in 20AA and your business has always been profitable.

A government department:

•         conducted an industry wide review of rebates claimed for professional services provided by practitioners;

•         found that there was an industry wide incorrect use of codes which resulted in overclaimed rebates;

•         found that such use was not fraud;

•         provided practitioners with a payment plan which included interest

You were required to repay $XXX in overclaimed rebates.

Your net loss from your practice activity for the income year ended 30 June 20XX was $ZZZ which is $YYY more than the rebate repayment.

You stated the other reason for making a loss in the income year ended 30 June 20XX was due to the opening of a competitor business in close proximity to your practice.

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

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.

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 loss is 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, special circumstances are those which have materially affected their business activity causing it to make a loss, In this context, the Commissioner may exercise this discretion for the financial year in question where, but for the special circumstances the activity would have made a tax profit.

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. In the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, 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...

Later, in the Federal Court Case of Secretary, Department of Employment, Education, Training & Youth Affairs v. Barrett and Another(1998) 82 FCR 524 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed that:

The word 'special' must be read in context. In normal parlance it signifies that the event or circumstances in question are out of the ordinary or normal course.

Tamberlin J then quoted the following passage with approval from the AAT case of Re Beadle and Director-General of Social Security (1984) 1 AAR 362; (1984) 6 ALD 1:

An expression such as 'special circumstances' is by its very nature incapable of precise or exhaustive definition. The qualifying adjective looks to circumstances that are unusual, uncommon or exceptional. Whether circumstances answer any of these descriptions must depend upon the context in which they occur. For it is the context which allows one to say that the circumstances in one case are markedly different from the usual run of cases. This is not to say that the circumstances must be unique but they must have a particular quality of unusualness that permits them to be described as special.

As stated at paragraph 14 of Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion:

The special circumstances must be outside the control of the operators of the business activity. Such circumstances are specifically defined to include drought, flood, bushfire or some other natural disaster4. In the case of other events, failure for no adequate reason to adopt practices commonly used in an industry to prevent or reduce the effects of special circumstances may point to the special circumstances not being outside the control of the operator.

Further as stated noted at paragraph 49 of TR 2007/6:

The special circumstances must have affected the business activity. Some indicators of the effects on the business activity that could lead to the exercise of the discretion in regard to the special circumstances limb are:

•         destruction of stock or equipment (refer to Example 2 at paragraph 112 of this Ruling);

•         delays in ploughing, planting, harvesting etc (refer to Example 3 at paragraph 115 of this Ruling);

•         delay in growth of crops (refer to Example 4 at paragraph 118 of this Ruling);

•         inability of operator to perform duties (refer to Example 5 at paragraph 122 of this Ruling); and

•         loss of business opportunities (refer to Example 6 at paragraph 125 of this Ruling).

A review of the information provided indicates the Commissioner would not exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 for special circumstances as the loss from the business activity is not considered to be special circumstances outside of your control but a normal consequence of commercial business decision made by you and others.

You have stated that your business activity did not make a tax profit in the income year ended 30 June 2020 due to two 'special circumstances', the one-off repayment and the opening of a competitor nearby which were outside of your control.

It is considered that the repayment resulting from industry wide review is not a special circumstance outside of your control. Although you have stated that the incorrect use of codes was industry wide, if you had used the correct codes previously, you would not have had to make the repayment. Even if the industry review was considered a 'special circumstance' we do not consider the outcome was outside your control. You had control over which codes were claimed. Despite your claim it was an industry wide issue, the behaviour of other practitioners should not affect how you made your claims.

In addition, the commencement of competition nearby is not considered a special circumstance but rather a situation that many businesses may be expected to have to deal with in the normal course of undertaking a business. Competition is a standard risk of carrying out a business in most industries and is not unusual or out of the ordinary.

Even if the industry review was considered an 'special circumstance' outside of your control, since a business having competition is not considered a 'special circumstance' the Commissioner could not exercise his discretion to allow any of the business loss to be deducted in calculating your taxable income. As per paragraph 50A of TR 2007/6:

Where the business activity is carried on by an individual who does not satisfy the income requirement and this activity would have made a loss even if it had not been affected by special circumstances, it is also unlikely that it would be considered unreasonable for the loss deferral rules to apply and therefore the Commissioner is unlikely to exercise the discretion.

Therefore, the Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the income year ended 30 June 20XX.