Edited version of private advice

Authorisation Number: 1051957390805

Date of advice: 4 March 2022

Ruling

Subject: Deferral of non-commercial losses

Question 1

Is paragraph 35-10(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) satisfied so that Division 35 does not require deferral of the loss?

Answer

Yes.

This ruling applies for the following period:

Income tax year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The taxpayer has been operating two retail businesses, one as a sole trader and one as a 50% partner.

The taxpayer has also operated another business, as a sole trader.

Both retail businesses have been substantial and profitable, financial records have been supplied.

After 15 years of profitable trading, the taxpayer sold both the sole trader businesses.

The businesses recorded tax losses due to after sale transactions and payment of employee provisions.

In the 20XX year, the taxpayer received income from the partnership business, salary and wages, dividends, franking credits, reportable superannuation contributions and had deductions. There were no reportable fringe benefits and no total net investment losses.

Two of the businesses were run from the same address, with the other business occupying the basement of one of retail premises.

All three businesses stock similar products to varying degrees.

Two retail premises are located on a main road with high visibility in standalone rented premises. These premises have a loyal, local customer base as well as passing trade. The opening hours are long and seven days a week, but not 24 hours per day.

All fixtures and fittings are owned by the businesses.

All three businesses employ qualified employees of a variety of roles and positions.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 35-10

Income Tax Assessment Act 1997 section 35-30

Income Tax Assessment Act 1997 section 35-55

Reasons for decision

Summary

As the income requirement and at least one of the applicable tests have been met, paragraph 35-10(1)(a) of the ITAA 1997 is satisfied and Division 35 of the ITAA 1997 does not require deferral of the loss. Accordingly, a consideration of the Commissioner's discretion in section 35-55 of the ITAA 1997 is not necessary.

Detailed reasoning

Subsection 35-10(2) of the ITAA 1997 says:

If the amounts attributable to the *business activity for that income year that you could otherwise deduct under this Act for that year exceed your assessable income (if any) from the business activity for that year, or your share of it, this Act applies to you as if the excess:

(a) were not incurred in that income year; and

(b) were an amount attributable to the activity that you can deduct from assessable income from the activity for the next income year in which the activity is carried on.

That is, for the 2009-10 and later income years, Division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity carried on by an individual taxpayer (alone or in partnership) unless:

•         The taxpayer satisfies the income requirement in subsection 35-10(2E) and one of the four tests in paragraph 35-10(1)(a); or

•         One of the exceptions in relation to primary production or professional arts business applies (see paragraph 35-10(1)(c), but not relevant in the current case); or

•         The Commissioner exercises his discretion (see paragraph 35-10(1)(b)).

Paragraph 35-10(1)(a) of the ITAA 1997 provides that an income requirement must be met (along with one of the four tests), in order to offset this loss against your other income. If the income requirement is not met, the Commissioner may exercise his discretion to allow the deferral of the losses.

As a preliminary step, we must first consider subsection 35-10(3) of the ITAA 1997 which states in applying the Division, business activities may be grouped together if they are 'of a similar kind'. Where business activities are grouped, these are treated as one single activity for the purposes of Division 35 of the ITAA 1997. Whether business activities are 'of a similar kind' and can be grouped is a matter of fact and degree and characteristics such as the following listed in paragraph 51 of Taxation Ruling TR 2001/14 Income tax: Division 35 - non-commercial business losses need to be considered:

•         The location(s) where they are carried on

•         The type(s) of goods and/or services provided

•         The market(s) conditions in which those goods and/pr services are traded

•         The type(s) of assets employed in each; and

•         Any other features affecting the manner in which they are conducted.

Further, paragraph 86 TR 2001/14 says that business activities which are 'of a similar kind' are those which inherently have the same nature or character; the activities must be similar, they do not need to be identical (Goodfellow v. FC of T 77 ATC 4086; 7 ATR 265).

If we consider the above characteristics in this case, it is noted that both the retail business are located in suburbs close in proximity, with the other business being located in the basement of one of the retail premises. All three businesses sell similar goods and products, with some additional services provided. Both retail businesses operate in the same market conditions, both open similar hours and operating with both local customers as well as passing trade. Both businesses operate in a rented, standalone premises on a main road with high visibility. All three businesses employ qualified employees over a variety of roles and positions. One of the businesses is an offshoot business that directly provides goods and services to a section of the public. Considering the characteristics above, it is concluded that the business activities being carried on by the taxpayer are 'of a similar kind' under subsection 35-10(3) and can therefore be grouped and treated as one single activity for the purposes of Division 35 of the ITAA 1997.

In this case, when it is accepted that the business activities can be grouped in the relevant year, the loss from the sole trader business is applied against the income from the partnership, leaving the taxpayer with a loss from the business activities.

We then apply the income requirement under subsection 35-10(2E) of the ITAA 1997 to the individual's circumstances.

The income requirement under subsection 35-10(2E) of the ITAA 1997 is met when in any given year the sum of the:

•         Individual's taxable income

•         Reportable fringe benefits

•         Reportable superannuation contributions, and

•         Total net investment losses

is less than $250,000. Any excess deductions that are subject to Division 35 must be disregarded.

In this case, the taxable income plus the reportable super contributions is less than the $250,000 therefore the income requirement under subsection 35-10(2E) of the ITAA 1997 is met.

In addition to the income test, we must consider whether the business activity meets one of the following tests as set out under paragraph 35-10(1)(a) of the ITAA 1997 for that year:

i)    Assessable income test (s35-30)

ii)   Profits test (s35-35)

iii) Real property test (s35-40)

iv)     Other assets test (s35-45)

Assessable income test

Section 35-30 of the ITAA 1997 states that the rules in section 35-10 do not apply to a business activity for an income year if:

a)  the amount of assessable income from the business activity for the year; or

b)  you started to carry on the business activity, or stopped carrying it on, during the year - a reasonable estimate of what would have been the amount of that assessable income if you had carried on that activity throughout the year;

Is at least $20,000.

In this case, the amount of assessable income from the business activity for the year is at least $XXX, therefore the assessable income test under section 35-30 of the ITAA 1997 is met.

Information has not been provided which would allow consideration of the profits test, the real property test or other assets tests. However, as the assessable income test has been met, in addition to the income requirement, paragraph 35-10(1)(a) has been satisfied and Division 35 does not require deferral of the loss.

As Division 35 is not applicable to the taxpayer in the circumstances, an exercise of the Commissioner's discretion under section 35-55 of the ITAA 1997 is not necessary.