Edited version of private advice

Authorisation Number: 1051962138544

Date of advice: 21 March 2022

Ruling

Subject: Non-commercial losses - Commissioner's discretion

Question

Will the Commissioner exercise their discretion under section 35-55 of the Income Tax Assessment Act 1997 to allow you to offset your business loss against your other assessable income?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You do not satisfy the less than $250,000 income requirement set out in subsection 35-10(2E) of the Income Tax Assessment Act 1997 (ITAA 1997).

You commenced a primary production business.

You have incurred a loss in that year due to large expenditure being claimed, including depreciation.

You have advised the initial expenditure was necessary for commencing the business activity.

You expect the business activity to incur losses in the next X financial years.

The business activity incurred a loss. Of this loss amount, depreciation expense accounted for the majority of the expenses.

The business activity did not report any income during the year.

You provided projections to indicate the business activity will continue to incur losses in at least the next X financial years.

Relevant legislative provisions

Income Tax Assessment Act 1997 paragraph 35-10(1)(b)

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

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

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 meet the income requirement and you pass one of the four tests; or

•                    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.

It is only in certain circumstances that the Commissioner has discretion to determine that it would be unreasonable for the loss deferral rule to apply.

Relevant to your application, the lead time Commissioner's discretion in paragraph 35-55(1)(c) of the ITAA 1997 may be exercised (per paragraph 16B of Taxation Ruling TR 2007/6 Income Tax: non-commercial business losses: commissioner's discretion) for a financial year where:

•                    you do not satisfy the income requirement; and

•                    because of its nature, the activity has not produced, or will not produce, assessable income greater than the deductions attributable to it; and

•                    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) of ITAA 1997).

For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is producing a loss is inherent to the nature of the business and is not peculiar to your situation. TR 2007/6 provides at paragraph 78, that the consequences of business choices made by an individual (for example, the size and scale of the activity) are not inherent characteristics of a business activity.

The discretion under lead time is intended to cover business activities which, by their nature, require a number of years to produce assessable income. Examples of activities which would fall into this category are forestry, viticulture and certain horticultural activities (paragraph 1.51 of the Explanatory Memorandum for the New Business Tax System (Integrity Measures) Act 2000).

The discretion is not intended to be available in cases where the failure to make a profit is for reasons other than the nature of the business, such as, a consequence of starting out small and needing to build up a client base, or business choices made by an individual that are not consistent with the ordinary or accepted practice in the industry concerned per paragraph 2.35 of the Tax Laws Amendment (2009 Budget Measures No. 2) Act 2009.

Regarding the first element of paragraph 16B of TR 2007/6, 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 (2004) 134 FCR 569). 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.

In your case, you have incurred losses primarily due to capital expenditure incurred to commence the business activity. As a result of this expenditure, you have a significant amount of depreciation claimable that comprises a large portion of this loss. However, the decision to commence your operations in this manner does not constitute an inherent characteristic of the business activity, but instead is a consequence of a business choice made. Large amounts of depreciation being claimable does not constitute an inherent characteristic that cannot be overcome by conducting the business activity in a different way.

The business activity does not have an inherent characteristic -unlike for example the planting of an apple tree, that prevents an entity engaged in the business activity from producing assessable income and making a tax profit in the first year of operation. There is no time-based component to the activity that cannot be avoided by conducting the activity in a different way.