Edited version of private advice

Authorisation Number: 1051989052067

Date of advice: 15 June 2022

Ruling

Subject: Commissioner's discretion - non-commercial losses

Question

Will the Commissioner exercise the discretion in 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 in the 20XX income year?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Individual A's income for non-commercial loss purposes was below the $250,000 threshold as outlined in subsection 35-10(2E) of the ITAA 1997.

Individual A was engaged in a business activity which had commenced.

The business activity has not satisfied one of the four tests as outlined in Division 35 of the ITAA 1997 in any year of operation.

The business activity had limited hours of operation due to Individual A having other full-time employment.

In the 20XX income year, the business activity produced its highest income turnover.

In the 20XX income year, Individual A commenced leasing a shop front.

The business had an agreement to provide their services to another local business for guaranteed income per week.

Individual A was diagnosed with terminal illness in the 20XX income year.

Medical professionals advised Individual A not to continue working due to the increased risks of contracting COVID-19.

The business income in the 20XX income year was impacted due to Individual A being unable to perform their services during the peak period.

Individual A passed away in the 20XX income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

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

Income Tax Assessment Act 1997 section 35-30

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

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

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

•         The exceptions apply, or

•         The Commissioner exercises their discretion.

Individual A did satisfy the income requirement (that is taxable income, reportable fringe benefits and reportable superannuation contributions but excluding business losses, did not exceed $250,000), however one of the four tests was not satisfied, and Sean did not fall into any exceptions outlined in 35-10(4) of the ITAA 1997.

Therefore, the business losses are subject to the deferral rule unless the Commissioner exercises discretion. The Commissioner will only grant discretion in certain circumstances where it would be unreasonable for the loss deferral rule to apply.

The Commissioner's approach to exercising the discretion under section 35-55 of the ITAA 1997 is outlined in TR 2007/6 Income Tax: non-commercial losses: Commissioner's discretion.

As outlined in paragraph 41 of TR 2007/6, for individuals who satisfy the income requirement, the following factors must be satisfied before deciding whether it is appropriate for the discretion in paragraph 35-55(1)(a) to be exercised for the year in question:

•         The business activity is affected by special circumstances such that it is unable to satisfy any of the tests; and,

•         The special circumstances affecting the business activity are outside the control of the operators of the business activity.

Paragraph 35-55(1)(a) of the ITAA 1997 specifically defines drought, flood, bushfire, or some other natural disaster as special circumstances, however the application of special circumstances is not explicit only to these circumstances. As per paragraph 54 of TR 2007/6 depending on the facts, special circumstances discretion can potentially be applied to broader circumstances than just natural disasters, for example: oil spills, chemical spray drifts, explosions, government restrictions, or illnesses affecting key personnel.

Individual A was engaged in a business activity which commenced in the 20XX income year. In the 20XX income year, they were diagnosed with terminal illness and advised by medical professionals to cease performing their services due to the increased risks of contracting COVID-19. The business activity was significantly impacted by the circumstances as Individual A was the sole operator. It is accepted that the special circumstances of the terminal illness diagnosis and the COVID-19 pandemic were outside of their control.

However, as per the factors outlined in paragraph 41 of TR 2007/6, it is also necessary to determine that had the special circumstances not existed would the business activity have satisfied one of the four tests.

Information has been provided to attest that Individual A was anticipating to upscale their business operations prior to their diagnosis. Individual A signed a rental agreement in the 20XX income year to lease a shopfront to perform their services. They were also anticipating leaving their other employment to operate the business activity on a full-time basis. Financial projections have been provided for the 20XX income year however, the projection is still short of meeting the assessable income test as outlined in section 35-30 of the ITAA 1997.

Paragraph 13 of TR 2007/6 details that special circumstances are those have materially affected the business activity, causing it to not satisfy any of the four tests in Division 35. The business activity has failed to satisfy one of the tests in all years of operation. While it is accepted that Individual A was making business choices to upscale their business operations, there is limited evidence to support that had the special circumstances not occurred the business activity would have satisfied one of the four tests in the 20XX income year.

As per paragraph 50 of TR 2007/6, in a situation where a business activity would have failed to satisfy a test even if the special circumstances had not occurred, it is unlikely that the Commissioner would consider it to be unreasonable for the loss deferral rules to apply, and therefore the Commissioner would be unlikely to exercise the discretion. TR 2007/6 provides example 7 at paragraph 128.

Considering the business activity has not previously been able to satisfy one of the four tests, and the lack of evidence to support that the activity would have met one of the tests in the 2021 financial year it would be unreasonable for the discretion to be granted despite the acknowledgment of the impact of the special circumstances. Therefore, the Commissioner will not exercise the discretion outlined in paragraph 35-55(1)(a) of the ITAA 1997, and as such the losses will defer.