Edited version of private advice

Authorisation Number: 1051992804731

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 through to 20XX income years?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

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

You are engaged in a primary production business activity which commenced in the 20XX income year.

The primary production exception under subsection 35-10(4) of the ITAA 1997 does not apply as your other assessable income exceeds $40,000.

You reside in a different state to the property where you conduct your business activity.

In the 20XX income year, bushfires destroyed your property. As a result, all assets were destroyed.

You received an insurance payout in the 20XX income year as a result of the bushfires.

You admit that your property was underinsured.

To recommence the business activity, repairs are required to the property's fences, dams, pumps, sheds, and gates.

Due to the COVID-19 border closures from March 2020 to December 2021, you have been unable to attend the property to assess and rebuild the business activity.

Flooding from February 2022 to April 2022 has further delayed your ability to attend to the property due to road closures.

You intended to expand your business activity to include additional primary production activities.

You claim that had the special circumstances not occurred one of the new business activities would have been the predominant business activity in the 20XX income year.

You may not recommence your original business activity.

Your business activity has not satisfied one of the four tests in the 20XX through to 20XX income years.

In the 20XX income year, the business activity was able to satisfy the assessable income test due to the insurance payout received.

The business activity reported income in the 20XX and 20XX income years, whilst not reporting any income in the 20XX and 20XX income years.

You have provided projected income for each of the business activities for the 20XX, 20XX and 20XX income years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 section 35-55

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

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

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

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.

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

Therefore, the business losses are subject to the deferral rule unless the Commissioner exercises their 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 is it 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 13 of TR 2007/6 details that special circumstances are circumstances which are sufficiently different to circumstances that occur in the normal course of conducting a business activity. Ordinarily, special circumstances are those which have materially affected the business activity causing it to not satisfy any of the four tests.

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.

In your circumstances, you were engaged in a business activity which commenced in the 20XX income year. Your property was affected by bushfires in the 20XX income year. Due to receiving an insurance payout for the damages caused to the property as a result of the bushfires, you were able to pass the assessable income test in the 20XX income year. However, you have indicated that your property was underinsured, and your loss is far greater than the insurance payout received. Further to the bushfires, you have also indicated that you were affected by additional special circumstances of COVID-19 border closures and flooding. Due to these circumstances, you have been unable to attend your property to assess the damages and determine the requirements to rebuild your business activity.

It is accepted that you were impacted by special circumstances beyond your control, and there are no industry practices or business measures you could have implemented to prevent the effects of the special circumstances. 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.

You have indicated that you were expecting to expand your business activity to include additional primary production business activities, however due to the special circumstances you were unable to commence operations. You advised that had the special circumstances not occurred one of these activity's would have been the predominant business activity in the 2021 income year. There is limited evidence to attest that had the special circumstances not occurred you would have commenced the operations. Further, to claim a loss or apply the Commissioner's discretion to allow a loss, the business activity needs to have commenced. Therefore, it would be unreasonable for the Commissioner to consider the expected business activities in your financial projections.

You have provided financial projections for your commenced business activity had the special circumstances not occurred. You have detailed that your assessable income for the 20XX, 20XX and 20XX income years would still have been short of the assessable income test as outlined in section 35-30 of the ITAA 1997. You have also failed to meet one of the four tests in the 20XX, 20XX, 20XX, and 20XX income years. You only passed the assessable income test in the 20XX income year due to the insurance payout you received in relation to the bushfire damages.

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.

Whilst it is accepted that you were affected by special circumstances beyond your control, it is not accepted that the special circumstances materially affected your business activity from satisfying one of the four tests. 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.