Edited version of private advice

Authorisation Number: 1052023852808

Date of advice: 25 August 2022

Ruling

Subject: Non-commercial loss

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 your calculation of taxable income for the year ended 30 June 20XX?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You do not satisfy the <$250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

From the sudden passing of a parent, you received two superannuation lump sum (SLS) payments totalling an amount greater than $250,000 during the year ended 30 June 20XX.

You carry on an aircraft charter and lease business.

You commenced business operations in XXX 20XX.

You used the SLS to purchase the business.

The business comprises of two aircraft.

The planes are located at an international airport.

The planes are 'cross hire' to a flight training centre, as well as 'cross hire' to accredited licensed pilots.

Substantial set up costs were incurred during the year ended 30 June 20XX.

The aircraft were both depreciated in full using temporary full expensing.

Repairs and maintenance and other expenses were incurred.

Other business income was less than $X for the year ended 30 June 20XX.

You did not make a profit in the year ended 30 June 20XX and a loss was incurred.

You met the other assets test as assets you own and use in the business have a value of at least $XX.

One of the planes had X hours of flying time in the year ended 30 June 20XX, with an insurance claim pending, while the other plane had no income due to COVID-19 and not being used by the flight training centre.

One of the two aircraft were to be sold and better aircraft purchased in July 20XX.

Your business was impacted in the following ways:

•         a parent passing away unexpectedly and you would have been able to claim the losses without the SLS being included in your income and pushing you over the income requirement in subsection 35-10(2E) of the ITAA 1997

•         bad weather

•         COVID-19

•         trouble getting your client to hire the planes.

Your tax representative advised if you had not made the choice to apply the temporary full expensing measures to purchase of the planes, you would have made a profit in the year ending 30 June 20XX. You made the decision to use the temporary full expensing measures for the planes, and this resulted in the business loss.

The business continued to operate at a loss during the year ended 30 June 20XX.

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

Paragraphs 12 to 15 of Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion list the special circumstances limb from paragraph 35-55(1)(a) of the ITAA 1997. Special circumstances are held to be those that are distinguishable from those circumstances that occur in the normal course of conducting a business and are circumstances that specifically caused a business to make a loss. Paragraph 13A states that Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the income year(s) in question where:

•         but for the special circumstances, the business activity would have made a tax profit; and

•         the activity passes at least one of the four tests or, but for the special circumstances, would have passed at least one of the four tests.

Special circumstances are those that are outside of the control of the business operator and include drought, flood, bushfire or some other natural disaster, as per paragraph 14 of TR 2007/6.

You contend that the passing of your parent impacted your ability to generate a profit in the year ended 30 June 20XX, as it was sudden and prevented other tests being met. The receipt of SLS payments from your parent's passing, resulted in you not meeting the income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You met the assessable income test under section 35-30 of the ITAA 1997 with your aircraft charter and lease business as your business activity would have earnt at least $XX in the year ended 30 June 20XX, by making a reasonable estimate of earnings for a full financial year as you only began operating in XXX 20XX.

Paragraph 41D of TR 2007/6 states:

For individuals who do not satisfy the income requirement, the factors that must be satisfied before deciding whether to exercise the special circumstances limb of the discretion for an income year are that:

•         the business activity is affected by special circumstances such that it is unable to produce a tax profit; and

•         the business activity either satisfies at least one of the tests or 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.

You have advised the business activity was impacted by the death of your parent, which occurred prior to the business commencing, bad weather, COVID-19 and the inability to cross hire your aircraft to the flight training centre.

'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 and specifically caused a business to make a loss.

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 years 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.

Paragraphs 53 and 54 of TR 2007/6 state that special circumstances are not restricted to including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of paragraph 53. The use of 'including' also caters to circumstances such as oil spills, chemical spray drifts, explosions, disturbances to energy supplies, government restrictions and illnesses affecting key personnel might, depending on the facts, constitute special circumstances of the type in question. In your instance, though a difficult situation, the passing of your parent was not an illness to key personnel of the business. In addition to this, the death of your parent occurred before the business commenced.

It is understood that you suffered a personal loss from the passing of your parent; however the degree to this impacting your inability to make a profit in the business you commenced after the death, would not bare any impact on the business making a profit.

The second aspect to the first factor is that the special circumstances have impacted the business activity such that the special circumstances are the cause of the business being unable to produce a tax profit.

Your financial statements demonstrate that the business activity incurred a loss in the year ended 30 June 20XX. The majority of this loss was attributable to the choice of using the temporary full expensing measures to fully depreciate both aircraft. The remaining expenses were repairs and maintenance and all other expenses. It is acknowledged that there are expenses associated with commencing a business or business activity; however none of the expenses or the loss can be attributed to the passing of your parent.

Example 7A at paragraphs 129A to 129E of TR 2007/6 describe a situation where Commissioner's discretion might be granted for a business that had been profitable in prior years and was then impacted by a natural disaster, drought. Consideration was given to strong past performance and continuing ability to satisfy the non-commercial loss tests.

Your situation is more aligned to paragraph 129E which states:

If the facts were that the business had not made a profit in recent times, and moreover, was not reasonably expected to do so in the future, the mere fact that, for example, the business satisfied the real property test, or the other assets test, would not, in itself, indicate that it was unreasonable for losses from the business to be deferred. This would be so, even if the business activity was affected by special circumstances to some extent, but not to the extent that these circumstances caused what would otherwise be a profitable activity to be one which made a loss.

Your business activity commenced less than X years ago, and you have not made a profit to date. The circumstances you contend were special circumstances did not cause the activity to make a loss for the year ended 30 June 20XX. You continued to operate at a loss during the year ended 30 June 20XX.

The Commissioner under paragraph 50A of TR 2007/6 can consider that, where a 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 unlikely that it would be considered unreasonable for the loss deferral rules to apply and therefore the Commissioner is unlikely to exercise the discretion. In your circumstances, the loss that has been incurred has a direct link to business decisions made by you, mainly your choice to use temporary full expensing measures to claim a deduction for the entire purchase price of the two aircraft, resulting in the loss in the year ending 30 June 20XX.

A taxpayer has a choice whether to apply the temporary full expensing measures in relation to the purchase of their assets for their business. Alternatively, they may choose to instead apply the general depreciation rules in Division 40 of the ITAA 1997. The effective life for aeroplanes is 20 years when used for general use and 20 years when used predominantly for agricultural spraying or agricultural dusting (Taxation Ruling TR 2020/3 Income tax: effective life of depreciating assets (applicable from 1 July 2020)); however subsection 40-102(4) of ITAA 1997 provides the capped life of an aeroplane as being 8 years if used predominantly for agricultural spraying or agricultural dusting or 10 years if the former does not apply.

You stated COVID-19 impacted on the business making a profit. Even though a decision was made to commence business during the pandemic, there are no specific events related to COVID-19 that prevented your business from making a profit.

The income requirement in subsection 35-10(2E) of the ITAA 1997 is met when the individual's income is under $250,000 (paragraph 13A of TR 2007/6). There is no legislation that provides a discretion in regard to this requirement. Where you are not applying for Commissioner's discretion based on special circumstances or due to a lead time, there are no other grounds for applying for Commissioner's discretion where you do not meet the income requirement.

Paragraphs 6 and 6A of TR 2007/6 state:

6. The object of Division 35 is to act as an integrity measure. One of the ways it achieves this is by preventing losses from non-commercial activities that are carried on as businesses by individuals (alone or in partnership) being offset against other assessable income in the income year the loss is incurred. The rule in subsection 35-10(2) defers losses from business activities unless they satisfy a test, are eligible for an exception or the Commissioner exercises the discretion in subsection 35-55(1).

6A. However, in addition, for the 2009-2010 and later income years, the 'income requirement' in subsection 35-10(2E)2A applies. This change prevents certain high income individuals from claiming losses from their business activities, even though the activity may satisfy one or more of the tests. A new lead time limb in paragraph 35-55(1)(c) has also been introduced, to address cases where such individuals have started to carry on a business activity with a lead time.

You state that you would have been able to claim the losses from the activity; however, were not able to due to receiving the SLS payments, which resulted in you not meeting the income requirement in subsection 35-10(2E) of the ITAA 1997. The payments were received before the business commenced, meaning that the payments were not received after deciding to use the temporary full expensing measures or planning to offset your income with your business losses. The SLS payments were used to purchase the business and business assets and were hence an integral part of establishing the business.

The decision to not allow the discretion in this case would be due to the loss arising from the choices you made to use of the temporary full expensing measures and other ordinary expenses incurred as part of the business, not from special circumstances beyond your control.

Considering the loss was not caused due to special circumstances outside your control, the business has not previously made a profit and business commenced during the COVID-19 pandemic, it would be unreasonable for the loss deferral rules to not apply to your situation and inappropriate for the Commissioner to exercise his discretion to allow you to apply the losses against your other income.

As the discretion has not been exercised, the losses will defer until a profit is made by the business.