Edited version of private advice

Authorisation Number: 1052047076675

Date of advice: 19 October 2022

Ruling

Subject: 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 losses from a business activity in the calculation of my 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 commenced your business activity in the 20XX financial year.

You satisfy the less than $250,000 income requirement, however you do not pass any of the four tests.

You operate your business as a sole trader and have no employees.

You have full time salaried employment and have undertaken the business activity on a part-time basis.

You do not have a business plan.

You incurred start-up costs for tools, equipment, consumables and a new motor vehicle.

Your non-commercial business loss is largely attributed against a claim for temporary full expensing of depreciating assets.

In the 20XX financial year COVID-19 impacted your business activity.

Government imposed COVID-19 restrictions are now being relaxed which will attract new clients holidaying in the region which will increase revenue in the 20XX/20XX financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 35-10

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

Reasons for decision

Summary

For discretion to be exercised, the Commissioner must be satisfied that you were affected by special circumstances beyond your control, and had the special circumstances not occurred, the business activity would have passed one of the 4 tests. It is accepted that COVID-19 border closures were special circumstances beyond your control. However, it is not accepted that the special circumstances have materially affected the business activity to meet any of the tests. You commenced the business activity during this time and were aware of the circumstances, a decision which was under your control. In addition, you started the business activity on a part time basis which restricted your ability to earning business income. Your inability to make a profit was also due to your decision to claiming the temporary full expensing on depreciating assets. Therefore, it would be unreasonable for the Commissioner to grant their discretion under paragraph 35-55(1)(a) of the ITAA 1997.

Detailed reasoning

Business losses

Where a person has a business loss, Division 35 of the ITAA 1997 needs to be considered.

Division 35 of the ITAA 1997 applies to losses from certain business activities. Under the rule in subsection 35-10(2) of the ITAA 1997, a loss made by an individual from a business activity will not be taken into account in an income year unless:

•         the exception in subsection 35-10(4) of the ITAA 1997applies,

•         you satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 and one of the four tests in sections 35-30, 30-35, 35-40 or 35-45 of the ITAA 1997 are met, or

•         the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

Exception

The exception in subsection 35-10(4) of the ITAA 1997 applies to a primary production business or a professional arts business and where your assessable income for the income year (except any net capital gain) from other sources not related to that activity, is less than $40,000.

In your case, the exception in subsection in 35-10(4) of the ITAA 1997 does not apply.

Subsection 35-10(2E) of the ITAA 1997

The income requirement in subsection 35-10(2E) of the ITAA 1997 applies from 1 July 2009 and will be met where the sum of the following amounts for an income year is less than $250,000:

•         taxable income (ignoring losses subject to the non-commercial loss rules)

•         reportable fringe benefits

•         reportable superannuation contributions

•         net investment losses.

If you meet the income requirement, you must satisfy one of the 4 tests. If you pass, you can offset the loss in the year in question.

If you do not meet any of the 4 tests you can apply for Commissioner's discretion under section 35-10 of the ITAA 1997 to allow the claim. The Commissioner will only exercise the discretion in limited circumstances if:

•         there are special circumstances outside your control that have prevented you passing one of the 4 tests, or,

•         because the nature of the business, there is a lead time period before your business can pass one of the 4 tests or make a profit.

If there are no grounds for the Commissioner to exercise the discretion, the loss must be deferred for that income year.

Four Tests

The 4 tests are:

•         assessable income test (section 35-30 of the ITAA 1997),

•         profits test (section 35-35 of the ITAA 1997),

•         real property test (section 35-40 of the ITAA 1997),

•         other assets test (section 35-45 of the ITAA 1997).

You satisfy the income requirement contained in subsection 35-10(2E) of the ITAA 1997, however you do not meet any of the 4 tests.

You have requested the Commissioner exercise his discretion under section 35-55(1)(a) in that there are special circumstances outside your control that have prevented you passing one of the 4 tests.

Commissioner's discretion

Taxation Ruling TR 2007/6 Income Tax: non-commercial business losses: Commissioner's discretion (TR 2007/6), sets out the Commissioner's interpretation of the exercise of the Commissioner's discretion.

Special circumstances

The special circumstances discretion may be exercised for the income year in question where your business activity is affected by special circumstances outside your control.

'Special circumstances' are those circumstances which are sufficiently unusual or different to distinguish them from the circumstances that occur in the normal course of conducting a business activity.

The following has been extracted from paragraphs 47 to 53 of TR 2007/6 in relation to special circumstances:

Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to special circumstances outside the control of the business activity, 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 the paragraph. These events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affect the business activity.

Ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity would not be considered to be special circumstances. These fluctuations are expected to occur on a regular or recurrent basis when carrying on a business activity and affect all businesses within a particular industry.

Temporary full expensing - depreciation and other expenses

A taxpayer has a choice whether to apply the temporary full expensing provisions in relation to the purchase of their assets for their business (refer to Law Companion Ruling LCR 2021/3 Temporary full expensing, paragraphs 86-88). Alternatively, they may choose to instead apply the general depreciation rules in Division 40 of the ITAA 1997 (LCR 2021/3 paragraphs 150, 154 and 155). Normally, the effective life for the asset is several years (refer to Taxation Ruling TR 2020/3); and section 40-102 of ITAA 1997 provides a capped life for the asset. However, you have chosen to apply the temporary full expensing provisions to claim the full cost of assets, apportioned for private use where applicable.

Paragraph 13A of TR 2007/6 describes how the Commissioner's discretion 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 4 tests or, but for the special circumstances, would have passed at least one of the 4 tests.

Application to your circumstances

In your case, you commenced operating your business activity in July 20XX. You were aware of COVID restrictions when you commenced your business activity. You incurred set up expenses in the form of one-off purchases relating to tools, equipment, consumables, motor vehicle and depreciation. The losses described in your application have not resulted from any special circumstances or any circumstances beyond your control. The Commissioner considers that the activity hasn't passed a test because of decisions you made and not due to special circumstances. You started the business on a part time basis which restricted your ability to pass a test as you were restricted in earning business income and by claiming the temporary full expensing. These expenses have contributed to the loss in the income tax year. You have chosen to claim the favourable tax provisions offered in the income tax year. Choosing to apply the temporary full expensing provisions to your income tax year does not constitute special circumstances to allow the exercising of the Commissioner's discretion.

In conclusion, the Commissioner does not consider it to be unreasonable for the non-commercial rules to apply and will not exercise the discretion to allow you to include any loss from the business activity in the calculation of the taxable income for the financial year. The loss from the business will be subject to the loss deferral rule in subsection 35-10(2) of the ITAA 1997.