Edited version of private advice

Authorisation Number: 1052054189683

Date of advice: 31 March 2023

Ruling

Subject: Commissioner's discretion - non-commercial business 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 your calculation of taxable income?

Answer

Yes.

This ruling applies for the following period:

30 June XXXX

Relevant facts and circumstances

You are an Australian resident for taxation purposes.

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

You, trading as Business Activity, have operated a travel agency business for 21 years at address provided.

The business commenced on 1 July 19XX.

Due to the COVID government mandated regulations the travel agency business was unable to earn any meaningful income.

The Business Activity, as a 100% travel agency business was severely impacted by federal and state government imposed travel restrictions in response to the COVID pandemic from XXXX and throughout all of the XXXX financial year. This resulted in the business losing virtually all income producing capacity.

You made the decision to mothball the business during the year with all employees being terminated in the 2021 financial year.

Despite JobKeeper payments providing some respite, this was not adequate given the near 100% reduction in income and so the business was wound down whilst continuing to provide services to clients over the next 12 months.

Financial summary of the business activity

Table 1: Financial summary of the business activity

* Partially affected by COVID restrictions - overall up to the end of February the activity was in profit in the amount of $XXX.

** Affected by COVID restrictions

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 subsection 35-10(1)

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

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

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

Income Tax Assessment Act 1997 section 35-30

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

Reasons for decision

Non commercial losses

Division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless:

•         you satisfy the income requirement and you pass one of the four tests;

•         the exceptions apply; or

•         the Commissioner exercises his discretion.

You do not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 (that is your taxable income, reportable fringe benefits and reportable superannuation contributions but excluding your business losses, exceed $250,000) and the activity is not an excepted business activity.

Relevantly, the Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the income year(s) in question where the business activity is affected by special circumstances outside the control of the operators of the business activity.

'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.

Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion provides guidance on how the discretion under subsection 35-55(1) of the ITAA 1997 may be exercised to determine that it would be unreasonable for the loss deferral rule in subsection 35-10(2) to apply to a loss attributable to an individual taxpayer's business activity.

For most individuals who do not satisfy the income requirement it is expected that the business activity will meet one of the four objective tests.

Access to the special circumstances limb is not limited to those individuals who satisfy the income requirement. Individuals who do not meet the income requirement, but who can demonstrate their business is commercial, and has been affected by special circumstances, may also be considered under the special circumstances limb.

Relevantly, paragraph 13A of TR 2007/6 provides:

For those individuals who do not satisfy the income requirement in subsection 35-10(2E) special circumstances are those which have materially affected the business activity, causing it to make a loss.

For these individuals the Commissioner's discretion in paragraph 35-55(1)(a) 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.

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.

Affected by 'special circumstances'

For the exercise of the Commissioner's discretion in regard to the special circumstances limb, the business activity must be affected by special circumstances.

No exhaustive definition of 'special circumstances' is provided in the ITAA 1997. However, the term has received considerable judicial consideration in respect of other legislation.

In the case Community Services Health, Minister for v. Chee Keong Thoo (1988) 78 ALR 307; (1988) 8 AAR 245 Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation at ALR 324:

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...

In the case Employment, Education, Training Youth Affairs, Department of v. Barrett (1998) 82 FCR 524; (1998) 52 ALD 499; (1998) 27 AAR 291 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed at FCR 530 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 went on to say:

The AAT observed in Re Beadle and Director-General of Social Security (1984) 6 ALD 1 at 3 (which was approved by the Full Court in Beadle v. Director of Social Security) (1985) 60 ALR 225):

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.

In the context of Division 35 of the ITAA 1997, special circumstances are ordinarily those affecting the business activity such that it is unable to satisfy a test and it would be unreasonable for the loss deferral rule to apply. Subject to the 'special circumstances' listed in paragraph 35-55(1)(a), 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. However, substantial unexpected fluctuations of a scale not regularly encountered previously may qualify on a case by case basis.

While paragraph 35-55(1)(a) of the ITAA 1997 refers to 'special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster', the use of the word 'including' indicates that the type of circumstances to which the special circumstances limb of the discretion can potentially apply is broader than those which are natural disasters. For example, 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.

The special circumstances must have affected the business activity. Some indicators of the effects on the business activity that could lead to the exercise of the discretion in regard to the special circumstances limb are:

•         destruction of stock or equipment;

•         delays in ploughing, planting, harvesting etc;

•         delay in growth of crops;;

•         inability of operator to perform duties; and

•         loss of business opportunities.

In the 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.

Where the business activity is carried on by an individual who does not satisfy the income requirement in 35-10(2E) of the ITAA 1997 and this activity would have made a loss even if it had not been affected by special circumstances, it is also unlikely that it would be considered unreasonable for the loss deferral rules to apply and therefore the Commissioner is unlikely to exercise the discretion.

Outside the control of the operators of the business activity

For these other kinds of events, the operators of the business activity must show that the special circumstances were outside their control.

The concept of 'control' was discussed in Secretary, Department of Employment, Education and Youth Affairs v. Ferguson (1997) 76 FCR 426; (1997) 48 ALD 593; (1997) 147 ALR 295 for the purposes of subsection 45(6) of the Employment Services Act 1994. At 76 FCR 438; 48 ALD 603; 147 ALR 306, Mansfield J said:

The expression in s45(6)(a) requires that the main reason for the failure was something that the person had within that person's control. The concept of 'control' in that context is one of fact, but I think it is intended to mean something which the person could have done something about.

...

It recognises the focus of the expression upon occurrences which the person concerned could not realistically prevent.

For individuals who do not satisfy the income requirement, the business activity must have been materially affected by the special circumstances, causing it to make a loss. In this context, the Commissioner may exercise this discretion for the income year(s) in question where, but for the special circumstances:

•         your business activity would have made a tax profit

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

Losses in the preceding years

In TR 2007/6, the Commissioner explains that losses in the preceding years will not preclude the exercise of the discretion where it can be demonstrated the business would have made a tax profit in the relevant income year but for the special circumstances:

Example 7A18A

129A. Alister carries on a business of breeding cattle for sale, and has done so for the past 20 years. In prior years this business activity has been very profitable. However, in the 2010 income year it was affected by drought, which caused Alister to spend much more than anticipated on fertilizer and seed to maintain the condition of his pastures. The drought also affected the average sale price per head Alister could obtain for his cattle. A large loss was made from the business for the 2010 income year.

129B. Alister did not meet the income requirement (subsection 35-10(2)(E)) for the 2010 income year. Therefore, the fact that his business activity satisfied both the assessable income and profits tests for this year does not automatically mean that the loss deferral rule in subsection 35-10(2) does not apply. This is due to the change in paragraph 35-10(1)(a), and the introduction of subsection 35-10(2E) (the income requirement). He applies for the Commissioner to exercise the discretion under the special circumstances limb in paragraph 35-55(1)(a), and decide that the loss deferral rule not apply.

129C. Alister's application shows that special circumstances outside of his control, in the form of the drought, caused his business activity to make the loss in question, where, but for those circumstances a profit would have been made.

129D. The Commissioner notes the inherent profitability of the business, as borne out by its strong past performance in this respect. He concludes that, while the factors in paragraph 35-10(1)(a) are not directly to be applied, the fact that the business continues to satisfy the assessable income test and the profits test points towards it being 'commercial' in the sense indicated by the scheme of Division 35. The Commissioner concludes that it would be unreasonable in these circumstances for the loss to be deferred, and exercises the special circumstances limb of the discretion.

129E. 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.

Application in your circumstances

For the income year, the business activity satisfied the assessable income test in section 35-30 of the ITAA 1997.

The Commissioner must also be satisfied that it was because of special circumstances that the business activity did not make a tax profit for the income year. It is accepted that the government's response to the COVID pandemic is a special circumstance that affected the operations of the travel agency business in that income year. It is accepted that for the income year ending 30 June 2020 the business activity was also affected by the government's response to the COVID pandemic.

The figures provided for the business activity show that it made a profit in seven of the income years from the income year ending 30 June XXXX to the income year ending 30 June XXXX. This suggests that it was as a result of the special circumstances that the loss occurred in the income year ending 30 June XXXX.

As the business activity passes the assessable income test in section 35-30 of the ITAA 1997 and it is accepted that the Government imposed travel restrictions are special circumstances that have affected the business activity, the Commissioner accepts that it is the special circumstances meant that the business activity did not produce a tax profit for the income year and so would exercise the discretion under the special circumstances limb in paragraph 35-55(1)(a) of the ITAA 1997; that the rule in subsection 35-10(2) of the ITAA 1997 does not apply to the business activity for the income year ended 30 June XXXX.