Edited version of private advice

Authorisation Number: 1052057135089

Date of advice: 30 January 2023

Ruling

Subject: Commissioner's discretion - non-commercial losses lead time

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your business activities in the calculation of your taxable income for the 20XX income year?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are engaged in the business activity of XXXX.

Your business activity commenced in the 20XX financial year.

You did not have any business income for the 20XX financial year.

You made a tax loss of $XXXXX from your business activity for the 20XX income year

You had an assessable income of $XXXXX from the other sources for the 20XX income year

Your income for non-commercial loss purposes is below $250,000.

You advised a lead time of X months (XX/XX/20XX to XX/XX/20XX) for product design, sampling, manufacturing, and quality control for your product.

You advised there was close to X months (XX/XX/20XX to XX/XX/20XX) of delivery time for the initial stock order and advised to consider this as part of the lead time as well.

You further advised that this is the standard shipment timeframe provided by your manufacturer.

You will be selling XXX units per year at AUD$XX equivalent commencing 20YY financial year.

Your product was on Amazon product live for sale from XX/XX/20XX.

You advised evidence from independent sources were not available and hence you provided generic evidence (for a start-up) to indicate a Z-year timeframe as commercially viable period for your business activity.

You have provided your business plan and projected financials for X years (20XX-20XX financial years').

You provided year to date (YTD) sales figures for 20XX financial year on XX/XX/20XX.

Your YTD sales data for the 20XX financial year suggests, you had sold XX units for unit price ranging between USD$XX and USD$XX.

You have provided generic evidence to indicate a Z-year timeframe as commercially viable period for your business activity.

You have provided your business plan and projected financials for K years (20XX-20XX financial years').

You are anticipating meeting one of the four tests in the 20AA financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 35

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

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

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

Income Tax Assessment Act 1997 section 35-30

Income Tax Assessment Act 1997 section 35-35

Income Tax Assessment Act 1997 section 35-40

Income Tax Assessment Act 1997 section 35-45

Income Tax Assessment Act 1997 section 35-55

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

Reasons for Decision

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) (lead time) to allow you to include any losses from your business activity in the calculation of your taxable income for the 20XX income year?

Summary

Having regard to your full circumstances, it is not accepted that there is anything inherent in the nature of your business activity that prevents it from meeting the assessable income test (which is the test relied on in the ruling application) within the commercially viable period for the industry. Therefore, the Commissioner will not exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 for the 2022 income year.

Detailed reasoning

Division 35 of the ITAA 1997 prevents losses of individuals from non-commercial business activities being offset against other assessable income in the year the loss is incurred. The rule in subsection 35-10(2) of the ITAA 1997 will apply to defer a loss incurred by an individual from a business activity unless:

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

b)    you satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 and one of the following four tests:

                      i.        the assessable test (section 35-30 ITAA 1997)

                     ii.        the profits test (section 35-35 ITAA 1997)

                    iii.        the real property test (section 35-40 ITAA 1997)

                   iv.        the other assets test (section 35-45 ITAA 1997); or

c)    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 primary production businesses or professional arts businesses when assessable income for the year (except any net capital gain) from other sources not related to the business activity is less than $40,000.

Commissioner's discretion

Under section 35-55 of the ITAA 1997, you can apply for Commissioner's discretion to be exercised where:

a)    special circumstances outside your control have resulted in a loss; or

b)    there is a lead time between the commencement of the activity and the production of any assessable income.

Lead time

The relevant discretion may be exercised for the income year in question where:

•         it is in the nature of the business activity that there will be a period of time before it can be expected to pass one of the four tests: and

•         there is an objective expectation that your business activity will make a tax profit or meet one of the four tests within the commercially viable period for your industry.

As stated in paragraph 17 of TR 2007/6 Taxation Ruling Income tax: non-commercial business losses: Commissioner's discretion (TR 2007/6), for the failure to satisfy one of the four tests (subparagraph 35-55(1)(b)(i)) or produce a tax profit (subparagraph 35-55(1)(c)(i)) to be 'because of its nature', the failure must be because of some inherent characteristic that the taxpayer's business activity has in common with other business activities of that type.

The meaning of the phrase 'because of its nature' is expanded upon in paragraphs 77 and 78 of Taxation Ruling TR 2007/6:

77. Therefore, the phrase 'because of its nature' refers to inherent characteristics of the type of business activity being conducted by the taxpayer, which are common to any business activity of that type. These inherent characteristics must be the reason why the activity is unable to satisfy any of the tests. The discretion is not intended to be available where the failure to satisfy one of the tests is for other reasons.

78. The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity.

Application to your circumstances

For the discretion to apply, the Commissioner must be satisfied that there is an objective expectation that your business activity will pass one of the tests or make a profit within a period that is commercially viable for the industry concerned. The objective expectation must be based on independent information, where such information is available.

The lead time discretion is intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is producing a loss or not meeting the assessable income test (which is the test relied on in your ruling request) is inherent to the nature of the business and is not peculiar to your situation.

In your case, you had advised there were no delays in product design, sampling and manufacturing that were carried on between XX/XX/20XX to XX/XX/20XX and the X months' timeframe was due to lead time. Considering the phrase 'because of its nature' in conjunction with your case, it is difficult to deem product design, manufacturing, and shipping of stock as an inherent characteristic for your business activity. We view this period as the preliminary period before your business commenced. Based on the information you provided, your business commenced on XX/XX/20XX when you placed your commercial order for the XXX of product.

Therefore, it is not accepted that there is anything inherent in the nature of your business that is the reason the business activity does not or will not meet the assessable income test or make a tax profit within the commercially viable period.

You have stated that the activity would meet the assessable income test in the 202Y income year. However, we are not satisfied that the activity would meet the assessable income test in 202Y financial year based on the following:

•         You have provided income forecasts to show that your activity will meet the assessable income test and produce a tax profit in the 202Y financial year. You forecast to sell XXX product for AUD$XX each, therefore your business income is forecast be AUD$XX,XXX in the 202Y financial year.

•         However, the YTD sales indicate you have only sold X units since July 202X with a sales turnover of approximately AUD$X (since the product was sold in USD, an assumption was made on the average price of USD$X (AUD$X) was made, the sale price per unit ranged between USD$B to USD$C).

•         Considering the YTD sales for 202Y financial year, you still have XXX of product to be sold to meet the assessable income test.

Reviewing your sales to date information for the 202Y financial year, we are unable to determine a reasonable estimate of what you would sell to show that you would meet the assessable income test if you carried on the activity throughout the 202Y financial year. Based on your sales information to date, we consider it highly improbable that you will meet the assessable income test for the 202Y financial year.

Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997 and you cannot claim a deduction for your losses against other income in the 202X income year.

Commissioner's discretion

The Commissioner will not exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997 for the 202X financial year because, based on the information provided, the Commissioner is not satisfied that your activity will meet the assessable income test (which is the test relied on in the ruling application) or produce a tax profit within the commercially viable period for the industry.

The rule in subsection 35-10(2) of the ITAA 1997 will apply to defer to a future income year any losses from your activity for the year ended 30 June 202Y. A deferred loss will be deductible against any tax profit from your activity, or similar business activity, in future years.

If your activity satisfies the income requirement and one of the tests in Division 35 of the ITAA 1997 in a future year, then the deferred loss can be deductible in that year.