Edited version of private advice

Authorisation Number: 1052085243287

Date of advice: 3 March 2023

Ruling

Subject: Commissioner's discretion - 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 activity in your calculation of taxable income for the relevant financial years?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You satisfy the under $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You carry on an activity.

You provided details:

•         on how your activity was impacted by COVID-19 during the relevant financial years

•         of the assets used in your calculation for the 'other assets test'

•         on 2 methods that you used to calculate your assets for the purpose of the other assets test for your hired assets

•         of the figures you calculated for both methods for the purpose of the 'other assets test'

•         regarding the equipment that you hire

•         on the tax losses you incurred for the relevant financial years

•         of your assessable income (actual and projected) for the relevant financial years.

You used the market value of the assets that you purchased for the calculation of the assets for the 'other assets test'.

You expect your activity to make a net profit in a later financial year.

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

Summary

Having regard to your full circumstances, it is not accepted that your activity was affected by special circumstances outside your control that prevented you from meeting one of the four tests. Consequently, the Commissioner will not exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 for the relevant financial years.

Detailed reasoning

Non-commercial loss provisions

Division 35 of the ITAA 1997 prevents losses from a non-commercial business activity carried out by an individual taxpayer (alone or in partnership) from being offset against other assessable income in the year in which the loss is incurred, unless:

•         the individual meets the income requirement and the business activity satisfies one of the 4 stipulated tests (paragraph 35-10(1)(a));

•         an exception in subsection 35-10(4) applies; or

•         the Commissioner exercises the discretion in subsection 35-55(1) for the business activity for one or more income years.

The exceptions are for primary production business or professional arts business where your income from other sources not related to that activity is less than $40,000.

Four Tests

Where a business activity does exist, losses can be offset against income from another source when the taxpayer satisfies at least one of the following tests:

•         assessable income test;

•         real property test;

•         other assets test; or

•         profits test.

Assessable income test

If the assessable income from the business activity is $20,000 or more in the relevant year, section 35-30 of the ITAA 1997 provides that the loss incurred from the business activity is deductible. Your actual and projected assessable income is less than $20,000 for the relevant financial years.

Other assets test

Subsection 35-45(1) of the ITAA 1997 provides that if the individual uses certain other assets that have a value of $100,000 or greater on a continuing basis in carrying out the business activity, losses from the business activity will be able to be deducted against other sources of income. The value of the other assets must be determined in accordance with the legislation.

How the value of the asset is calculated for the purpose of the 'other assets test' is outlined under section 35-45 of the ITAA 1997 as follows:

•         an asset whose decline in value is deductible under Division 40. The value of the asset is the asset's written down value

•         an asset that you lease from another entity. The value of the asset is the sum of the amounts of the future lease payments for the asset to which you are irrevocably committed, less an appropriate amount to reflect any interest component for those lease payments.

In your situation, you do not satisfy the 'other assets test' as the value of the leased assets will be the amount that you have paid to hire them along with any future irrevocably committed payments, not the value of the asset had you owned them. Also the value that you used in your calculation for the other assets was not the asset's written down value. The other assets figure that you calculated for the some of the relevant financial years was less than $100,000. The value of the other assets had you calculated them in the manner set out in the legislation would have been a lot less than $100,000.

The exceptions do not apply to you and although you satisfy the income requirement, you did not meet any of the four tests in the years under consideration in the relevant years. Your business losses are subject to the deferral rule unless the Commissioner exercises his discretion.

Special circumstances

You have requested the Commissioner to exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 in the relevant financial years, on the basis of special circumstances.

'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.

For individuals who satisfy the income requirement, the business activity must have been materially affected by the special circumstances, preventing it from making a profit or passing one of the four tests. In this context, the Commissioner may exercise this discretion for the income year(s) in question where, but for the special circumstances your business would have:

•         made a tax profit or

•         passed one of the four tests.

It is accepted in your case that the COVID-19 lockdown constitutes special circumstances. However, this in itself is not sufficient for the discretion to be exercised. The Commissioner must also be satisfied that your activity would have made a profit or have passed one of the four tests but for the special circumstances. That is, the special circumstances discretion can only be exercised where it can be seen that it was only the special circumstances which caused the loss or caused you to fail one of the tests.

Conclusion

Based on the figures that you provided, you would not have passed one of the four tests or made a tax profit if the special circumstances did not apply.

The Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the years in question. The losses from your activity cannot be used against your other income in the relevant financial years. The losses will be carried forward to be offset against later years where there is a profit from your activity if you meet the requirements in Division 35 to be able to claim the deferred losses in a later year.