Edited version of private advice

Authorisation Number: 1052088374674

Date of advice: 16 February 2023

Ruling

Subject:Commissioner's discretion

QuestionOne:

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 because of special circumstances in your calculation of taxable income for the 20XX-XX financial year?

Answer

No.

QuestionTwo:

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to include any losses from your business activity because of its nature in your calculation of taxable income for the 20XX-XX financial year?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

Relevant facts and circumstances

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

During the ruling period, you had a full-time position. This position was separate to your activity. You spent a number of hours per day outside business hours working on the activity.

Your activity involves the development of a product with internationally sourced ingredients.

A website is maintained for the purpose of selling products.

You undertook a number of tasks during the ruling period relating to your activity and you received pre-orders for your product in the relevant financial year.

You have a number of followers on social media.

You provided a financial statement for your activity which outlined expenses with no income related to the activity. You plan to make a tax profit in a future year.

You have kept detailed records of expenses and have a business plan and financial forecast. A number of units are required to be sold to turn a profit to meet the income threshold of $20,000.

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)

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

Detailed reasoning

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.

In your situation, none of the exceptions would apply and although you satisfy the income requirement, you do not meet any of the four tests in the years under consideration. 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 2021-22 financial year, 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.

Taxation Ruling TR 2007/6 sets out the Commissioner's interpretation of the exercise of the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 53 of this ruling:

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 affected the business activity.

For the Commissioner to excise the discretion they must be satisfied that where a business activity has been affected by special circumstances outside the control of the operators of that activity, had these circumstances not existed, the activity would have satisfied one of the four tests in Division 35, or made a tax profit.

Special circumstances discretion is not intended to be available where the failure to make a profit or to meet a test is for reasons other than circumstances outside of the business operators' control, such as, utilising temporary full expensing or specific business choices and decisions made.

In your case, you stated that your business was affected by COVID-19, due to delays in the availability and supply of ingredients for your product from overseas and this prevented you from making a tax profit or passing the assessable income test.

While we appreciate your situation, it is not accepted that these circumstances constitute special circumstances in the way this term is used in the legislation. We believe these occurrences to be standard risks of carrying out a business in your industry and not unusual or out of the ordinary. Furthermore, as you commenced your business during COVID-19, COVID-19 was a standard risk of carrying out a business during these times. In addition, based on your business assessable income figures you would not have met the $20,000 assessable income test in any of the financial years had the circumstances not applied.

Nature of business-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 your business activity will produce a tax profit or meet one of the four tests within a commercially viable period for your industry.

Having regard to your full circumstances, it is not accepted that it is the nature of the business activity that has prevented one of the four tests being passed. You commenced the activity and have not yet derived any income from the activity prior to the end of the relevant financial year, as outlined in the financial statement.

This discretion is intended to cover a business activity where there is an inherent period of time between the commencement of the activity and the production of assessable income. For example, an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

The legislation does not support any view that the discretion should be exercised for any start-up activity that is yet, for example, to satisfy the assessable income test in section 35-30 of the ITAA 1997, simply because of the small scale on which it was started, or because a client base is being built up.

We do not consider that there is a lead time between the commencement of your activity and the production of any assessable income. We do not consider that there is anything inherent or innate in the nature of your business activity that it has not yet been able to satisfy one of the tests. Your activity is of a type that is able to produce income when the product is available for purchase.

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