Edited version of private advice

Authorisation Number: 1052193570102

Date of advice: 5 December 2023

Ruling

Subject: Commissioner discretion - special circumstances

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 2022-23 financial year?

Answer

No.

This private ruling applies for the following period:

Year ended 30 June 20YY

The scheme commenced on:

1 July 2020

Relevant facts and circumstances

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

Your business activity commenced in the 2020-21 financial year. The income from your activity decreased each year from when it began. You made a loss from the activity in the relevant financial year, which had high expenses that exceeded your income.

You were going through personal circumstances which had an impact on your mental health. You said you were unable to concentrate and or devote the time to your business that it deserves. You stated that the circumstances led you to scale down your activities.

You spent minimal time on the activity in the 2022-23 financial year. At the same time you had employment with more than one employer in the relevant financial year, which was not the case in the previous years that you were carrying on your activity.

Your main clientele is from a specific profession. You have expertise in professional development for this profession. Your activity is advertised through Facebook.

You said that you did not prepare a budget or a plan.

An accounting system is used for record keeping for your activity.

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

These reasons for decision accompany the Notice of private ruling for the 2022- 23 financial year.

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 to allow you to include any losses from your activity in your calculation of taxable income for the 2022-23 financial year?

Summary

Having regard to your full circumstances, it is not accepted that your business activity was affected by special circumstances outside your control and that these 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 2022-23 financial year.

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 year under consideration. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion.

You have requested the Commissioner to exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 in the 2022-23 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. It says at paragraphs 7 and 10:

Paragraph 7. Sections 35-30, 35-35, 35-40 and 35-45 set objective tests, at least one of which should be satisfied by a business activity for it to be regarded as commercial for the purposes of the Division. If a business activity fails to satisfy any of these tests in a loss year then it is treated as a non-commercial business activity and the losses from the business activity are, subject to certain exceptions, deferred. The discretion provided to the Commissioner should be interpreted in the light of this context.

Paragraph 10. The aim of the Division is to defer losses from business activities which do not satisfy at least one of the four tests. The discretion is not intended to apply where a business activity makes a loss because of factors which can apply to any business and which do not affect the ability of the activity to satisfy one of the four tests.

In your case, you believe that your activity would have generated more than $XX,000 in assessable income or made a tax profit in the relevant financial year if it were not for your personal situation that affected your concentration and led you to scale down your business activity.

Your business income has declined significantly every year since it began, declining to a loss situation in the relevant financial year. Your expenses exceeded your income, leading to a loss situation. The mere fact the business satisfied the assessable income in previous years would not, in itself, indicate that it was unreasonable for losses from the business to be deferred in the relevant financial year. 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.

Since you commenced your activity, you have also taken up employment and increased to working for more than one employer in the relevant financial year. If the operators of a business activity fail for no adequate reason to adopt certain practices commonly used in their industry to prevent or reduce the effects of certain circumstances, then that may point to the circumstances being within their control, such as a decision to work more than one job and allow minimal time per week in a business activity. (Paragraph 55 and 57 of TR 2007/6)

There was no evidence provided to support your reduced capacity to conduct your activity while at the same time demonstrating capacity to be employed at more than one job during the relevant financial year. Based on the available information it is not clear that the personal circumstances materially affected the business activity.

It is important to consider whether the activity is carried on for commercial reasons and in a commercially viable manner. Whether an activity is a business or hobby is a question of fact. A decision is made by:

•         referring to the business indicators listed in TR 97/11, and

•         making a decision based on the overall weighting of these indicators.

No single indicator determines whether a business is being carried on. Based on available evidence, your activity does not appear to have a significant element of commerciality:

•         the activity failed to satisfy any of the set objective tests and resulted in a loss in the relevant financial year

•         minimal time per week allocated to the activity

•         there is no business plan. While not compulsory, it can show that the activity will be profitable, provide realistic estimates of quantity and volume of sales, and that the activity has a significant commercial purpose

•         you have no plan or system in place to make the activity succeed.

Paragraph 29 of TR 97/11

29. The phrase 'significant commercial purpose' is referred to by Walsh J in Thomas v. FC of T 72 ATC 4094; (1972) 3 ATR 165, (refer to paragraph 81) and discussed further by Gibbs CJ and Stephen J in Hope. The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity (refer to paragraphs 77 to 85), the repetition and regularity of activity (refer to paragraphs 55 to 62) and the profit indicators (refer to paragraphs 47 to 54). A way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business. Any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the business should also be considered but are not necessarily determinative: see Thomas. In that case, Walsh J found that the taxpayer's activities in growing macadamia nut trees and avocado pear trees amounted to the carrying on of a business. The court was influenced by the scale of the activity, and the taxpayer's expectation of an ongoing financial return. Consideration should also be given to whether the taxpayer is a pioneer in the activity or has developed a new method of undertaking the activity, whether successful or not.

While we appreciate your situation, it is not accepted that the personal circumstances constitute special circumstances in the way this term is used in the legislation. It has not been shown how the special circumstances have affected your activity and stopped you from producing a tax profit or stopped you meeting the assessable income test in the relevant financial year, or how you would have made a profit had it not been for these circumstances.

Instead, the activity loss occurred due to you scaling down your activity, high expenses, non-commercial factors as outlined, leading to a non-commercial activity in the relevant year. The activity has shown a marked decline in income every financial year since it started.

The Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 for the 2022-23. This being the case you will have to defer your losses from your activity for this year to be offset against future profits from this activity.