Edited version of private advice

Authorisation Number: 1052232235220

Date of advice: 21 March 2024

Ruling

Subject: Commissioner discretion - non-commercial losses

Question 1

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 for the 20YY-YY financial year?

Answer

Yes.

Question 1

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 business activity in your calculation of taxable income for the 20YY-YY to 20YY-YY financial years?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20YY

Year ended 30 June 20YY

Year ending 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

You do not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997.

You work as a XXXX and maintain a private business.

You see your private clients in the public system as the services provided by a large public sector are superior to the smaller private sector at which you work and the outcomes safer for clients.

You previously worked 50% of the week in public sectors and 50% in private sectors.

Your private business had always been profitable from when it first commenced.

Your private business continues but has been limited for a number of reasons.

During the COVID pandemic your state government introduced limitations to business in the private system with only the most critical cases allowed.

You believe the risks of COVID in sectors during the pandemic drove many clients to avoid XXX consultation and consideration of XXXX.

These restrictions continued through to the end of the 20YY-YY financial year.

A significant proportion of the business was in the management of clients from a region of your state.

The business performed consultations and during the pandemic access to these clients and therefore XXXX was limited due to your state government restrictions on travel as well as bordering state restrictions preventing travel.

75% of these consultations were unable to be performed during 20YY-YY.

In retrospect you believe the restriction for travel into regional the part of your state and Region 2 only existed during the 20YY-YY financial year.

Government websites show restrictions were lifted by February 20YY.

In February 20YY the state Premier announced all XXXX XXX in both public and private sectors would resume by the end of February 20YY.

You advised you had ongoing restrictions across public and private XXXX in your state due to XXXX staff catching COVID and therefore being unable to work. You state COVID client numbers often prevented cases occurring as there were no xxxx xxxx.

Many clients had significant concerns about attending any business due to the infection rates within businesses during the pandemic and therefore they were understandably very concerned about having XXXX. The most significant reduction in your private business has come from decreased xxxx procedures as your consulting with clients has remained steady.

Clients that you were unable to see during the 20YY-YY period often took different optional plans as the threat of COVID remained in 20YY-YY.

Staff that have had COVID are restricted from working in any business system in your state with a 5 day exclusion period. This was very relevant in 20YY-20YY and remains so however vaccination has significantly reduced the burden of disease affecting business staff.

You were an essential worker and able to work in the public sector system but these restrictions did not impact on the delivery of xxxx xxxx in public or private. Outside of the state government restrictions on business, it was staffing issues that continued to cause delays.

You perform very little private business XXXX business. You do perform XXXX business on private clients in public business. The majority of your private business is xxxx work.

You perform complicated major xxxx of multiple xxxx, one of which take around 6-8 hours. You see your private clients in the public sector as the services provided by a large public business are superior to the smaller private business at which you work and the outcomes safer for clients.

The majority of your private business for lesser xxxx is performed in a private business but increasingly clients are finding that their xxxx only covers them in a public business.

You perform minimal xxxx in your private business and during much of the pandemic these xxxx clients were unable to be xxxx to a private business until they were proven on a COVID-19 PCR to be negative.

You had xxxx cancelled due to clients, staff and xxxxx being COVID positive.

You advised the lockdown dates for the 20YY-YY financial year.

One of your relatives had been unwell for an extended period of time and underwent a surgical operation followed by 4 months in hospital during 20YY. The issue recurred in the latter half of 20YY and they underwent other treatments until late in February 20YY when they started XXX. They required XXX for their ailment over a 2 month period through MM - MM 20YY and this impacted on your earning capacity.

You took 2 weeks of compassionate leave during this time and were unable to see clients or work for this short period. Throughout 20YY-YY however you had reduced your private business work to be able to help your family.

You were contacted in April 20YY and seconded to a role as a result.

You did not apply for the role, but were selected from a group of candidates, but you are unaware of who the candidates were.

As part of a major investment in xxxx and reform in your state post pandemic, your role was established.

You were not aware of the process or the position until you had been selected and approved.

You agreed to the secondment.

At the moment you are seconded until the end of the financial year, but there it is likely that the position will be ongoing if funded in the budget.

You are seconded to an additional 2 places of work, but also had to decrease your private xxxx and consulting time to be able to provide the 2 day a week secondment role.

The role is to lead recovery and reform of xxxxpractices in your state. This is paid partly through their public business appointments. This has also impacted on the business and reduced consulting opportunities.

The amount of time you could spend on your private business work was decreased significantly during the secondment role.

Your businesses financial situation over the past 5 years is as follows:

20YY: profit

20YY: profit

20YY: loss

20YY: loss

20YY: loss

Your costs rose significantly due to inflation, increased costs of running a xxxx business and the rise in interest rates on your business loans.

For the 20YY-YY financial year you expect that private xxxx activity will continue to recover. You provided your expected income and expenses, based on 30 June 20YY with an expected loss also provided.

You anticipate a loss during the 20YY-YY financial year as you have not yet seen a recovery in the volume of the type of xxxx that you provide to the community back to your pre pandemic xxxx volumes. You continue your secondment to the state department until the end of June 20YY and after the budget, you will then make decision about the ongoing impact of this role.

Your secondment role will also reduce during the 20YY-YY financial year, allowing an increase in consultation and xxxx sessions.

Re-evaluation of business loans and costs is currently in process with plans to pay down the business loans more rapidly and to reduce costs in other aspects of the business.

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 section 35-55

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.

Commissioner's Discretion

The Commissioner's approach to exercising the discretion under subsection 35-55(1) of the ITAA 1997 is outlined in Taxation Ruling TR 2007/6 Income Tax: non-commercial losses: Commissioner's discretion. There are two discretions available to the Commissioner under section 35-55 of the ITAA 1997: lead time and special circumstances. You have applied under special circumstances.

Special Circumstances

The special circumstances discretion may be exercised for the financial year/s in question where your business activity is affected by special circumstances outside your control.

Special circumstances are those circumstances which are sufficiently unusual or different to distinguish them from the circumstances that occur in the normal course of conducting a business activity.

TR 2007/6 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 Administrative Appeals Tribunal 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 (paragraph 47 of TR 2007/6). 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.

Paragraph 49 of TR 2007/6 states:

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 (refer to Example 2 at paragraph 112 of this Ruling;

•         delays in ploughing, planting, harvesting etc (refer to Example 3 at paragraph 115 of this Ruling);

•         delay in growth of crops (refer to Example 4 at paragraph 118 of this Ruling);

•         inability of operator to perform duties (refer to Example 5 at paragraph 122 of this Ruling);and

•         loss of business opportunities (refer to Example 6 at paragraph 125 of this ruling).

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.

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 to your circumstances

In your case, the special circumstances that you have put forward for Commissioner's discretion are Covid restrictions that prevented you from making a profit and that you were still recovering from past restrictions, your ill relative and their treatment, your secondment for 2 days a week and large business loans with increasing in interest rates with inflation, that has increased your costs significantly.

Having regard to your full circumstances, it is accepted that your business activity was affected by special circumstances outside your control and that these prevented you from making a tax profit in the 20YY-YY financial year. Consequently, the Commissioner will exercise his discretion in the 20YY-YY financial year and allow you to include any losses from your business activity in your calculation of taxable income for the 20YY-YY financial year.

Beyond 20YY-YY

Although COVID could be seen as a special circumstance as it was beyond your control and allowed up until the 20YY-YY financial year, it is no longer a special circumstance beyond that.

This is confirmed by TR 2007/6 where it states at paragraphs 14 and 15:

14. The special circumstances must be outside the control of the operators of the business activity. Such circumstances are specifically defined to include drought, flood, bushfire or some other natural disaster. In the case of other events, failure for no adequate reason to adopt practices commonly used in an industry to prevent or reduce the effects of special circumstances may point to the special circumstances not being outside the control of the operator.

15. The discretion can be exercised in income years after the one in which the special circumstances occurred if the effects of those special circumstances continue to prevent the business activity from satisfying any of the tests in those later income years. However, there may be situations where the special circumstances, because of their continued existence, become the ordinary or usual situation. It would not be appropriate to exercise the discretion once this occurs.

For earlier financial years it is accepted that COVID and related government restrictions could be deemed a special circumstance that impacted your business to make a profit. Beyond this it is deemed that there are no continuing special circumstances as COVID has become the norm, where all businesses need to carry on due to the continued existence of COVID. The government restrictions relating to limiting elective surgeries were lifted during the 2021-22 financial year.

In addition to this 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. Your ability to make a profit was significantly impacted by your acceptance of the secondment to the state department as it meant that you had a 2 day per week commitment that reduced your ability to generate income for your business.

Moreover you advised that your running costs have increased as a result of inflation and rising interest rates. These are not special circumstances as they are ordinary economic, weather or market fluctuations that might reasonably be predicted to affect the business activity. 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.

Finally, the figures you provided for the business activity showed that you had barely broken even prior to and at the beginning of the pandemic and made a loss for the 20YY-YY financial year and further losses in the 20YY-YY and 20YY-YY financial years. You have also forecast a loss in the 20YY-YY financial year. You have significant management fees, which coupled with the reduction in business income due to the absence from your business through the secondment and industry wide rising interest rates, you are incurring losses from your business activity that are not considered special circumstances as your absence is within your control, the market conditions are not unique to you and COVID is no longer a special circumstance.

The losses for the 20YY-YY and 20YY-YY financial years will be deferred until you make a profit.