Edited version of private advice

Authorisation Number: 1052250369790

Date of advice: 13 May 2024

Ruling

Subject: Commissioner's discretion - non-commercial business losses

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 the losses from your business in the calculation of your taxable income for the income year ended 30 June 20XX?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced/s on:

1 July 20XX

Relevant facts and circumstances

You are an Australian resident for taxation purposes.

You commenced your business activity on 1 July 20XX.

You operated XX businesses during the XX years to 30 June 20XX.

You are requesting the Commissioner's discretion for the 20XX income year due to being affected by 'special circumstances':

•         Covid-19

•         Staffing issues and

•         Increased interest rates

•         Local council decisions.

Your businesses were severely impacted by Covid-19 due to the associated lockdowns.

You do not satisfy the under $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997.

You meet 3 out of 4 tests:

• Assessable income test
• Profits test
• Other assets test.

Your profit and loss statement shows:

•         Profit for the 20XX income year.

•         Profit for the 20XX income year.

•         Loss for the 20XX income year.

•         Profit for the 20XX income year

•         Loss for the 20XX income year

Income tax return figures show that you made a net profit in the years ending 30 June 20XX, 30 June 20XX, 30 June 20XX, 30 June 20XX and 30 June 20XX.

You are aiming to break even or better, in 20XX and return to profits in the 20XX year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

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 35-30

Income Tax Assessment Act 1997 section 35-35

Income Tax Assessment Act 1997 section 35-45

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

Reasons for decision

Issue 1

Income tax: Non-commercial business losses: Commissioner's discretion

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 the losses from your business in the calculation of your taxable income for the income year ended 30 June 20XX?

Summary

The business activity passes the assessable income test in section 35-30, the profit test in section 35-35 and other assets test in section 35-45 of the Income Tax Assessment Act 1997 (ITAA 1997) and having regard to your full circumstances, it is accepted that your business activity was affected by special circumstances outside your control which prevented you from making a tax profit in the year ended 20XX.

Consequently, the Commissioner will exercise his discretion in the 20XX income year under the special circumstance's limb, in paragraph 35-55(1)(a) of the ITAA 1997, to determine that the loss deferral rule does not apply.

Detailed reasoning

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 as your taxable income, reportable fringe benefits and reportable superannuation contributions but excluding your business losses, exceed $250,000 The activity is not an excepted business activity.

Relevantly, the Commissioner's discretion in paragraph 35-55(1)(a) of the ITAA 1997 may be exercised for the income year in question where the business activity is affected by special circumstances outside the control of the operators of the business activity.

Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion 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.

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.

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 AAT 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. 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.

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;

•         delays in ploughing, planting, harvesting etc;

•         delay in growth of crops;

•         inability of operator to perform duties; and

•         loss of business opportunities.

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.

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.

Application in your circumstances

For the 20XX income year, the business activity satisfied the assessable income test in section 35-30, the profit test in section 35-35 and other assets test in section 35-45 in the ITAA 1997.

It is accepted that Covid-19 is a special circumstance that affected the operations of the business for the income year ending 30 June 20XX resulting in the tax loss.

Figures reported in your income tax returns show that your business activity made a profit in XX of the XX income years from the income year ending 30 June 20XX to the income year ending 30 June 20XX. This suggests that it was as a result of the special circumstances that the loss occurred in the income year ending 30 June 20XX.

The Commissioner accepts that the special circumstances lead to the business activity not producing a tax profit for the income year and so will exercise the discretion under the special circumstances limb in paragraph 35-55(1)(a) of the ITAA 1997. As a result, the rule in subsection 35-10(2) of the ITAA 1997 does not apply to the business activity for the income year ended 30 June 20XX.