Edited version of private advice

Authorisation Number: 1052307724898

Date of advice: 24 October 2024

Ruling

Subject: Commissioner's discretion - non-commercial 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 losses from your service activity in your calculation of taxable income for the 2021 and 2022 financial years?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2021

Year ended 30 June 2022

The scheme commenced on:

1 July 2020

Relevant facts and circumstances

You began preparing yourself to undertake your service activity to supplement your employment income early in the period covered by this ruling.

You intended to undertake this activity from your home.

COVID 19 related restrictions, including lockdowns, in your area continued on an intermittent basis well into the period covered by this ruling.

You had recently been stood down from your full-time work because of the COVID 19 restrictions in place at the time.

In the previous year you had developed a medical condition which limited the physical activity you could undertake and required ongoing management. You chose to undertake your service activity as the physical demands it placed on you were within the limits imposed by your physical condition.

You believed you could make a profit from this activity based on the difference between the cost of the materials, the fee you could charge for this activity, and the number of clients you expected in a day.

You had no formal business plan for this activity but intended to create one.

You undertook training in this activity and gained qualifications from a recognised training provider.

You relied on the advice from this training provider, your general understanding of demand in this industry, and the encouragement of family and acquaintances for market research.

You set up a dedicated room within your home to undertake this activity, hoping to save on rental costs.

You built a website and printed business cards to advertise your services, and advertised through social media and word of mouth.

Throughout this period you undertook your research, completed your training, and prepared your premises for delivery of this service. You were engaged in this activity for 15-20 hours a week.

You were ready to take appointments to provide your services some time into the relevant period.

Specific COVID 19 related restrictions were imposed by the government in your area for a number of months soon after this time.

The lockdowns and ongoing management of your medical conditions prevented you from engaging in any service provision appointments.

You may have had a few conversations regarding potential appointments but do not have detailed records of cancelled bookings, or the specific dates or phone numbers involved.

You never provided your services to a paying client and you derived no income from this activity.

The total cost of your preparations for your activity was over $XXX.

You kept records of these costs on a spreadsheet for taxation purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 paragraph 35-10(1)(a)

Income Tax Assessment Act 1997 subsection 35-10(4)

Income Tax Assessment Act 1997 subsection 35-55(1)

Income Tax Assessment Act 1997 subsection 35-5(2)

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Division 35 of the ITAA 1997 prevents losses from a non-commercial business activity carried out by an individual taxpayer 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.

Subsection 35-5(2) of the ITAA 1997 specifies that Division 35 is not intended to apply to activities that do not amount to carrying on a business.

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. Further guidance on whether an individual can be said to have commenced or be carrying on a business can be found in case law.

In the case of Evans v. Federal Commissioner of Taxation 89 ACT 4540; (1989) 20 ATR 922 Hill J stated that whether or not an activity amounts to carrying on a business for taxation purposes is a question of fact. There is no exhaustive or determinative definition which can be applied to determine this matter. The facts of each case must be examined. In Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548, Webb J said:

The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.

When does a business activity commence?

The actual date of commencement of a business activity is a question of fact (Goodman Fielder Wattie Ltd v. FC of T 91 ATC 4438; (1991) 22 ATR 26) (Goodman Fielder Wattie).

For a business activity to have commenced a person must have:

•         purpose, intention and a decision to commence the business activity

•         acquired a minimum level of business assets to allow that business activity to be carried on, and

•         actually commenced business operations (Calkin v. CIR [1984] 1 NZLR 440).

A mere intention to start carrying on the business activity will not be sufficient.

For example, if your business activity is characterised as a primary production activity, involving the planting and cultivating of trees, then the planting of the trees could be seen as the commencement of that business. Alternatively, if your business activity is characterised as the manufacturing and selling of a product, the business would generally be considered to commence once you have manufactured and begun selling the product.

In your case the business activity you intended to carry on is characterised as a service activity, involving the provision of services to clients on the payment of a fee.

We can now consider the indicators set out above to determine whether this business activity has commenced.

Purpose, Intention and Decision

The intention and purpose of a taxpayer in engaging in an activity is relevant to when a business commences. However, an intention to commence a business alone will not determine that the business activity has actually commenced.

The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity. This is developed by researching the proposed business and, in some instances, by experiment. This process culminates in a final decision on whether to commence business. However, not all businesses commence in such an orderly manner.

It is clear from the information you have provided that you researched your proposed business activity, decided on the form of that business and commenced preparation to undertake that activity.

Acquisition of a minimum level of business assets to allow that business activity to be carried on

Most business activities have a structure that provides the framework of the business. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity.

In Calkin v. CIR [1984] 1 NZLR 440 Richardson J said at 446-447:

Clearly it is not sufficient that the taxpayer has made a commitment to engage in business: he must first establish a profit-making structure and begin ordinary business operations.

For a business activity to commence, an appropriate business structure should be in place and begin ordinary business operations.

As to what the business structure will consist of, and its size, will be a question of fact and degree, and will depend on the nature of the business activity.

Your activity consists of providing services to clients for a fee.

You undertook training in this activity and gained qualifications from a recognised training provider.

You prepared a room in your house in which to deliver this service.

You built a website and printed business cards to advertise your services, and began advertising your services through social media and through word of mouth.

By a date well into the period covered by this ruling you had the business assets and structures necessary for your service activity in place and were ready to begin providing your service to paying clients.

Commencement of Business Operations

The carrying on of a business is not a matter merely of intention. It is a matter of activity. As noted by Brennan J in Inglis v Federal Commissioner of Taxation (1979) 10 ATR 493; 80 ATC 4001, the level of activity is important in deciding whether a business is being carried on.

In Hadlow and FC of T [2002] AATA 1250; (2002) 2002 ATC 2294; (2002) 51 ATR 1197 the Small Taxation Claims Tribunal considered the amounts incurred by a taxpayer to research and develop a book. The question for decision was whether the activities were merely preparatory and preliminary or whether the activity had reached a stage where it was able to be characterised as a business.

In concluding that the activity was not carried on as a business in the relevant years, member Mowbray stated at paragraph 26:

Clearly Mr Hadlow has the subjective intention to carry on a business, but that is not sufficient. There must be business activity. There is a real question whether the activities to date are merely preparatory or preliminary (see Goodman Fielder Wattie at 4447), and whether the project has reached the stage where it is able to be characterised as a business. There has been much activity but the concept of business does not equate with being busy (Goodman Fielder Wattie at 4447; 386; 339).

Mr Hadlow has researched, undertaken travel, and visited museums, libraries and farms in pursuit of a particularly interesting topic. He has expended money but has made no sales, received no advances nor signed any contracts.

In Hope v The Council of the City of Bathurst 80 ATC 4386 (1980) 144 CLR 1 Mason J considered the question of whether 'transactions were entered into on a continuous and repetitive bases for the purpose of making a profit' significant in concluding that a business was being carried on. The permanent character of the activity in question was another indicator that might support this conclusion.

It is accepted that you were under COVID 19 related government restrictions preventing clients visiting the site you had established for your business in your home for the months those restrictions were in place. it is also accepted that the time you spent managing your health conditions may have limited the time you could spend providing services to your clients. The COVID 19 related government restrictions may have delayed your prospects of providing your service to a fee-paying client. You did not, however, at any stage before or after these restrictions move beyond a few conversations about potential appointments to recording actual bookings for your service, or provide your services to a paying client.

This being the case no transactions were entered into while you were undertaking this activity, the activity was not ready to be characterised as a business. and you never actually commenced carrying on business operations.

Summary

You had prepared yourself and a room in your home to undertake your service provision activity and were ready to begin providing those services in the weeks before COVID 19 related government restrictions were imposed. As at that time you had taken no paying clients, and the restrictions further delayed the possibility of you taking clients until they were lifted. You have no records of any cancelled bookings and did not take any paying clients before or after the restrictions were lifted. In short your activity never commenced as a business.

You were not carrying on a business with your service activity in the relevant period.

Conclusion

As you were not carrying on a business of providing services the provisions of Division 35 of the ITAA 1997 will not apply. The Commissioner will not exercise his discretion under paragraph 35-55(1)(a) of the ITAA 1997 to allow you to offset your losses against your other income in the relevant financial years.