Edited version of private advice

Authorisation Number: 1052324946223

Date of advice: 31 October 2024

Ruling

Subject: Non-commercial losses - 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 business activity in your calculation of taxable income for the 2023-24 financial year?

Answer 1

No.

This ruling applies for the following period:

Year ended XX June 20XX

The scheme commenced on:

XX July 20XX

Relevant facts and circumstances

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

During the 20XX-XX financial year you purchased a property in your state. You reside at this property.

It is an acreage property.

During the 20XX-XX financial year you commenced an activity on the property.

You operate the activity in a partnership with your spouse.

The activity is in the middle stages of setting up.

The business also has a mobile setup to take the activities to clients.

You currently derive income from the business mainly through its mobile setup. This setup and activities are taken to locations to provide requested activities. There are also onsite days held on weekends where groups, up to a given number of people, attend to participate in similar activities as the mobile setup.

Over the next 12 months it is anticipated that the onsite facilities will be complete and the activities will centre on the property rather than on the mobile facilities. Onsite facilities are to be completed. When finished, this will enable activities to be provided to an organisation.

The business has seen an increase in income since initial start up to the present day, as more activities and infrastructure is added. The plan is to be fully set up and finished in the next X years.

The business was originally started with the intention of being small scale.

You sustained an injury leaving you unable to continue working in your ordinary employment.

The decision was made to build the business up so that it could generate a healthy and sustainable income.

Infrastructure includes sheds for equipment.

You coordinate and provide resources for the current infrastructure and the ongoing expansion.

Your spouse facilitates the mobile activities, manages the finances, and co-ordinates activities.

The business is promoted mainly through social media. You have found that social media gives a greater and broader dispersion of information about the business and its activities and allows quick and easy interaction with enquirers and potential and current clients.

The relay of experiences with the business on social media is a great tool in attracting new business and keeping in contact with previous and current clients.

Once contact or an enquiry is made, the range of activities is outlined to the potential client and then bookings are taken, whether it be for a mobile meeting or an onsite visit.

Word-of-mouth has also been a popular way that new business has occurred.

You met the assessable income test and real property test in the 20XX-XX financial year.

During the 20XX-XX financial year, your employer terminated your employment and paid you your accrued leave entitlements which resulted in your exceeding the income limit.

The business is still in the buildup phase where there is considerable infrastructure expense. You and your spouse as partners, indicate that the major components and shed, are in the final stages of completion.

You started small and had the accident and expanded the activity from there. As you have been receiving payments, you started building.

You claim the inability to offset your tax loss against your other income has impacted on the expansion of the business by reducing the funds available to finish the full setup of infrastructure and delaying the move to a greater onsite involvement of the business where more people can be accommodated in activities and activities can run 7 days a week.

You stated the following should be taken into consideration:

•                you exceeded the income requirement due to receiving a lump sum.

•                you are not able to offset your business losses due to the total income you derived.

•                your income has never exceeded the income requirement previously.

•                the business was still in the buildup phase with considerable expenses and a loss was incurred.

It is anticipated that over the next X years the business will be producing a profit as infrastructure and purchase costs are significantly decreasing.

Since inception, income has increased each financial year. You project an increase of in the 20XX-XX financial year also. Expenditure has been estimated using current ongoing costs and projections.

You incurred a number of expenses including capital expenditure onsite, repairs and maintenance.

The money received in consequence of the termination payment was spent on infrastructure and facilities.

You have a depreciation schedule for the 20XX, 20XX and 20XX financial years showing the use of temporary full expensing for 20XX and 20XX and using the rate of XX% for 20XX.

Since commencing your activity you have made losses each year.

You expect to make a small profit in the 20XX-XX financial year.

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

Summary

Commissioner's discretion for non-commercial losses has not been granted as you did not have special circumstances that prevented you from making a profit in your business activity.

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 (that is your taxable income, reportable fringe benefits and reportable superannuation contributions but excluding your business losses, exceed $XXXX) 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 years 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, you exceeded the income requirement due to receiving a lump sum payment upon termination of your employment. As you have exceeded the income requirement, you are not able to offset your business losses against your other income. You have never previously exceeded the income requirement and have been able to offset your losses.

The business made a loss as you state that the business was still in the buildup phase with considerable expenses incurred during the financial year.

You have not made a profit in any year since the commencement of the activity and you have not provided evidence to show that but for any special circumstances, you would have made a profit in the 20XX-XX financial year.

Failing the income requirement under subsection 35-10(2E) of the ITAA 1997 for any reason is not considered to be 'special circumstances' as it does not affect the business activity or cause it to make a loss.

Consequently, the Commissioner will not exercise his discretion in the 20XX-XX financial year and not allow you to include any losses from your business activity in your calculation of taxable income for the 20XX-XX financial year.

The losses for the 20XX-XX financial year will be deferred until you make a profit in a future year.