Edited version of private advice

Authorisation Number: 1052349115057

Date of advice: 13 January 2025

Ruling

Subject: Non commercial loss - lead time

Question 1

Are you, as a partner in a partnership, carrying on a business of product manufacture and distribution in the relevant income year for the purposes of accessing the Commissioner's discretion under paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

No, it is considered that the business has not actually commenced in the relevant income year.

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to include your share of any losses from your partnership's product manufacture and distribution activity in your calculation of taxable income for the relevant income year?

Answer 2

Not applicable, as the business has not actually commenced in the relevant income year.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

X November 20XX

Relevant facts and circumstances

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

You conceived the idea for your business in October 20XX and commenced researching and developing the product on X November 20XX.

You registered a partnership (the partnership) for an ABN on a specified date to conduct product manufacture and distribution activities.

You provided your business concept and the trading name the business operates under.

You intend to sell directly to consumers via your online website and via retailers.

The partnership's activities are run by the co-founders, which is yourself and Person B. You have no employees.

You provided details of your first product offering.

The proposed product required Research and Development expenditure to engage scientists to develop the final product.

It took X months for the product to be developed.

You are required to get government food safety approval.

You are currently in discussions with retailers and manufacturers to sell the product on a national basis. You have not entered any agreements.

You enlisted the services of a graphic designer to create your packaging and website and a lawyer specialising in this field to assist with legal compliance and licensing.

At the time of application:

•                     The product was fully developed, and formula finalised.

•                     A production trial was set to begin.

•                     You obtained a trademark for the product.

•                     You had a nil budget for marketing and intended to use social media to address your target audience.

You and Person B own a vehicle each in your individual names that are used for the partnership's business purposes.

The partnership does not have any capital assets.

The partnership obtained a license on a specified date from the relevant authority permitting the supply of the product for a specific period.

You are currently self-funded, however intend to get a business loan once production begins.

You expect manufacturing to begin at the end of the 20XX calendar year, or early in the 20XX calendar year.

The partnership currently has a manufacturing trial with a specified manufacturer. The partnership has completed a test product and has formula amendments to make due to the results of the trial.

The partnership will not enter a contract until you are satisfied with the results of the production trial.

The partnership has purchased the product's ingredients for the manufacture trial.

The manufacturer estimates it will take until XXX 20XX to reach a commercial quantity ready for sale.

You estimate that within a 48-hour timeframe the product can be manufactured and delivered to the retailer or sold on your online platform.

The partnership incurred a loss of a specified amount for the relevant income year. You provided a list of the expenses that attributed to the loss.

Negotiations with a large retailer have halted as the product has not been manufactured yet.

You intend to primarily sell directly to consumers through your online store and expanding into retail as the product gains traction.

Your online store/website is completed and is ready to go live once the product is manufactured.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 35

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

Income Tax Assessment Act 1997 section 35-30

Income Tax Assessment Act 1997 section 35-35

Income Tax Assessment Act 1997 section 35-40

Income Tax Assessment Act 1997 section 35-45

Income Tax Assessment Act 1997 section 35-55

Questions 1 and 2

Summary

Based on the information provided, your partnership's activities to date are considered preliminary to the carrying on of your intended business and it is considered that your partnership's business of the product manufacture and distribution had not actually commenced in the relevant income year. Therefore, the Commissioner is unable to exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to include your share of any losses from your partnership in calculating your taxable income for the relevant income year.

Detailed reasoning

Division 35 of the ITAA 1997 prevents losses from non-commercial business activities carried out by an individual taxpayer (alone or in partnership) being offset against other assessable income in the year the loss is incurred. The rule in subsection 35-10(2) of the ITAA 1997 will apply to defer a loss incurred by an individual from a business activity unless:

(a)           the exception in subsection 35-10(4) of the ITAA 1997 applies

(b)           you satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 and one of the following four tests:

(i)            the assessable test (section 35-30 ITAA 1997)

(ii)            the profits test (section 35-35 ITAA 1997)

(iii)            the real property test (section 35-40 ITAA 1997)

(iv)            the other assets test (section 35-45 ITAA 1997); or

(c)           the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

Exception

The exception in subsection 35-10(4) of the ITAA 1997 applies to primary production businesses or professional arts businesses when assessable income for the year (except any net capital gain) from other sources not related to the business activity is less than $40,000.

Commissioner's discretion

Under section 35-55 of the ITAA 1997, you can apply for the Commissioner's discretion to be exercised where:

(a)           special circumstances outside your control have resulted in a loss; or

(b)           there is a lead time between the commencement of the activity and the production of any assessable income.

The lead time discretion is intended to cover a business activity that has a lead time from the commencement of the activity and the production of any assessable income.

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 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).

We must examine the above indicators considering the characterisation of your business activity.

In Goodman Fielder Wattie, Hill J stated at 4,447:

Critical to the resolution of the present controversy, is the characterisation of the business activity itself which is said to have commenced. It was conceded properly by the applicant that if the business claimed to be carried on by it was to be characterised as one of manufacturing and selling monoclonal antibody products, then that business did not commence until around November 1982...

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 it is considered that the business activity you intend the partnership to carry on is characterised as the manufacturing and selling of a product. 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 will not determine that the business activity has actually commenced.

The 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 provided that you conducted experiments and research on your proposed product, decided on the method to carry on the activity and have committed to it.

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 is the manufacturing and selling of a product. The partnership does not have any capital assets. In the relevant income year, the partnership had completed the purchase of the ingredients for the product and was undertaking a manufacturing trial. It has not yet entered a contract with a manufacturer nor secured access to the equipment and tools required for production of a commercial quantity. As such the partnership had not yet obtained the required business assets or structure to commence the activity in the relevant income year.

Actual commencement of business operations

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.

At the time of application, the partnership has not entered any manufacturing contracts and is conducting manufacturing trials. The partnership has not manufactured a commercial quantity of the product for it to be available for commercial sale. The systematic and regular transactions from which the partnership will produce revenue as part of its business operations has not commenced.

Conclusion

Your partnership's activities to date are considered preliminary to the carrying on of your intended business and it is considered that your partnership's business of product manufacture and distribution had not actually commenced in the relevant income year.

Consequently, as the business activity has not commenced, the Commissioner would not be in a position to exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to include your share of any losses from your partnership in calculating your taxable income for the relevant income year.