Edited version of private advice

Authorisation Number: 1052360985000

Date of advice: 10 April 2025

Ruling

Subject: NCL discretion

Question 1

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your online business activity in your calculation of taxable income for the 2023-24 financial years?

Answer 1

No

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

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

You are a sole trader that runs an online business selling stock.

You do not have a business plan.

All the stock is selected and purchased by you. The items are then shipped to you and the products are photographed and posted on the website. Customers can then purchase or rent the items, you then package items and send to customers.

You previously used a storage unit to store stock but now have a dedicated space in your home.

The brand also has a registered database that receives email marketing. The business activity has a social media presence.

You have contracted different people to work on the business with you, there are no permanent employees.

A timeline of events was provided.

The business activity was unable to produce a tax profit in a particular financial year, because of the cost of setting up the business and the time it takes to build a customer base.

Profit and Loss Statements (actual and projected years) were provided.

You expect the business activity to make a tax profit in the following 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 paragraph 35-55(1)(c)

Reasons for decision

Summary

Having regard to your full circumstances, it is not accepted that there is anything inherent in the nature of your business activity that prevents it from making a tax profit within the commercially viable period for the industry. Therefore, the Commissioner will not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the 2023-24 financial year.

Detailed reasoning

Division 35 of the ITAA 1997 prevents losses from a non-commercial business activity carried out by an individual taxpayer (alone or in partnership) 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.

You have requested the Commissioner to exercise his discretion under paragraph 35-55(1)(c) of the ITAA 1997 in the 2023-24 financial year.

Under paragraph 35-55(1)(c) of the ITAA 1997, the Commissioner's discretion can be exercised where:

•              the business activity has started to be carried on but because of its nature it has not produced, or will not produce, assessable income greater than the deduction attributable to it; and

•              there is an objective expectation that within a period that is commercially viable for the industry concerned, the activity will produce assessable income for an income year greater than the deductions attributable to it for that year.

Where a taxpayer chooses to carry on the business activities in a manner that does not produce a tax profit within the period that is commercially viable for the industry concerned, paragraph 35-55(1)(c) of the ITAA 1997 may not be satisfied.

The Commissioner's approach to exercising the discretion under section 35-55 of the ITAA 1997 is outlined in TR 2007/6 Income Tax: non-commercial losses: Commissioner's discretion. Paragraph 18 of TR 2007/6 says that the lead time discretion provided by subparagraph 35-55(1)(c)(i) of the ITAA 1997 is available for a business activity if there is an initial period from when the activity commenced where the nature of the activity prevents a tax profit from being made. The note to paragraph 35-55(1)(c) provides: 'For example, an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income'.

For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is not making a tax profit is inherent to the nature of the business and is not peculiar to your situation (paragraph 77 of TR 2007/6).

The lead time discretion is not intended to be available where the failure to make a profit or to meet a test is for reasons other than the nature of the business, such as, a consequence of starting out small and needing to build up a client base, or 'business choices made by an individual (for example, the size and scale of the activity, the hours of operation, and the level of debt funding)' (paragraph 78 of TR 2007/6).

The example at paragraph 139 of TR 2007/6 is one where the taxpayer was new to the region and industry in which he chose to commence his business. He had no clientele. His funding and his advertising were limited, he kept his part-time employment, he worked at his business when he could. He chose where his business premises were located and his opening and closing times. He made losses each year and didn't satisfy any of the four tests. The Commissioner's view on this example is found at paragraph 140 of TR 2007/6:

The inability of Andrew's business activity to satisfy any of the four tests is due to his personal business choices as to hours of business, location and advertising, not any inherent characteristics that affect clock repair businesses. Accordingly, the requirement of subparagraph 35-55(1)(b)(i) is not met and the Commissioner would not exercise the discretion.

In your situation, you do not satisfy the income requirement as your income for non-commercial loss purposes is above $250,000, no exception applies, you did not make a tax profit in the year under consideration. Your business losses are subject to the deferral rule, unless the Commissioner exercises his discretion.

When does a business activity commence?

Taxation Ruling TR 2001/14 explains how Division 35 of the ITAA 1997 is to operate. Paragraph 69A of TR 2001/14 provides the requirements for a taxpayer to have started to carry on a business to be that they have:

•       made a decision to commence the business activity;

•       acquired the minimum level of business assets to allow that business activity to be carried on; and

•       actually commenced business operations.

A business has commenced for taxation purposes when it is capable of beginning ordinary operations and has begun ordinary business operations. Paragraph 103 of TR 2001/14 refers to a paragraph in Calkin v. CIR [1984] 1 NZLR 440 Richardson J where it says at 446 to 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 current business operations.

Paragraph 104 of TR 2001/14 states:

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.

Business Choices

It is clear from the information you have provided that your intention when you began was to engage in an online business activity. It is also recognised that you undertook significant preparatory activities such as designing your website, employing a contractor, and purchasing stock.

The time and costs for preparatory activities such as purchasing a commercial quantity of stock, assets for the activity, selling costs, setting up a website, engaging a contractor, prior to going online are personal decisions affecting your business activity.

These are individual circumstances affecting your activity rather than an inherent characteristic of the industry. These decisions would have impacted the length of time required before your business will make a profit. In the case of an online retail business, there is nothing inherent in the activity that requires a lead time. The nature of your activity is that it is possible to derive assessable income from the first day. The process of setting up and implementing your business structure and plan is not considered an inherent feature for lead time.

Building up a client base

You advised that a significant contributor to the losses of the business in the 2023-24 financial year was the building up of a client base for your online business activity. Building up a client base is considered a normal part of starting up any business and is not considered a reason for the Commissioner to exercise the discretion.

The note in paragraph 35-55(1)(c) does not support any view that the discretion should be exercised for any activity that is yet to make a tax profit simply because of the small scale on which it was started, or because a client base is being built up. It is not considered that there is anything inherent or innate in the nature of your business activity.

Conclusion

You have not shown that the reason that you have not made a profit is due to a lead time which is an inherent characteristic of the industry. There would not be a lead time for a retail business. You have shown your activity is of a type that is able to produce assessable income quite soon after its commencement, and this has been evidenced in your financial statements.

As a result, it has been deemed that the inability of your activity to make a profit, as outlined in Division 35 of the ITAA 1997, is not 'because of the nature' of the activity being carried on.

Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997 and you cannot claim a deduction for your losses from the online business against other income in the 2023-24 financial year. You must defer these losses to a future year when you meet the requirements.