Private ruling: non-commercial losses
Published: March 2014
Ruling period: Year ended 30 June 2011 Year ending 30 June 2017 Year ended 30 June 2012 Year ending 30 June 2018 Year ended 30 June 2012 Year ending 30 June 2019 Year ended 30 June 2013 Year ending 30 June 2020 Year ending 30 June 2014 Year ending 30 June 2021 Year ending 30 June 2015 Year ending 30 June 2022 Year ending 30 June 2016 Year ending 30 June 2023
Date scheme commenced: 1 July 2008

Ruling: Q1: 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 business activity in your calculation of taxable income for the 2010-11 to 2022-23 financial years? | A1: No.

Relevant facts and circumstances: You do not satisfy the income requirement set out in subsection 35-10(2E) of the ITAA 1997. You commenced developing a property in the 2007-08 financial year with substantial capital costs and you expect to make a tax profit in the 2023-24 financial year. You have supplied from independent sources furnishing the commercially viable period for this industry as 10 years from the commencement of the development. Your development was put on hold when the GFC hit and that period extended the time before a tax profit could be made.

Relevant legislative provisions: Income Tax Assessment Act 1997 paragraph 35-55(1)(c). | Income Tax Assessment Act 1997 subsection 35-10(2). | Income Tax Assessment Act 1997 subsection 35-10(2E).

Reasons for decision: Summary: The Commissioner will exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for an applicant who does not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 if certain conditions are satisfied for the years concerned. For the discretion to be exercised, the business activity must have started to be carried on and, for the excluded years: (i) because of its nature, it has not produced, or will not produce, assessable income greater than the deductions attributable to it; and (ii) there is an objective expectation, based on evidence from independent sources (where available) 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 (apart from the operation of subsections 35-10(2) and (2C) of the ITAA 1997). For the first requirement to be satisfied, the business activity must have started to be carried on. You have satisfied this requirement. The second requirement to be satisfied is that because of its nature the business activity has not produced, or will not produce assessable income greater than the deductions attributable to it. Paragraphs 74A to 82 Taxation Ruling TR 2007/6 examine the phrase 'because of its nature' that is applicable to your circumstances. 73A. Because the tests are not automatically relevant if the income requirement is not met, the first factor in paragraph 35-55(1)(c) considers whether it is 'because of its nature' that the activity has not produced, or will not produce, a tax profit. 74. The note under paragraph 35-55(1)(c) states: Paragraphs (b) and (c) are intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. 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. 75. Stone J in Eskandari confirmed this view when considering whether the Commissioner's discretion should be exercised in regard to losses incurred in a migration consultancy business. When looking at the type of activities referred to by the note and the EM, Stone J stated at FCA 31: Such activities have an inherent characteristic that cannot be overcome by conducting the business activity in a different way but only by changing the nature of the business. 76. And further at FCA 32: In my view, the phrase 'because of its nature' in s 35-55 indicates that the failure must be a result of some inherent feature that the taxpayer's business activity has in common with business activities of that type. 77. Therefore, the phrase 'because of its nature' refers to inherent characteristics of the type of business activity being conducted by the taxpayer, which are common to any business activity of that type. These inherent characteristics must be the reason why the activity is unable to satisfy any of the tests. The discretion is not intended to be available where the failure to satisfy one of the tests is for other reasons. 78. The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity and would not result in the requirements of subparagraphs 35-55(1)(b)(i) and (c)(i) being met. (Refer to Example 9 at paragraph 139 of this Ruling.) 79. The inherent characteristics may be present for an initial period from the time the business activity commences. After that initial period has elapsed, which can be several years, the inherent characteristics may cease to be the cause of business activities of the type in question being unable to satisfy any of the statutory tests. 80. The identification of this 'initial period' may often involve some practical difficulty, particularly where causes other than an inherent characteristic appear to be another reason why the business activity is unable to satisfy a test or produce a tax profit for a particular income year. Where both an inherent characteristic and some other factor are identified, this in itself will not mean that the requirement in subparagraphs 35-55(1)(b)(i) or (c)(i) is no longer met. It is only where it is clear that the reason the activity is unable to satisfy a test is not because of any inherent characteristic, but because of some other factor, that this requirement will not be met. Your business plan shows that you expect the business activity to produce assessable income greater than the deductions attributable to it in the 2023-24 financial year. It is accepted that while the inherent characteristics of developing this type project would result in low levels of assessable income being produced in the early years of this type of activity, your projections indicate that your losses are also incurred as a result of substantial expenses, including substantial interest expenses in the early years, the impact of the GFC and the extended period to complete the development. Paragraph 81 to 82 of TR 2007/6 state; 81. In effect, then, the initial period is the time from the commencement of the business activity to the end of the last income year for which it can still be said that an inherent characteristic affects the business activity's ability to satisfy a test. 82. However, cases may arise where this initial period has passed, and yet a particular business activity of this type is continuing to not satisfy any of the tests. In this situation it will be appropriate to enquire whether this is the result, not of any inherent characteristic but because of the way in which the operator has chosen to carry on their business activity. (Refer to Example 12 at paragraph 161 of this Ruling.) You have provided references from independent sources stating that a 10 year period is acceptable to produce a tax profit in your industry. In your circumstances you commenced the development the 2007-08 financial year and completed part of it in the 2010-11 financial year with the projected completion of the development by the 2020-21 financial year. Your projections indicate that the development is expected to make a tax profit in the 2023-24 financial year which is 6 years past the time that the independent industry would expect a tax profit to be made. Therefore the Commissioner will not exercise the discretion to allow you to include any losses from your development in your calculation of taxable income for the 2010-11 to 2022-23 financial years.