Private ruling: Non-commercial business losses
Published: June 2012
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012
Date scheme commenced: 1 July 2010

Ruling: Q1: Will the Commissioner exercise the discretion under paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include losses from your business activity in the calculation of your taxable income for the 2010-11 and 2011-12 financial years? | A1: No

Relevant facts and circumstances: The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: · the application for private ruling · the documents supplied with the application including a business plan · further written information received · records of conversation with your tax agent. You commenced your business activity in the 2008-09 financial year. You have claimed expenses for the business from this time. You employer full time in another position and have devoted your spare time to setting up the business. Part way through the 2010-11 financial year, you began earning assessable income from the business, however the business made a loss in that financial year. You also expect to make a loss in the 2011-12 financial year. You have provided a business plan including: · a description of the business and the area in which it operates · the products and services provided · a marketing plan · an operational plan · details of staffing levels, management and advisors You have provided projected financial figures showing that the business expects to make a tax profit in the 2012-13 financial year. You have provided discussion from an independent advisor stating: · it is expected that part of the activity would take longer than 2 years to make a profit as the activity would need to be built from scratch · the target market for the business has been especially hard hit by the global financial crisis, which has extended the time for that part of the activity to break even · that other business activities (aimed at the same target market) are also suffering from the economic downturn You have provided a copy of a media release from an economics firm. This release provides an outlook on the future of the industry and provides that: Demand will continue to grow over the next three years. Yield over the next three years is expected to increase at an average annual rate of 5.5%. You have stated that executive decisions were made around the beginning of the 2012 calendar year to close part of the activity on quieter nights to cut down on unnecessary expenses. Your income for non-commercial loss purposes is over $250,000.

Relevant legislative provisions: Income Tax Assessment Act 1997 Paragraph 35-55(1)(c)

Reasons for decision: Summary: The Commissioner will not exercise the discretion for lead time to allow you to include the loss from your business activity in your taxable income for the 2010-11 and 2011-12 financial years. This is because the failure to make a tax profit from the activity is due to the time taken to set up the activity and the business choices you have made rather than the nature of the business activity. | Detailed Reasoning - Detailed reasoning: For the 2009-10 and later financial years, Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997) will apply to defer a non-commercial loss from a business activity unless: · you meet the income requirement and you pass one of the four tests · the exceptions apply · the Commissioner exercises his discretion. In your situation, you do not satisfy the income requirement (that is, your taxable income, reportable fringe benefits and reportable superannuation contributions but excluding your business losses, exceeds $250,000) and do not come under any of the exceptions. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion. Paragraph 35-55(1)(c) of the ITAA 1997 provides that the relevant discretion may be exercised for the income year in question where: · it is in the nature of your business activity that there will be a period before a tax profit can be produced · there is an objective expectation your business activity will produce a tax profit within the commercially viable period for your industry. The note to paragraph 35-55(1)(c) of the ITAA 1997 states: Note: This paragraph is 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. The type of feature contemplated by the phrase 'because of its nature', in the context in which it appears, is that referred to in the note quoted above. That is, that there is an inherent or innate feature of the activity resulting in an inability to produce income in the year of commencement and (in most cases) a number of years thereafter. Further examples that fall into this category are forestry, viticulture and certain horticultural activities. For the Commissioner to exercise the discretion you must be able to show that the reason your business activity is producing a loss is inherent to the nature of the business and is not peculiar to your situation. For example, the discretion will not be available where the failure to make a profit is for reasons other than the nature of the business activity such as: a consequence of starting out on a small scale, the time taken to set up your business activity, the need to build a client base, or, as a result of personal business choices including the hours worked, location or marketing. Having regard to your full circumstances, it is not accepted that it is in the nature of the business activity that has prevented you from making a tax profit. The evidence provided does not support your claim that there is a lead time of four years between the commencement of your activity and the production of a tax profit. The information from your advisor only discusses your part of your operation and makes no mention of the other portion of your activity. The evidence provided only suggests that it may take more than two years to produce a tax profit from a new part of your operation. It does not indicate that it takes approximately 18 months to set up a new activity for operation nor does it provide any indication that four years would be considered the commercially viable period to return a profit in the industry. Secondly, your advisor has stated that your activity has suffered from a lack of consumers from your specific target market (which you state have been hardest hit by economic conditions), and this has extended your breakeven point for that part of your activity. However, the failure to attract your targeted market is not considered an inherent characteristic of your activity. It is simply a business choice to target a specific market and is something that can be overcome by conducting the activity in a different way (eg. targeting a different market). Importantly, you advise that part of your activity is now closed on quieter nights, indicating that the evidence provided relating to that part of your activity is no longer as relevant. In addition, the media release by the economics firm only provides an outlook of the expected increase in demand and yields around the nation. It does not provide evidence that there is a lead time between the commencement of your activity and the ability to make a tax profit. It only provides that business conditions in the industry are expected to improve. Accordingly, we consider that you have not provided sufficient evidence to indicate that there is a four year lead time between the commencement of your activity and the production of a tax profit. Further, as your business has already been able to generate assessable income, we do not consider that there is anything inherent in the nature of your business activity that would prevent you from making a tax profit until the fourth year of operation. Your activity is of a type that is able to produce assessable income quite soon after its commencement, as the income from your business activity has demonstrated. As it is considered that the loss is not inherent in the nature of your business activity, the Commissioner will not exercise the discretion under paragraph 35-55(1)(c) of the ITAA 1997 to allow you to deduct a loss in the 2010-11 and 2011-12 financial years. Accordingly, under Division 35 of the ITAA 1997, your losses must be deferred in these years.

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