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

Ruling: Question and answer: | 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 non primary production activity in your calculation of taxable income for the 2010-11 financial year? | No

Relevant facts and circumstances: The arrangement that is the subject of this ruling is described below. The following documents have been relied upon to reach a decision: Your application for private ruling. You commenced your business recently. Your business earns income from non primary production activity. Your business employs a number of full time staff. Your business invoices the customer the total expenses incurred and a specified mark up percentage for services provided after the end of the specified period. Due to the nature of your business and your invoicing system, there is time lag between the time expenses incurred and income received. Your business incurred loss in 2010-11 financial year because you report on a cash basis. Therefore a portion of the income for the services rendered in 2010-11 financial year were not received in the same year. In the 2011-12 financial year, your business expects to receive income in relation to the services rendered in certain periods. Your business expects to make tax profit in 2011-12 financial year. Your income for non commercial loss purposes is in excess of $250,000. Your total business income in the 2010-11 financial year is positive.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 35-10(2) | Income Tax Assessment Act 1997 Subsection 35-10(2E) | Income Tax Assessment Act 1997 Paragraph 35-55 (1)(a) | Income Tax Assessment Act 1997 Paragraph 35-55 (1)(c)

Reasons for decision: Summary: Division 35 of the ITAA 1997 applies to losses from certain business activities for the 2000-01 income year and subsequent years. Under the rule in subsection 35-10(2) of the ITAA 1997, a 'loss' made by an individual (including an individual in a general law partnership) from a business activity will not be taken into account in an income year unless: · the 'Exception' in subsection 35-10(4) of the ITAA 1997 applies, or · subsection 35-10(2E) of the ITAA 1997 is satisfied for that year and one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 is met, or · the Commissioner exercises the discretion in section 35-55 of the ITAA 1997. Section 35-1 of the ITAA 1997 provides that an income requirement must be met (along with certain tests) in order to include losses from a business activity in your taxable income calculation. If the income requirement is not met, the Commissioner may exercise discretion to allow the inclusion of the losses. You satisfy the income requirement under subsection 35-10(2E) of the ITAA 1997 if your income for non-commercial loss purposes is less than $250,000. In your case, you do not satisfy the income requirement as your income for non-commercial loss purposes is above $250,000 in the 2010-11 financial year. Your non primary production activity will only be potentially subject to these provisions if it is carried on as a business. The Commissioner is satisfied that your activity is carried on as a business. | Detailed Reasoning - Special circumstances: Paragraph 35-55(1)(a) of the ITAA 1997 sets out the first arm of the Commissioner's discretion as follows: The Commissioner may, on application, decide that the rule in subsection 35-10(2) does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply that rule because: (a) the business activity was or will be affected in the excluded years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster; or The Note to paragraph 35-55(1)(a) of the ITAA 1997 states that the particular paragraph is intended to provide for a case where a business activity would have satisfied one of the tests if it were not for the special circumstances. Paragraph 41D of the Taxation Ruling TR 2007/6 explains that 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. Paragraph 35-55(1)(a) of the ITAA 1997 refers to 'special circumstances' outside of the control of the operators of the business activity. No exhaustive definition is given of 'special circumstances' but the paragraph does include drought, bushfire and other natural disasters. The question of what constitutes 'special circumstances' has been judicially considered on many occasions. In the Federal Court case of Community Services Health, Minister for v. Chee Keong Thoo (1988) 8 AAR 245; (1988) 78 ALR 307, Burchett J considered 'special circumstances' in the context of the Health Insurance Act 1973 and made the following observation: 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… Later, in the Federal Court Case of Secretary, Department of Employment, Education, Training & Youth Affairs v. Barrett and Another (1998) 82 FCR 524 'special' was considered in the context of 'special weather conditions' for the purposes of the Austudy Regulations 1990. Tamberlin J observed 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 then quoted the following passage with approval from the AAT case of Re Beadle and Director-General of Social Security (1984) 1 AAR 362; (1984) 6 ALD 1: 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. It can be seen that to determine what is 'special circumstances', we need to look at the context in which the phrase is used. Also, it is clear that 'special circumstances' will be something out of the ordinary or unusual. 'Special circumstances' in paragraph 35-55(1)(a) of the ITAA 1997 is used in the context of a situation occurring such that it would be unreasonable for the Commissioner to apply the loss deferral rule for a particular year or years. Paragraphs 48 and 49 of Taxation Ruling TR 2007/6 expand upon the events that can be accepted as 'special circumstances' and explains that it is not limited to natural disasters. In particular, paragraph 49 details some indicators of the affects on the business activity that could lead to the exercise of the discretion. Some of these indicators are: · Destruction of stock or equipment. · Delays in ploughing, planting, harvesting etc. · Delay in growth of crops. · Inability of operator to perform duties, and · Loss of business opportunities. To consider the discretion in paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner should be satisfied that the activity was affected by special circumstances outside the control of the operators of the business activity. In your case, you have not made a tax profit in the 2010-11 financial year because you report on a cash basis, which result in a portion of the income earned in 2010-11 not received till the next financial year. The Commissioner is not satisfied that your business activity is affected by special circumstances such that it is unable to produce a tax profit in the 2010-11. Therefore, the Commissioner is unable to exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(a) of the ITAA 1997 for the 2010-11 financial year. | Detailed Reasoning - Nature of the activity: The Commissioner may, on application, decide that the rule in subsection 35-10(2) does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply that rule because: (c) for an applicant who carries on the business activity who does not satisfy subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made - the business activity has 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)). The Note to paragraph 35-55(1)(c) of the ITAA 1997 states that the particular 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. The note includes an example of 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. Paragraphs 77 and 78 of Taxation Ruling TR 2007/6, which discusses non-commercial business losses and the Commissioner's discretion, state: 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. 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 activiy. Your business is capable of producing income in the 2010-11 financial year as shown in the 2010-11 Business and Professional Schedule you have lodged. The Commissioner is not satisfied that anything inherent in the nature of your business activity has prevented you from being able to produce a tax profit in 2010-11 financial year. The invoicing system of your business is not an inherent characteristic of the type of business activity being conducted. The failure of your business to make a profit in 2010-11 financial year is a consequence of business choices made by you to invoice after certain period. The discretion in paragraph 35-55(1)(c) is not intended to be available in cases where the failure to make a profit is for reasons other than those that are inherent in the nature of the business. The requirements of paragraph 35-55(1)(c) of the ITAA 1997 have not been met. Therefore, the Commissioner is unable to exercise the discretion available in accordance with subsection 35-55(1) and paragraph 35-55(1)(c) of the ITAA 1997 for the 2010-11 financial year.

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