Private ruling: Non-commercial losses
Published: April 2014
Ruling period: Year ended 30 June 20FF
Date scheme commenced: 1 July 20EE

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 20EE-FF financial year? | A1: No.

Relevant facts and circumstances: Your income for non-commercial loss purposes is greater than $250,000. You decided in 20XX to develop acreage into a number of lots. This development is a one-off and you have no intentions to develop land for resale in the future. In 20YY a statement of environmental effects and a development application and lodged it with the council. In 20ZZ the council granted development consent for a multiple stage subdivision in accordance with your development plans. In 20AA the marketing of stage one was commenced. This coincided with the global financial crisis (GFC) which had an immediate adverse effect on sales however marketing continued throughout 20BB, 20CC and 20DD. In 20EE, a few sales in stage one were negotiated and entered into and finalised in 20FF. The gross proceeds of this stage were used to pay contributions, postponed rates, land tax, civil works and bank debt. The period in which you expect to make a profit from the remaining lots is market driven and cannot be predicted however, as marketing is continuous and the desirability of the area you are confident the sales should proceed speedily. The GFC and the large number of other residential subdivisions in your area had an adverse effect on sales.

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

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. 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 73A to 80 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. You have not provided a commercially viable period for your industry however you have explained that the industry is market driven. In your case you decided in 20XX to develop your land into a number of lots and in 20FF a few lots of stage one had been sold. This was approximately nine years after your business commenced and did not produce a tax profit as gross proceeds of this stage were used to pay contributions, postponed rates, land tax, civil works and bank debt. We consider that the reason your property development business activity has not produced a profit in the 20EE-FF financial year is due to the business choice you have made to hold off on developing or selling the properties you hold due to unfavourable market conditions. This market was also impacted by the GFC and these conditions are not inherent to the nature of the business activity rather it is peculiar to your situation. Therefore the Commissioner will not exercise the discretion to allow you to include any losses from your land development activity in your calculation of taxable income for the 20EE-FF financial year.