Private ruling: Non-commercial losses - Commissioner's discretion
Published: June 2012
Ruling period: Year ended 30 June 2009 | Year ended 30 June 2010 | Year ended 30 June 2011 | Year ending 30 June 2012
Date scheme commenced: 1 July 2008

Ruling: Q1: Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) 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 2008-09 to 2011-12 income years? | A1: No.


Relevant legislative provisions: Income Tax Assessment Act 1997 paragraph 35-55(1)(b)

Reasons for decision: Summary: The lead time discretion 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. In the case of your business activity, there is nothing inherent in the activity that requires a lead time before any assessable income can be earned. Therefore, the lead time discretion will not be exercised. | Detailed Reasoning - Detailed reasoning: Under paragraph 35-55(1)(b) of the ITAA 1997, the Commissioner's discretion can be exercised where the business activity satisfies these requirements: for an applicant who carries on the business activity who satisfies 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 satisfied, or will not satisfy, one of the tests set out in section 35-30, 35-35, 35-40 or 35-45 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 either meet one of those tests or 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)(b) of the ITAA 1997 refers to the paragraph being intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. It provides the example of the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income. The phrase 'objective expectation' was discussed in the Administrative Appeals Tribunal case of Scott v. Commissioner of Taxation [2006] AATA 542; VS2005/31-33, where it was said: 31. …in determining a commercially viable period, the test is primarily an objective one based on independent sources. According to the Commissioner, this approach was taken by the Federal Court in Commissioner of Taxation v Eskandari (2004) 134 FCR 569 where Stone J said, at 581-582: In some cases it may be a straight forward exercise to identify the industry in which the business activity takes place. Some industries are well-established and the basis for an ''objective expectation'' can readily be based on a comparison between the tax payer's business and other businesses within that industry, particularly where businesses or business associations within the industry produce material such as annual reports or industry papers. 32. Despite what Stone J said, Mr Scott contended that there were other circumstances which had to be taken into account when determining the commercially viable period expressed in the Olives Australia document. However, according to the Commissioner, this is impermissible because, as the Federal Court held in Eskandari , in most cases only objective material will be considered. It is only where, because of the nature of the industry, there is very little or no objective evidence that recourse may be had to the circumstances of the tax payer. That is not the case in the olive industry, which has been established for centuries. I agree with that submission. It seems to me that if it were permissible to take into account subjective considerations of each individual grower, there might be an almost infinitely variable period which could be described as the commercially viable period. Further, in the case of Scott , additional plantings made at a later time were not permitted to be included in the commercially viable period, as follows: The fact that a grower elects not to plant sufficient trees at the outset to ensure the business is commercially viable is a decision for that individual grower. Such a grower could not expect the Commissioner to exercise his discretion under s 35-55 in his or her favour because, to do so, would effectively render nugatory the rule dealing with losses from non-commercial business activities. Paragraph 17 of Taxation Ruling TR 2007/6 deals with the exercise of the Commissioner's discretion under this subparagraph and the meaning of 'because of its nature': For the failure to satisfy one of the four tests to be 'because of its nature', the failure must be because of some inherent characteristic that the taxpayer's business activity has in common with other business activities of that type (see Federal Commissioner of Taxation v. Eskandari ). Paragraph 78 of TR 2007/6 states; 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 subparagraph 35-55(1)(b)(i) being met. The example at paragraph 139 of TR 2007/6 explains 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 and he worked at his business when he could. He chose where his business premises were located and also 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. There is no generally accepted commercially viable period for your activities. You state that the time that one can take to produce income in your industry can be extensive (between 5 to 15 years) due to the time it takes to develop the project. The factors affecting the commercially viable period for your mixed activities are unique to your situation depending on the projects undertaken and the time spent on them and are not issues that are inherent to your industry. They are subjective and impermissible considerations, as affirmed in the cases of Eskandari and Scott and cannot be used as determinative factors in this private ruling. In your circumstances, it is reasonable to propose that the part-time basis on which you conduct your activities due to your employment commitments and your agreement to be paid in instalments contributed to the losses incurred in the 2008-09 to 2011-12 income years. It could be possible for others in your industry to not agree to payment by instalments, thereby receiving assessable income greater than the deductions attributable to it in a shorter timeframe. The way the activity has been sold is not necessarily peculiar or inherent to your industry. In reference to the above paragraphs, you have not shown that the reason that you have not met a test or made a profit is due to a lead time (of between '5 to 15 years') that is an inherent characteristic of your industry. Therefore, the Commissioner will not exercise the discretion under paragraph 35-55(1)(b) of the ITAA 1997 and you cannot claim a deduction for your losses against other income in the 2008-09 to 2011-12 income years. You must defer these losses to a future year where you meet a test or make a profit from your business activity.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Relevant facts: You satisfy subsection 35-10(2E) of the ITAA 1997. That is, your income for non-commercial loss purposes is less than $250,000. | Your business activity in Australia commenced during the 2007-08 income year. | Your activities are mixed activities within the entertainment industry. | Under the terms of your agreement for your activity, the consideration will be paid in instalments, as they move through the various phases of production. | Your first payment, payable on signing the agreement, satisfied the assessable income test in that year. | Further payments will be made on the first day of principle and then upon release of the project. | You anticipate activities in the forthcoming year, however you need to spend money on developing them. | You state that 'it is very common for activities to be in development for between 5 and 15 years' and as such, the businesses have long periods of time between selling rights and seeing a return. | You expect to make a profit in the 2012-13 income year.