Private ruling: Non Commercial Losses
Date of advice: 1 July 2015
Published: July 2015
Ruling period: Year ended 30 June 20YY
Date scheme commenced: 1 July 20XX

Ruling: Q1: Are you carrying on a business? | A1: Yes. | Q2: 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 enterprise in the calculation of your taxable income? | A2: No.

Relevant facts and circumstances: You satisfy the $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997. In X, you commenced your own business, designing and producing products specialising in lighting. You registered your business name with ASIC, developed your own promotional website and registered an Australian Business Number. You incurred a loss in the 20XX-YY financial year. You do not meet any of the four tests required to claim your losses. You expect your business to be profitable from the XXXX financial year and onwards. You have spent time setting up a viable workshop to enable an effective production process. Initially, you intend to predominantly produce on orders received rather than hold large quantities of completed stock. You have been unable to borrow working capital and need to work part time to provide funds to further your business.

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

Reasons for decision: Summary: Whether a business is being carried on depends on the 'large or general impression gained' ( Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all the indicators of carrying on a business, and no one indicator will be decisive ( Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). These indicators are described in Taxation Ruling TR 97/11. Outlined below are matters that would generally be taken into account in weighing-up the indicators to establish whether a taxpayer is carrying on a business. | Detailed Reasoning - Significant commercial purpose or character: This indicator generally covers aspects of all the other indicators. The business should be carried out on such a scale and in such a way as to show it is being operated on a commercial basis and in a commercially viable manner and that the taxpayer's involvement in the activity is capable of producing a tax profit. | Detailed Reasoning - Purpose and intention to engage in business and nature of the activities: The taxpayer should be able to demonstrate an intention to derive assessable income from the sale of the produce of the business activity. A taxpayer should also be able to demonstrate that appropriate activities have been carried out by that taxpayer, or on the taxpayer's behalf, to allow this to occur. | Detailed Reasoning - Intention to make a profit and prospect of profits: The taxpayer's involvement in the business activity should be motivated by wanting to make a tax profit and the taxpayer's activities should be conducted in a way that facilitates this. This will require examining whether objectively there is a real prospect of making such a profit from participating in the business, that is, from the carrying on of a business of primary production of that taxpayer. | Detailed Reasoning - Repetition and regularity: The taxpayer's activities should involve repetition and regularity and have an air of permanence about them. | Detailed Reasoning - Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business: The taxpayer's activities or those conducted on the taxpayer's behalf should, unless circumstances dictate otherwise, be based around business methods and procedures of a type ordinarily used in ventures that would commonly be said to be businesses. The activities should be carried out using accepted practices. | Detailed Reasoning - Organisation, systematic, business-like manner: The activities conducted by, or on behalf of the taxpayer, should be carried out in a systematic and organised manner. This will usually involve matters such as the keeping of appropriate business records by the taxpayer. If someone else carries out the activities on the taxpayer's behalf, there should be regular reports provided to the taxpayer on the results of those activities. | Detailed Reasoning - The size and scale of the activity: The business should be large enough to make it commercially viable. | Detailed Reasoning - There is a hobby when:: • it is evident there is no intention to make a profit from the activity • losses are incurred because the activity is motivated by personal pleasure and not to make a profit • the transaction is isolated and there is no repetition or regularity of sales • there is no system to allow a profit to be produced in the conduct of the activity • the activity is carried on a small scale • there is an intention by the taxpayer to carry on a hobby, a recreation or a sport rather than a business, and/or • any produce is sold to friends and relatives and not to the public at large. Having regards to your circumstances, it is accepted that you are carrying on a business in designing and manufacturing Australian made products. | Detailed Reasoning - Questions 2: For the 2009-10 and later financial years, Division 35 of the 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, none of the exceptions would apply and although you satisfy the income requirement, you do not meet any of the four tests in the years of income under consideration. Your losses are therefore subject to the deferral rule, unless the Commissioner exercises his discretion. The relevant discretion may be exercised for the income year in question where: • it is in the nature of the business activity that there will be a period of time before it can be expected to pass one of the four tests • there is an objective expectation your business activity will produce a tax profit or meet one of the four tests within a commercially viable period for your industry. This discretion is intended to cover a business activity where there is an inherent period of time between the commencement of the activity and the production of 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. For the discretion to be applied there needs to be 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 viticulture and certain horticultural activities. The note above does not support any view that the discretion should be exercised for any start-up activity that is yet, for example, to satisfy the assessable income test in section 35-30 of the ITAA 1997, simply because of the small scale on which it was started, or because a client base is being built up. We do not consider that there is a lead time between the commencement of your activity and the production of any assessable income. Your business was able to generate income from professional fees in your first financial year in operation. Therefore, we do not consider that there is anything inherent or innate in the nature of your business activity that it has not yet been able to satisfy one of the tests. Consequently, the Commissioner will not exercise the discretion in paragraph 35-55(1)(b) of the ITAA 1997 to allow you to include any losses from your enterprise in the calculation of your taxable income. Losses that cannot be taken into account in a particular year of income, because of subsection 35-10(2) of the ITAA 1997, can be applied to the extent of future profits from the business activity, or are deferred until one of the tests is passed, the discretion is exercised, or the exception applies.