Private ruling: Non-commercial business losses and the Commissioner's discretion
Date of advice: 4 March 2016
Published: April 2016
Ruling period: Years ended 30 June 20WW to 30 June 20YY
Date scheme commenced: 1 July 20ZZ

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 property development activity (the activity) in the calculation of your taxable income for the 20VV-WW to 20XX-YY financial years? | A1: No.

Relevant facts and circumstances: You do not satisfy the income requirement set out in subsection 35-10(2E) of the ITAA 1997. You commenced the activity in 20AA when you purchased a block of land. The intention of the purchase was for property development and sub division in the future. You purchased earthmoving and other equipment in order to clear the land and conduct road works. You have performed all development work yourself to ensure final land surveying is easier and cheaper. You have advised that there have been numerous delays in the development of the land. You have provided no independent evidence as to the commercially viable period for your industry. You expect the development of the land to be completed and the properties to be available for sale in the X financial year, with a projected profit of approximately $X.

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), and | Income Tax Assessment Act 1997 Paragraph 35-55(1)(c).

Reasons for decision: Summary: For the 20VV-WW and later income years, Division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless: • you satisfy the income requirement and you pass one of the four tests, • the exceptions apply, or • the Commissioner exercises the discretion. In your situation, you do not satisfy the income requirement and you do not come under any of the exceptions. 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 such as: a consequence of starting out on a small scale, having a staggered start, continued high finance expenses. Also, in order to exercise the lead time discretion, the Commissioner must be satisfied there is an objective expectation, based on evidence from independent sources, that your business activity will produce assessable income greater than the deductions attributable to it for that year, within a commercially viable period (paragraph 35-55(1)(c) of the ITAA 1997). The Commissioner's view on this issue is set out in TR 2007/6. The following is an extract from the ruling: 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 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 business activity being conducted by the taxpayer, which are common to any business activity type. The 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 some other reason. 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.) In your case you have provided no independent evidence as to the commercially viable period for your industry. However you state that there have been numerous delays to the progress of the activity, which were all outside your control, and which affected the time and funds available for the activity. As such you have performed all development work yourself, and plan on doing the same in the future to ensure development costs are kept to a minimum. In your case, we consider that the reason your activity will take X years to become commercially viable is peculiar to your situation, due to the fact that you have decided to undertake all work on the property yourself. The circumstances you listed which you claim to have caused the delays to the activity are private in nature, and are not inherent characteristics of the activity being conducted, nor are they common to any business activity in your industry. Therefore, the Commissioner will not exercise the discretion to allow you to include any losses from your business in your calculation of taxable income for the financial years in question.