Private ruling: Commissioner’s discretion for non-commercial losses
Date of advice: 31 July 2018
Published: September 2018
Ruling period: Year ended 30 June 20XX | Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

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 the calculation of your taxable income for the 20XX financial year? | A1: No.

Relevant facts and circumstances: You performed research and engaged industry experts incurring significant costs in the 20XX financial year. You took receipt of stock and actually commenced trading in the 20XX year. You project that you will make a loss in the 20XX financial year. You project that you will make a tax profit in the 20XX financial year. You do not satisfy the income requirement set out in subsection 35-10(2E) of the ITAA 1997. You are currently building up your client base.

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)(c)

Reasons for decision: Detailed Reasoning - Detailed reasoning: 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 satisfy the income requirement and you pass one of the four tests ● the exceptions apply ● the Commissioner exercises his discretion. However, for this division to apply, your activity should be carried on as a business. Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. The case of Evans v. Federal Commissioner of Taxation 89 ACT 4540; (1989) 20 ATR 922 stated that whether or not an activity amounts to carrying on business for taxation purposes is a question of fact. There is no exhaustive or determinative definition which can be applied to determine this matter. The facts of each case must be examined. In Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548, Webb J said: The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained. | Detailed Reasoning - When does a business activity commence?: The actual date of commencement of a business activity is a question of fact ( Goodman Fielder Wattie Ltd v. FC of T 91 ATC 4438; (1991) 22 ATR 26) ( Goodman Fielder Wattie ). For a business activity to have commenced a person must have: ● purpose, intention and decision to commence the business activity ● acquired a minimum level of business assets to allow that business activity to be carried on, and ● actually commenced business operations ( Calkin v. CIR [1984] 1 NZLR 440). We must examine the above indicators in light of the characterisation of your business activity. In Goodman Fielder Wattie , Hill J stated at 4,447: 'Critical to the resolution of the present controversy, is the characterisation of the business activity itself which is said to have commenced. It was conceded properly by the applicant that if the business claimed to be carried on by it was to be characterised as one of manufacturing and selling monoclonal antibody products, then that business did not commence until around November 1982...' For example, if your business activity is characterised as a primary production activity, involving the planting and cultivating of trees, then the planting of the trees could be seen as the commencement of that business. Alternatively, if your business activity is characterised as the manufacturing and selling of a product, the business would generally be considered to commence once you have manufactured and begun selling the product. | Detailed Reasoning - Purpose, Intention and Decision: The intention and purpose of a taxpayer in engaging in an activity is relevant to when a business commences. However, an intention to commence a business will not determine that the business activity has actually commenced. The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity. This is developed by researching the proposed business and, in some instances, by experiment. This process culminates in a final decision on whether to commence business. However, not all businesses commence in such an orderly manner. | Detailed Reasoning - Acquisition of a minimum level of business assets to allow that business activity to be carried on: Most business activities have a structure that provides the framework of the business. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity. In Calkin v. CIR [1984] 1 NZLR 440 Richardson J said at 446-447: Clearly it is not sufficient that the taxpayer has made a commitment to engage in business: he must first establish a profit-making structure and begin ordinary business operations. For a business activity to commence, an appropriate business structure should be in place and begin ordinary business operations. As to what the business structure will consist of, and its size, will be a question of fact and degree, and will depend on the nature of the business activity. | Detailed Reasoning - Commencement of Business Operations: As noted by Brennan J in Inglis v Federal Commissioner of Taxation (1979) 10 ATR 493; 80 ATC 4001, the level of activity is important in deciding whether a business is being carried on. Brennan J stated at ATC 4004-4005; ATR 496-497 that: The carrying on of a business is not a matter merely of intention. It is a matter of activity. Yet the degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the supposed business is being conducted. In Hadlow and FC of T [2002] AATA 1250; (2002) 2002 ATC 2294; (2002) 51 ATR 1197 the Small Taxation Claims Tribunal considered the amounts incurred by a taxpayer to research and develop a book. The question for decision was whether the activities were merely preparatory and preliminary or whether the activity had reached a stage where it was able to be characterised as a business. In concluding that the activity was not carried on as a business in the relevant years, member Mowbray stated at paragraph 26: Clearly Mr Hadlow has the subjective intention to carry on a business, but that is not sufficient. There must be business activity. There is a real question whether the activities to date are merely preparatory or preliminary (see Goodman Fielder Wattie at 4447), and whether the project has reached the stage where it is able to be characterised as a business. There has been much activity but The concept of business does not equate with being busy ( Goodman Fielder Wattie at 4447; 386; 339) Mr Hadlow has researched, undertaken travel, and visited museums, libraries and farms in pursuit of a particularly interesting topic. He has expended money but has made no sales, received no advances nor signed any contracts. | Detailed Reasoning - Application to your circumstances: It is clear from the information you have provided that you have researched your proposed business activity, decided on the form of that business and have committed yourself to it. In the 20XX financial year you had extensively researched and sought advice and committed to establishing the profit making structure of the activity. However, you had not yet taken receipt of stock, nor actually commenced trading by 30 June 20XX. The business activity had not yet commenced for the purposes of Division 35 of the ITAA 1997 in the 2016 financial year. As the activity had not commenced, the Commissioner is not able to exercise the discretion in section 35-55(1)(c) of the ITAA 1997 as you were not yet carrying on the business activity. You did take receipt of stock and actually begin trading in 20XX. The business activity has commenced in the 20XX financial year. | Detailed Reasoning - The Commissioner’s Discretion: For the 2009-10 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. The relevant discretion may be exercised for the income year in question where: ● it is in the nature of your business activity that there will be a period before a tax profit can be produced, ● there is an objective expectation your business activity will produce a tax profit within the 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 greater than the deductions attributable to it. For example: forestry, viticulture and certain horticultural activities. The note following paragraph 35-55(1)(c) does not support any view that the discretion should be exercised for any start-up activity that is yet to produce assessable income greater than the deductions attributable to it simply because a client base is being built up. The Explanatory Memorandum to the New Business Tax System (Integrity Measures) Bill 2000 (the EM) provides at paragraph 1.48 that: The discretion is provided to ensure that certain individuals who carry on genuine commercial businesses are not disadvantaged due to particular circumstances which prevent them from satisfying tests 1 to 4. In addition, paragraph 1.51 of the EM comments: The arm of the safeguard discretion … will ensure that the loss deferral rule in section 35-10 does not adversely impact on taxpayers who have commenced to carry on activities which by their nature require a number of years to produce assessable income. Paragraph 73A of Taxation Ruling 2007/6 (TR 2007/6) provides the Commissioner’s view that because the tests are not automatically relevant if the income requirement is not met, the first factor in paragraph 35-55(1)(c) of the ITAA 1997 considers whether it is ‘because of its nature’ that the activity has not produced, or will not produce, a tax profit. The note under paragraph 35-55(1)(c) of the ITAA 1997 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 of years would pass before the activity could be reasonably expected to produce income. Stone J in Federal Commissioner of Taxation v Eskandari (2004) 134 FCR 569 (Eskandari’s case) confirmed this view when considering whether the Commissioner’s discretion should be exercised in regard to losses incurred in a migration consultancy business. “Because of its nature’ was interpreted to mean an inherent characteristic 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. Paragraph 78 of TR 2007/6 provides the Commissioner’s view that the consequences of business choices made by an individual are not inherent characteristics of a business activity and would not result in the requirements of subparagraph 35-55(1)(c)(i) being met. Paragraph 83 of TR 2007/6 provides that paragraphs 35-55(1)(b) and (c) will typically apply in situations where a lead time exists between the commencement of the activity and the production of assessable income from that activity. | Detailed Reasoning - Application to your circumstances: In your circumstances the business activity commenced in the 20XX financial year and proceeded to build its client base. We do not consider that there is anything inherent or innate in the nature of the business activity that prevents it from producing a tax profit. The business activity is of a type that is able to produce assessable income quite soon after its commencement. 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 20XX financial year.