Private ruling: Commissioner's discretion for non-commercial losses
Date of advice: 22 February 2017
Published: August 2017
Ruling period: Year ended 30 June 20WW | Year ended 30 June 20XX | Year ended 30 June 20YY | Year ended 30 June 20ZZ
Date scheme commenced: 1 July 20VV

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 in relation to the product in your calculation of taxable income? | A1: No. | Q2: Will the loss from the sale of the units, as a result of an "isolated transaction" be deductible under section 8-1of the ITAA 1997? | A2: Yes.

Relevant facts and circumstances: You purchased a house in 20UU with the purpose of building a number of residential units for resale. You operated in partnership with your spouse. You entered a contract in late 20UU to construct the building. One unit was sold and settled in 20VV. This property was sold at a loss The real estate market in the area has suffered several downturns due to a decline in a specific industry. The remaining units are still on the market. You have not prepared profit and loss statements for the activity. You have completed property development activities previously through a related company and a trust. This is the first property development you have undertaken as individuals.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 35-10 | Income Tax Assessment Act 1997 section 35-55 | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: Your activity of purchasing a house, constructing a number of residential units for resale, and selling the completed units is considered to be an isolated transaction. Any profit made on the sale of the property is assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997). Conversely, any loss made will be deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Non Commercial Losses Division 35 of the ITAA 1997 applies to losses from certain business activities for the year ended 30 June 2001 and subsequent years. Under the rule in subsection 35-10(2) of the ITAA 1997, a 'loss' made by an individual (including an individual in a general law partnership) from a business activity will not be taken into account in an income year unless: ● the 'exception' in subsection 35-10(4) of the ITAA 1997 applies, or ● satisfy subsection 35-10(2E) of the ITAA 1997 for that year and one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 is met, or ● the Commissioner exercises the discretion in section 35-55 of the ITAA 1997. Generally, a 'loss' in this context is, for the income year in question, the excess of a taxpayer's allowable deductions attributable to the business activity over that taxpayer's assessable income from the business activity. To consider paragraph 35-55(1)(a) and 35-55(1)(b) of the ITAA 1997, your activity should be carried on as a business. The question of whether you are carrying on a business is a question of fact and degree. There are no hard and fast rules for determining whether your activities amount to the carrying on of a business. 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. However, the courts have developed a series of indicators that you can apply to your circumstances to determine whether you are carrying on a business. Taxation Ruling TR 97/11 'Income tax: Am I carrying on a business of primary production?' summarises these indicators. Although TR 97/11 specifically refers to primary production, the same principles apply to all business. Your activity will only be potentially subject to these provisions if it is carried on as a business. Carrying on a business of property development Section 995 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business as established by case law. The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 (TR 97/11) which uses the following indicators to determine whether a taxpayer is carrying on a business: ● whether the activity has a significant commercial purpose or character; ● whether there is repetition and regularity of the activity; ● whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business; ● whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit; ● the size, scale and permanency of the activity; and ● whether the activity is better described as a hobby, a form of recreation or a sporting activity. In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour. Application to your situation You purchased a house as a development opportunity with the purpose of building a number of residential units for resale. You subsequently sold one of the units for a loss, and are unable to sell the remaining units due a downturn in the local real estate market. This indicates that the activity had a substantial purpose and character. This is the first time that you have completed a multi-unit development activity, and it is considered this single occasion development does not show the repetition and regularity that would be associated with a property development business. Although your related entities did complete a previous dwelling development, the circumstances are considered to be distinguished enough that this is not considered to be the level of repetition that would indicate that a business was being carried on. The size and scale of this activity is not substantial, the activity lacks permanence, and will be concluded with sale of the units. The activity is not better described as a recreational activity. In the weighing up of the facts, the overall impression gained is that your activity of property development would not be considered to be a business. Although your activity does show some indicators that a business was being carried on, the lack of repetition and regularity, along with the lack of permanence of the activity does not support that a business of property development was carried on. As it is not considered that you are conducting a business, paragraph 35-55(1)(a) and 35-55(1)(b) of the ITAA 1997 will not apply. Isolated profit making transaction Taxation Rulings TR 92/3 and TR 92/4, discusses the treatment of profits and losses resulting from isolated transactions. An isolated transaction refers to those transactions outside the ordinary course of business of a taxpayer carrying on a business and those transactions entered into by non-business taxpayers. A profit from an isolated transaction is assessable under section 6-5 of the ITAA 1997, and a loss from an isolated transaction is deductible under section 8-1 of the ITAA 1997, when both of the following elements are present: (a) in entering into the transaction the taxpayer intended or expected to derive a profit which would have been assessable income, and (b) the transaction was entered into, and the profit or loss was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction. For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character ( Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd (1982) 150 CLR 355, 82 ATC 4031, 12 ATR 692). Whether a particular transaction has a business or commercial character depends on the circumstances of the transaction. In determining whether an isolated transaction amounts to a business operation or commercial transaction, paragraph 13 of TR 92/3 outlines a number of factors that must be considered, as follows: ● the nature of the entity undertaking the operation or transaction. For example, if the taxpayer is a corporation with substantial assets rather than an individual, that may be an indication that the operation or transaction was commercial in nature ● the nature and scale of other activities undertaken by the taxpayer ● the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained ● the manner in which the operation or transaction was entered into or carried out ● the nature of any connection between the relevant taxpayer and any other party to the operation or transaction ● if the transaction involves the acquisition and disposal of property, the nature of that property, and ● the timing of the transaction or the various steps in the transaction. For example, if the relevant transaction consists of the acquisition and disposal of property, the holding of the property for many years may indicate that the transaction was not business or commercial in nature. In your case, ● you entered the arrangement with the intention of making a profit from the sale of the completed dwelling ● you conducted the transaction as an individual in a partnership ● you had not previously engaged in commercial property development as an individual (all previous development activities were entered by a related company or a trust) ● the arrangement was entered into on a commercial basis We consider that the arrangement entered into was an isolated transaction to which TR 92/3 or TR 92/4 can apply. It was your primary intention to create a profit by building and selling the dwelling. As such, any profit made on the sale of the property is assessable under section 6-5 of the ITAA 1997 in the year in which the property was sold. Conversely, any loss made will be deductible under section 8-1 of the ITAA 1997 in the year in which the property was sold.