Private ruling: Non-commercial losses - Commissioner's discretion
Published: February 2015
Ruling period: Income year ended 30 June 20XX | Income year ended 30 June 20YY | Income year ended 30 June 20ZZ
Date scheme commenced: 1 July 20VV

Ruling: Q1: Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) and decide that the rule in subsection 35-10(2) of the ITAA 1997 does not apply to your business activity for the income years ended 30 June 20XX to 30 June 2016? | A1: The Commissioner is satisfied that it would be unreasonable for the rule in subsection 35-10(2) of the ITAA 1997 to apply for the income years ended 30 June 20XX to 30 June 20YY because your business activity was affected by special circumstances outside your control and has decided in accordance with paragraph 35-55(1)(a) of the ITAA 1997 that the rule does not apply to your business activity in those years. The Commissioner has declined to rule for the income years ended 30 June 20ZZ to 30 June 2016 as providing a ruling would not have any practical consequences for you and making the ruling would prejudice or unduly restrict the administration of a taxation law.

Relevant facts and circumstances: In or about 2000, the taxpayer purchased Business A. An associated entity was the lessee of the business premises and was also the manager and staff service entity for the business. Funds for the above were provided by two lending institutions, X & Y. In or about 200X, the taxpayer purchased Business B. An associated entity in its capacity as trustee purchased the business premises. At all relevant times the taxpayer has rented the business premises from associated entity. Another associated entity is the manager and staff service entity for Business B. Funds for the above and for refinancing the X & Y loans were provided by 'the Bank'. In or about 200Y the taxpayer entered into a franchise agreement and was granted a right to operate Business C. An associated entity was the lessee of the premises for Business C. Another associated entity A was the manager and staff service entity for Business C. The Bank provided funds to facilitate the above. The taxpayer owned a rental property. The Bank funded its acquisition. The Bank reviewed the above lending arrangements. As a result, lending ratios were reduced and the taxpayer and its associated entities were charged and paid penalty interest and were required to pay additional loan repayments. The taxpayer paid the additional loan repayments. As a result of the franchise agreement the taxpayer incurred additional stock costs. The above additional costs resulted in severe financial hardship and a receiver was appointed. The receiver undertook various actions which hampered cashflows and impeded the smooth running of the taxpayer's business and resulted in further additional stock and interest costs to the taxpayer and in financial loss. The taxpayer paid management fees to the receiver. As a result of the actions of the receiver the taxpayer incurred additional rental costs. The taxpayer has incurred business losses in each of the income years ended 30 June 20XX, 20YY and 20ZZ. The taxpayer has since been profitable. The taxpayer did not satisfy, and does not expect to satisfy, the income requirement in subsection 35-10(2E) of the ITAA 1997 in the income years income years ended 30 June 20XX, 20YY and 20ZZ. The taxpayer satisfied, or expects to satisfy, the assessable income test in section 35-30 of the ITAA 1997 in the income years income years ended 30 June 20XX, 20YY and 20ZZ.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 35-10(2) | Income Tax Assessment Act 1997 subsection 35-10(2E) | Income Tax Assessment Act 1997 section 35-30 | Income Tax Assessment Act 1997 section 35-35 | Income Tax Assessment Act 1997 section 35-40 | Income Tax Assessment Act 1997 section 35-45 | Income Tax Assessment Act 1997 subsection 35-55(1) | Income Tax Assessment Act 1997 paragraph 35-55(1)(a) | Taxation Administration Act 1953 Schedule 1 paragraph 359-35(2)(a)

Reasons for decision: Summary: Division 35 of the ITAA 1997 operates to prevent losses from non-commercial business activities being offset against other assessable income in the year the loss is incurred. The rule in subsection 35-10(2) of the ITAA 1997 defers losses from each business activity that is carried on unless (a) the income requirement in subsection 35-10(2E) of the ITAA 1997 is satisfied and one of the four tests set out in sections 35-30, 35-35, 35-40 and 35-45 of the ITAA 1997 are satisfied or (b) the Commissioner exercises the discretion set out in section 35-55 of the ITAA 1997 for the business activity for that year. Under paragraph 35-55(1)(a) of the ITAA 1997 the Commissioner may decide that the rule in subsection 35-10(2) of the ITAA 1997 does not apply to a taxpayer's business activity in cases where he is satisfied that it would be unreasonable for the rule to apply because business activity was or will be affected by special circumstances outside the control of the operators of the business activity. The term 'special circumstances' is not defined in the legislation however in accordance with judicial consideration, it is accepted that special circumstances are those that are unusual, different, uncommon or exceptional; the word special signifies that it is something out of the ordinary or normal course. Special circumstances are those circumstances which are sufficiently different to distinguish them from the circumstances that occur in the normal course of conducting a business activity. Although paragraph 35-55(1)(a) of the ITAA 1997 specifically refers to drought, flood, bushfire or some other natural disaster as being special circumstances outside the control of the taxpayer, the use of the word 'including' in that paragraph indicates that the type of circumstances to which the discretion can potentially apply is not limited only to natural disasters. Depending on the facts, circumstances other than natural disasters may constitute special circumstances of the type in question. Paragraph 35-55(1)(a) of the ITAA 1997 requires consideration of whether special circumstances beyond the control of the operator of the business activity were present This conveys the point that the circumstances cannot be a consequence of the operator's actions or inactions. It also requires consideration of whether the special circumstances affected the business activity. In considering whether special circumstances affected the business activity the Commissioner will look to indicators of the effects of the special circumstances on the business activity. In the case of a taxpayer that does not satisfy the income requirement special circumstances will have materially affected a business activity if it has caused it to make a loss. As provided in paragraph 41D of Taxation Ruling TR 2007/6 Income tax: non-commercial business losses: Commissioner's discretion , in the case of a taxpayer that does not satisfy the income requirement, the Commissioner must be satisfied that but for the special circumstances, the business activity would have made a tax profit and passed, or could have passed, one of the four tests and the special circumstances affecting the business activity are outside the control of the operators of the business activity. Additionally, TR 2007/6 provides that the discretion can be exercised in income years after the one in which the special circumstances occurred if the effects of those special circumstances continue to prevent the business activity from satisfying any of the tests in those later income years. | Detailed Reasoning - Application to the taxpayer's circumstances: In order to exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997, the Commissioner must be satisfied that special circumstances beyond the taxpayer's control existed or will exist in the relevant period and that but for the special circumstances the business activity would have made a tax profit. The special circumstances the taxpayer has described relate to the actions of the Bank and of the appointed receiver. Generally, circumstances that might reasonably have been predicted or that are not in any way unusual or uncommon as they might occur in the ordinary course of your business would not be considered to be special. In this case, the additional stock costs were incurred in the normal course of conducting your business. On its own the circumstance of the franchise agreement imposing these additional costs cannot be said to constitute a special circumstance. Similarly, the imposition of penalty interest and extra loan repayments could reasonably have been predicted and were incurred as an ordinary incidence of your business. On its own, the circumstance of the Bank reviewing the lending arrangements and the resulting additional costs would not ordinarily constitute a special circumstance. However, the financial hardship that ensued from the above circumstances and the eventual appointment of the receiver has resulted in special circumstances that have negatively impacted the taxpayer's business. The actions of the receiver and their effect on the taxpayer's business can be regarded as special circumstances. Although stock and interest costs are costs that would ordinarily have been encountered in the course of the taxpayer's business activity and resulted in the further additional stock and interest costs that would not have been incurred but for their actions. Additionally, it can be said that the management fees and additional rent incurred are additional costs that the taxpayer would not have encountered in the ordinary conduct of your business. Similarly, the hampering of cashflow and disruption to the smooth running of the business as a result of the receiver's actions did not occur as a result of normal business fluctuations that might be encountered in the ordinary course of trading. The actions of the receiver could not have been predicted or controlled and the extra responsibilities that these actions imposed on the taxpayer constitute sufficiently unusual circumstances which were outside the taxpayer's control in operating their business. It is accepted that the actions of the receiver have resulted in additional costs that the taxpayer would not otherwise have incurred and that they have resulted in losses. Accordingly, the Commissioner is satisfied that it would be unreasonable for the rule in subsection 35-10(2) of the ITAA 1997 to apply to your business activity and has decided in accordance with paragraph 35-55(1)(a) of the ITAA 1997 that it will not apply to your business activity for the income years ended 30 June 20XX to 30 June 20ZZ.