Private ruling: Non-commercial losses
Date of advice: 31 August 2016
Published: October 2016
Ruling period: Year ended 30 June 2016 | Year ended 30 June 2017
Date scheme commenced: 1 July 2015

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 for the 2015-16 and 2016-17 financial years? | A1: No.

Relevant facts and circumstances: You are designing a product and you are in the process of industrial design, engineering and patenting. You plan to manufacture and sell the product. You earn under $250,000 and do not currently meet the 4 criteria for exemption eligibility.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 35 | Income Tax Assessment Act 1997 Section 995-1

Reasons for decision: Summary: 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, you must be carrying on 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 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 activities will only be potentially subject to these provisions if it is carried on as a business. If your activity is not carried on as a business, and cannot reasonably be expected to produce assessable income, then, you cannot claim general deductions in relation to it, regardless of the operation of Division 35 of the ITAA 1997. | 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 began selling the product. In your case it is considered that the business activity you intend to carry on is characterised as the manufacturing and selling of a product. We can now consider the indicators set out above to determine whether this business activity has commenced. 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. Whether a taxpayer can be considered to be carrying on a business of research and development to get a product to the stage of commercial development was considered in Goodman Fielder Wattie Ltd v FC of T 91 ATC 4438; (1991) 22 ATR 26. Goodman Fielder Wattie Ltd (the company) carried on business in a number of areas. It entered into an agreement with a third party to establish a research and development centre for the production of a particular product that the company could exploit commercially. In October 1982, a decision was made to lease separate premises (factory premises) and set up commercial development and production facilities in these premises. Therefore, it was conceded by the company that if the business claimed to be carried on by it was to be characterised as one of manufacturing and selling the products, then that business did not commence until around November 1982 when the move to factory premises took place. In the above case, it was determined that a business had not commenced until research and development was completed and the company had proceeded to manufacture the products for the purpose of sale. Prior to this point, a saleable product had not yet been developed and income earning activities had not commenced. In your case, you have not begun ordinary business operations. At this point in time you do not have your product ready for sale. We consider that, up to this point, your activities were preliminary to the carrying on of your intended business. The activities conducted, such as design, engineering and patenting are considered to be preparatory activities which were directed to facilitate the business activity. As there has been no business conducted, Division 35 of the ITAA 1997 will not apply to the losses incurred in that year. Non-commercial loss discretion In your situation, none of the exceptions would apply. If you were carrying on a business your losses would be 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 forestry, viticulture and certain horticultural activities. The discretion should not 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. The discretion should not be exercised for any start-up As you are not considered to be carrying on a business the non-commercial loss provisions do not apply and the Commissioner is unable to exercise any discretion in this matter. However, even if you had commenced business, you have not produced any objective evidence to show that there is an inherent or innate characteristic preventing a business of manufacturing and selling a product from producing assessable income for any period of time ( F C of T v Eskandari [2004] FCA 8; 54 ATR 695).