Private ruling: The Commissioner's discretion and non-commercial business losses
Published: May 2015
Ruling period: Year ended 30 June 2014
Date scheme commenced: The scheme has commenced

Ruling: Q1: Is there a discretion that the Commissioner can exercise to exclude a lump sum payment from the calculation of the < $250,000 income requirement set out in subsection 35-10(2E) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the ITAA 1997 to allow you to include any losses from your business in your calculation of taxable income for the 2013-14 financial year? | A2: No.

Relevant facts and circumstances: You operate a business with turnover of more than $20,000 for the relevant financial year, however you have made a loss during that year. Your only other income is from a Government pension and some small investment earnings You sold a capital asset during the relevant financial year and made a substantial net taxable capital gain. Due to the capital gain you do not satisfy the < $250,000 income requirement set out in subsection 35-10(2E) of the ITAA 1997. You state the following in regards to the capital gain and business activity: • it was one-off capital gain and you will satisfy the < $250,000 income requirement in future years as you will pass one of the four tests • you believe that your business activity is commercial and that it cannot be said that you have incurred losses for the purpose of offsetting them against your pension income. You also state the following: • The explanatory memorandum to the introduction of the $250,000 limit contained this comment under the heading "Summary of new law" at item 1.9 - "These amendments also provide the Commissioner with a new discretion in cases where an individual does not meet the income requirement, but can nonetheless independently demonstrate that their business is genuinely commercial." • The explanatory memorandum talked about the amendments being to improve the integrity, fairness and equity of the non-commercial losses rule. It seems those fairness and integrity measures have worked in an opposite way in 2013/2014 for this taxpayer in this circumstance. One would think it could be reasonably argued that a one-off, out of the ordinary, capital gain has produced an unfair result in this case if the strict application of the rules was enforced.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 35 | Income Tax Assessment Act 1997 Subsection 35-10(1) | Income Tax Assessment Act 1997 Subsection 35-10(2) | Income Tax Assessment Act 1997 Dubsection 35-10(2E), and | Income Tax Assessment Act 1997 Paragraph 35-55(1)(a).

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, or • the Commissioner exercises his discretion. | Detailed Reasoning - One off payments and the $250,000 adjusted taxable income rule: The income requirement set out in subsection 35-10(2E) of the ITAA 1997, prevents you from accessing the four tests where your adjusted taxable income exceeds $250,000 (that is, your taxable income, reportable fringe benefits, reportable superannuation contributions and total net investment losses but excluding your business losses). Not all assessable income is included in calculating the adjusted taxable income. Any assessable income attributed to the business activity incurring the loss is not included in the adjusted taxable income calculation. This is because it forms part of the business losses, which are disregarded (the business losses are calculated by deducting the expenses attributed to the business activity from the assessable income 'from' that business activity). No other income is excluded in the calculation of the adjusted taxable income. Further, there is no discretion provided to Commissioner under Division 35 of the ITAA 1997, which enables him to exclude other income from the calculation of the adjusted taxable income. Therefore your capital gain from the sale of capital asset must be included in the adjusted taxable income calculation for the purposes of subsection 35-10(2E) of the ITAA 1997. | Detailed Reasoning - Special circumstances and the Commissioner's discretion: As explained above, in your situation you do not satisfy the income requirement for the purposes of subsection 35-10(2E) of the ITAA 1997, and you do not come under any of the exceptions. Your business losses are therefore subject to the deferral rule unless the Commissioner exercises his discretion. It is acknowledged that the explanatory memorandum states under the heading "Summary of new law" at item 1.9 - "These amendments also provide the Commissioner with a new discretion in cases where an individual does not meet the income requirement, but can nonetheless independently demonstrate that their business is genuinely commercial." The Commissioner's discretion referred to in the explanatory memorandum (and the only discretion available to the Commissioner under Division 35 of the ITAA 1997) is the discretion listed at paragraph 35-55(1)(a) of the ITAA 1997. It states that the Commissioner can decide not to apply the loss deferral rule if he is satisfied that its application would be unreasonable because the relevant business was or will be affected by special circumstances outside the control of its operators. 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. For those individuals who do not satisfy the income requirement, special circumstances are those which have materially affected the business activity, causing it to make a loss. Taxation Ruling TR 2007/6 sets out the Commissioner's interpretation of the exercise of the Commissioner's discretion under paragraph 35-55(1)(a) of the ITAA 1997. The following has been extracted from paragraphs 47 to 53 of this ruling: Although not limited to natural disasters, paragraph 35-55(1)(a) of the ITAA 1997 refers to special circumstances outside the control of the business activity, including drought, flood, bushfire or some other natural disaster. Cyclones, hailstorms and tsunamis are examples of other natural disasters that would come within the scope of the paragraph. These events are taken to be special circumstances outside the control of the operators of the business activity. The special circumstances must have affected the business activity. In your case, you have received a capital gain from the sale of a capital asset. Receiving this capital gain did not affect your business activity; instead it caused you to fail the income requirement under subsection 35-10(2E) of the ITAA 1997. This is not considered to be 'special circumstances' for the purposes of paragraph 35-55(1)(a) of the ITAA 1997. While we appreciate your situation, there is no other discretion available to the Commissioner under Division 35 of the ITAA 1997 that would allow you to claim your losses in the circumstances you describe.