ATO Targets High Income Individuals with Non-Commercial Business Activities
Under the Taxation Laws Amendment (Budget Measures 2) Act 2009 the ATO has made changes to the existing non-commercial loss rules from 1 July 2009. The ATO has moved to prevent individuals with an adjusted taxable income above $250,000 from having access to immediate deductions for losses generated from unprofitable business activities against their salary, wage and other income.
The amendments have been ‘sold’ by the Government as being necessary to prevent a loss of revenue due to the activities of wealth ‘hobby farmers’, the non-commercial loss rules can apply to a much boarder range of taxpayers.
In 2009/10 Lauren receives $220,000 salary income and has $50,000 reportable superannuation contributions. In addition to her salary Lauren owns a party planning business which she does in her spare time. The party planning business has never actually made a profit and in 2009/10 the party planning business had income of $15,000 and expenses of $25,000 resulting in a loss of $10,000. Lauren does not meet the income requirements as her total salary and reportable superannuation contributions are over $270,000 – over the $250,000 limit. As a result Lauren cannot apply the $10,000 loss against her assessable income (unless the Commissioner’s discretion is obtained). Instead the loss can only be applied against assessable income from the business in future income years.
A non-commercial loss is a loss made from business operations that are carried out as an individual, either as a sole trader or as a partner in a partnership. If a non-commercial loss is made then there are specific rules that must be passed to enable the non-commercial loss to be offset against income from other sources.
These key changes include:
- The introduction of an income requirement to further restrict the circumstances where a business loss can offset other income;
- A new exception for business losses solely caused by deductions claimed for the small business and general business tax break;
- A new Commissioner’s discretion for individuals who do not meet the income requirements but whose business activity is subject to a lead time;
- Ensuring existing Commissioner’s discretions continue to apply.
In addition from 1 Jul 2009 onwards non-commercial losses can only be offset against income from other sources if you meet on of the following criteria:
- One of the exceptions for primary production or professional arts businesses apply;
- The income requirement are met and one of the four tests is satisfied (profits test, assessable income test, other assets test, real property test) ;
- The Commissioner has exercised his discretion to allow you to claim the loss, or
- The loss is solely due to a deduction claimed under the small business and general business tax break.
An exception applies to specific net losses as a result of primary production or professional arts business activities if the total income from other sources not related to the business activity is less than $40,000 (excluding capital gains).
To meet the income requirements the total amount of the following must be less than $250,000
- Taxable income (excluding business losses);
- Reportable fringe benefits;
- Reportable superannuation contributions;
- Total net investment losses.
In addition to the income retirements one of the four tests must be passed. These tests are as follows:
- The assessable income from the business activity is over $20,000;
- The business has produced a profit in three of the past five years (including current year);
- The business uses real property or an interest in real property worth a least $500,000 on a continuing basis, OR
- The business holds other assets worth at least $100,000 on a continuing basis.
If the business fails to be in the exception category or meet the income requirement and one of the four tests then in limited circumstances may be able to apply for Commissioner’s discretion. An application for Commissioner’s discretion can only be applied for either in special circumstances or due to the nature of the business activity there is a lead time before the business can pass one of the four tests.
If the tax loss is due to a tax deduction arising from the small business and general business tax break the non-commercial loss can offset other income for the 2009-10 and 2010-11 financial years.
The non-commercial business loss tests must be applied each year that a business makes a loss. If it is determined that the loss cannot be claimed in the current financial year under the non-commercial loss rules then the loss is deferred until such a time it can offset future profits.
If you feel that you may be impacted by these developments we recommend that you contact us for advice and clarification.