Australia: Tough Non-Commercial Loss Rules For High Income Earners

A Bill has been introduced into Federal Parliament that will make it difficult for individuals with an income of $250,000 or more to claim deductions from non-commercial business activities.

The change to the non-commercial loss provisions in Division 35 of the Income Tax Assessment Act 1997 was foreshadowed in the Federal Budget in May this year where the Treasurer stated that "the Rudd Government will close a tax loophole that allows a relatively small number of mostly high wealth individuals to exploit parts of the tax system to unfairly minimise or avoid their tax obligations".

Date Of Effect

The changes to Division 35 are in the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 (Bill) which was introduced into Parliament on 21 October 2009.  The amendments will apply, if the Bill is passed, to the 2009-10 and later income years.


The non-commercial loss rules were introduced in 2000. The rules sought to address individuals reducing their tax by carrying on unprofitable business activities and then claiming tax deductions for losses from those activities against their other income.  Under these rules deductions for these losses were quarantined for use against income the business may generate in the future.

Four Tests Specified

Under the rules there are four tests specified.  If one of these tests is satisfied, then losses from the business can be claimed as a deduction.  The four tests are:

  • the assessable income test which requires that the assessable income from the business activity be at least $20,000
  • the profits test which requires that, for at least three of the past five years, the business activity has produced a profit
  • the real property test which applies if the reduced cost base of real property used on a continuing basis in the business is at least $500,000, and
  • the other assets test which applies if the value of certain other assets used on a continuing basis in the business is at least $100,000.

Under the current rules, if a taxpayer satisfies any one of these tests, losses from the unprofitable business may be deducted against the taxpayer's other income.  If none of the tests are satisfied the Commissioner has a discretion to allow the losses to be deducted against other income having regard to certain circumstances, such as whether the business activity was affected by special circumstances outside the control of its operators such as drought, flood, bushfire or some other natural disaster.

Introduction Of An Income Requirement

Under the amendments to Division 35 proposed by the Bill, an income requirement will have to be satisfied in order to be able to utilise the four tests outlined above.  Under this new test, the income requirement will be satisfied if the sum of the following (referred to as adjusted taxable income), for a taxpayer in an income year is less than $250,000:

  1. taxable income
  2. reportable fringe benefits
  3. reportable superannuation contributions
  4. total net investment losses.

If an individual has adjusted taxable income of less than $250,000 and one of the four tests is satisfied, losses from non-commercial activities may be applied against other income.  However, if adjusted taxable income is $250,000 or more, then the losses cannot be applied against other income and will be quarantined.

Commissioner's Discretion

Individuals that meet the income requirement (ie adjusted taxable income is less than $250,000) but cannot satisfy one of the four tests, continue to be able to seek the exercise of the Commissioner's discretion, as outlined above, so as to allow losses to be deducted against their other income having regard to special circumstances.

Individuals who do not meet the income requirement (ie adjusted taxable income is greater than $250,000) can nevertheless apply to the Commissioner to exercise a discretion not to apply the non-commercial loss rules if the Commissioner can be satisfied that:

  • because of its nature, the business has not produced, or will not produce, a profit, and
  • there is an objective expectation, based on evidence from independent sources that, within a period that is commercially viable for the industry concerned, the activity will produce a profit.

Example Of Exercise Of Discretion

An example of the exercise of the discretion provided in the Explanatory Memorandum to the Bill involves a taxpayer that does not meet the income requirement and who owns a vineyard valued at $750,000 that has never made a profit.  The taxpayer applies to the Commissioner to exercise discretion on the basis indicated above and provides an independent assessment that the vineyard will make a profit within seven years.  On this basis the Commissioner decides that there is an objective expectation, based on an independent assessment, that the vineyard will produce a profit in a given year that is considered commercially viable for the industry concerned.  In these circumstances the discretion is exercised favourably and the taxpayer can apply the loss against their other income.

Other examples are provided in the Explanatory Memorandum of situations where the discretion may be exercised favourably and unfavourably.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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