Losses that are incurred as a sole trader or as a partner in a business are defined as “non-commercial losses”. Depending on certain satisfied critera, taxpayers can potentially benefit from non-commercial losses. These losses can be offset against other income, including salary and wages, in order to effectively reducing total taxable income.
We’ll proceed to break down the requirements and testing process involved with incorporating non-commercial losses into your tax strategy.
Hobbies Versus Businesses
It’s important to note that not all activities that generate income can be defined as business activities for tax purposes. Only losses from business activities can be used as part of a strategy that offsets non-commercial losses — losses incurred from engaging with hobby activities are disregarded.
- The line between business and hobby activity is subjective in nature. If your activities meet the following requirements, however, you’re probably operating a business:
- You operate in a business-like manner
- Your activities are structured in a manner that resembles a business
- Your activities are conducted with the intent of generating income
- You are able to demonstrate business activities, scale, and size comparable with other businesses in the same industry
- Your activities are repetitive and planned in a business-like manner
Income Tests and Objective Tests
Non-commercial losses can only be offset if an individual passes an income test and one of 4 objective tests.
An individual must have an adjusted tax income of less than $250,000 in order to pass the income requirement. Adjusted tax income is calculated as the sum of all taxable income excluding business losses and includes reported superannuation contributions, reportable fringe benefits, net investment losses, and child support if applicable.
Businesses must meet one of the following 4 requirements in order to offset non-commercial losses:
- The business must generate an assessable income of over $20,000
- The business must generate a tax profit in at least 3 of the past 5 years, including the current year.
- The business must have property defined as “real property” in order to carry out business activities. This real property must hold a value over $500,000. The definition of real property includes land and structures fixed to land such as buildings. Real property also includes interests in a property such as a lease. Assets or dwellings used for private purposes on a short term basis can not be used to meet this requirement
- The business must use other assets valued over $100,000 to execute business activities. “Other” assets can include trading stock, plants, equipment, leased assets, patents, copyrights, and trademarks. Motor vehicles are exempt from this test.
Individuals that engage in professional arts businesses or primary production activities are exempt from the above tests. In order to be exempted from objective and income testing, individuals that meet this requirement must earn an income of $40,000 or less.
You will not be able to offset your losses against other income if you do not pass the above tests. If you fail the above tests your losses will be deferred to future years.
Commissioner Discretion Requests
Individuals may submit a commissioner discretion request in the case that they fail the tests for non-commercial losses. The commissioner may use their discretion to allow for the offset of losses in specific circumstances. Commissioner discretion requests are typically applicable in situations where losses can be attributed to factors such as natural disasters, flooding, drought, or other uncontrollable events.
The commissioner may grant a discretion request if an individual is able to demonstrate that a business activity is capable of generating a tax profit while satisfying one of the objective tests within a suitable time period.
If you’re planning on offsetting taxable income with non-commercial losses, it’s important to ensure that you meet the criteria. To find out whether you meet non-commercial loss offset requirements, get in touch with Fullstack for a consultation today.