ATO Rules on Non-Commercial Losses for Small Businesses in Australia blog image

Podcast: ATO Rules on Non-Commercial Losses for Small Businesses in Australia

Facebook Twitter LinkedIn Mail Us

E: Hello Everyone, welcome to our latest video. My name’s Ed Chan, I’m the founder and non-executive chairman of Chan & Naylor. Chan & Naylor’s an accounting firm and we’ve got offices in most states around Australia and we do things like prepare tax returns, financial accounts and structuring, setting up structures and financial planning and finance. Today’s topic is going to be around non-commercial loss provisions. I’ve got Janelle Bartlett here joining us and I’d like to welcome Janelle. Hi Janelle! How are you?

J: Hello Ed. Very well, thanks. Thanks for having me.

E: Thanks for being with us. Just give us a little bit of your background so that the listeners know where you’re from and how you fit in to the family.

J: Yes so my name is Janelle Bartlett and I’m the managing partner at Chan & Naylor Brisbane office. We have two locations in Brisbane and I’m a happy member of Chan & Naylor. Our practice looks after mostly businesses and quite a few investors so obviously our investor clients but we do have a lot of businesses that also have investments so I know a reasonable amount about these business provisions.

E: Yes hence the topic today. Because often someone who’s on a salary and often that’s how small businesses start off, someone that has a full time job and they start off a small business on the side and in the old days if you made a loss in that business – a lot of small businesses do that – cause you’re investing a lot of money into the business without an equal amount of income coming the other way so you create a bit of a loss and in the old days you can simply offset those losses against your wages but the new non-commercial loss provisions came in and actually stopped that. On that point Janelle could you just explain what are non-commercial loss provisions and how they apply to individuals or to businesses.

J: Basically they apply to individuals and partnerships, they don’t apply to companies or trusts. They’re completely irrelevant if you’re operating a company or trust or business through a company or trust. They, in certain circumstances, prevent the taxpayer from claiming those losses against their other income. So it’s unlike negative gearing. So negative gearing if you think of the property investment, with negative gearing there are particular provisions that allow the taxpayer to claim that loss so for example a taxpayer with $80,000 of income from a salary and a $20,000 negative gearing loss might expect to get a refund or a reduced tax bill of around $6,000 but if that same taxpayer has $80,000 in salary and $20,000 loss from a business as an individual sole trader, they may not be able to use that and they have to carry forward the loss and they don’t get to claim the extra tax refund.

E: Ok so if you were making a loss on a rental property you can offset those losses against your wages but if you’re making losses in a small business, you can’t offset those losses against your wages.

J: Generally speaking, the rules sort of tell you when you can or when you can’t but the rules are quite involved as we’re about to go through.

E: Why were these rules introduced?

J: Well, it’s basically to get to the Pitt St Farmer, that’s in Sydney,  in Brisbane we call them the Queen St. Farmer and I think in Melbourne they call them the Druite Framer. So the high income earner that has a farm in the blue mountains or the hinterland in the Gold Coast who takes their family there and tries to sort of say that that’s a business so it’s really aimed to stop that. The ATO had tried a number of measures those people from claiming these hobby farms really and they’re all unsuccessful so they wrote these really specific provisions. What has of course happened is it’s not only caught those Queen St. Farmers it’s caught a lot of genuine small businesses so it’s really been quite nasty for some of them.

E: Yes I was gonna say that I can understand the Queen St. Farmer and so forth but there are a lot of legitimate businesses and often that’s how they start and their losses are funded by the individual’s wages so it’s a legitimate way of starting a small business in fact that’s how I started and you know I was working for somebody else and then I was doing work on the side and sort of grew until I gave up my full time job continued on with the Chan & Naylor business. So it is a legitimate form. So when can you claim these losses? Because as we just said there are lots of legitimate businesses that do make losses in the beginning.

J: Yes, look the ATO rules are just broad, sweeping so it catches everyone.  There’s basically three rules that you must pass first and then there’s other rules you can pass through one of four.

So the first three are individual’s income from other sources other than the business must be under $20,000 so that’s really hard to pass. It’s $40,000 if the individual is operating an arts business like a musician or writer or proper production too. So the bar is still at $40,000 for those people which is still very low but $20,000 is very difficult, it’s really if you have a very small part time job or small investment income then you’ll be able to take that.

You’ll also have to make the second rule which is it only applies to similar businesses so there are all sorts of rules about determining what is a similar business. You can’t lump two businesses together that are not similar. So for example Bill might have a marketing company where he provides Facebook marketing to his clients. Now he might start another business where he offers a different type of marketing maybe pay-per-click marketing. Now the ATO would say yes these are similar businesses they can be offset. But if Bill goes and opens and online shoe shop, the ATO would say that’s not similar so the shoe shop makes a loss and the marketing company makes a profit, you can’t offset those. But if the Facebook marketing business makes a loss and the pay-per-click business makes a profit, you can offset those.

And the third rule which also has to be met is the individual’s income must be under $250,000.

So if the individual can meet those 3 rules, the taxpayer can move on to meet one of four other rules. So, it’s pretty difficult to meet those first three rules so to have your income under $250,000, the income from other sources under $20,000 or $40,000 depending on your industry and make sure you have similar businesses being linked together, not dissimilar businesses. So mainly the big problem there is the income under $20,000, most people can’t meet that.

So if they do meet that, then we can pass one of four additional tests.

If the accessible income of the business that you’re trying to offset is at least $20,000, you can offset your loss.

If you’ve made profits in 3 of the last 5 years, that’s a tick and you can offset your losses.

Or if you’re using real business property that’s valued at more than $500,000 so if you’ve got a separate factory or a separate office and it’s valued at $500,000.

Now interestingly, you don’t need to own that. You can lease it but it can’t be associated with your house so you can’t live in a $2 million house and say that the shed out the side is worth $500,000. It’s got to be business premises but you can lease it and it has to be a long term lease it can’t be “I’ve leased it for a month”.

Or the other one, the fourth of the four is that assets over $100,000. So you might have equipment like earth moving equipment for example is very expensive and that would take you across that particular threshold but the $100,000  item cannot be a motor vehicle. Of course earth-moving equipment is not a motor vehicle nor is a truck but it can’t be something like a car, a Porsche, can’t be something like that.

So basically the first three rules, you must meet all of those and then those last four, you can meet one of it, any one of them.

So one out of the four. So just to summarize what you said with the four. If your income from your small business is at least $20,000 turnover so I guess that cuts out a lot of hobby businesses, that’s what they’re trying to eliminate. So as soon as your income from that small business is over $20,000, even if you made a loss, you can offset those losses against your wages. And then the other one is if you’ve had three years of consecutive profits that’s basically saying that it’s a legitimate business, you’re now starting to make profits and it’s not just a loss-making scheme to try and get some tax benefits.

J: It could actually be 3 in 5 years. So it doesn’t have to be consecutive. It’s three in the last five years.

E: The last five years, okay that’s another one. And of course if you’ve got a property, that’s another one that you’ve explained and the last one was if you have some equipment so obviously if you had equipment of $100,000 it’s a fair bit of business and you’ve invested quite a bit of equipment into it. And if you do make a loss in that situation then you can offset those losses because they can see that you invested a significant amount of money into it. So that’s pretty clear. Lastly, Janelle, what recommendations would you have for your clients if they came along and they said I want to do this, what would you recommend.

J: Well, basically the main thing is to make sure you have enough working capital to start a business, that’s the thing we see the most is just that people starting businesses don’t start with enough working capital so then you need to have a business plan and enough working capital to get started to get past all of these rules but the good news is that losses carry forward indefinitely so if you do make a loss so you might make a loss for 2-3 years eventually if you make a profit in year 4, you can use those losses so they never die, they’re always there. And if you do have a number of businesses and you know one is making money and the other’s making a loss, you really should be operating as a company or a trust. In those cases, none of these rules apply, you can have your marketing company and your shoe shop online in the same company and you can offset those losses.

E: Okay, alright. I guess it’s mainly aimed at people running hobby farms or hobbies that are not legitimate businesses and they’re getting good decent refunds from the ATO and what the ATO is saying is that if you are a legitimate business and if you are making losses, yes you can carry forward those losses, you won’t lose them, you just can’t claim them against your other income from your wages. And until you’ve become profitable then you can carry forward those losses and you can use them up in some period in time in the future so that keeps everything legitimate and the ATO’s happy and everybody stays in the right side of the law.

J: That’s right. I guess there’s one other little thing and that is the startup provisions, new provisions. So I guess these non-commercial loss provisions have been around for quite a while now. I don’t know maybe 10 years?  Quite a long time I think. But there’s now a startup rules where a taxpayer can claim the cost of certain startup costs like accountant’s advice, legal advice, setting up your company, those sorts of things and that’s something that might have been lost into these loss provisions in the past.

E: Right, okay so I guess the general advice is go to your accountant, hopefully it’s a Chan & Naylor accountant to get some advice before you actually start out and so make sure that you’re setting everything up correctly rather than trying to fix things up later on.

J: Exactly right. That’s very good advice.

E: Well thank you very much, Janelle and that’s been very very helpful and hopefully our listeners or viewers sort of got something out of it so until next time, thanks again. See you later everyone. See you Janelle.

J: Thank you Ed, thanks very much.

If you liked this podcast, “ATO Rules on Non-Commercial Losses for Small Businesses in Australia, subscribe to our newsletter and stay in touch with us on our main Facebook page, as well as our Linkedin, Instagram, and Twitter pages.

The Chan & Naylor Group has national offices in North Sydney, South West Sydney, Sydney, Pymble and Parramatta in New South Wales, Melbourne, Moonee Ponds and Hawthorn in Victoria, Brisbane and Capalaba in Queensland, and East Perth in Western Australia that will be glad to provide you with expert superannuation advice. Contact us today.

2 responses to “Podcast: ATO Rules on Non-Commercial Losses for Small Businesses in Australia”

  1. Shruthi says:

    Thank you for this. Indeed useful.

Leave a Reply

Your email address will not be published. Required fields are marked *

Join our mailing list today!

Keep up to date with our latest news & updates!