When it comes to business losses, taxpayers generally make a business tax loss when the total deductions they can claim for an income year exceed the total of their assessable and net exempt income for the year.
If a taxpayer’s business makes a tax loss, they may be able to carry forward the loss and claim a deduction for their business in a future year. The structure of the business can affect whether the loss is offset and claimed in the current year, or rather carried forward and claimed as a deduction in a later year.
Sole traders or individual partners in a partnership may be able to offset their business losses against other types of assessable income for the same income year. Alternatively, they may be able to defer the loss or carry it forward and offset it when they next make a profit. Taxpayers who are operating a company may (if they satisfy certain criteria) be able to carry forward a tax loss for as long as they want and choose the year in which they claim the deduction (and trusts can also potentially carry forward business losses).
A non-commercial business loss is a loss incurred from a business activity that is not related to the taxpayer’s primary source of income, either as a sole trader or as a partner in a partnership. The activity may be one that is likely to be largely unprofitable and be lacking a significant, business-like purpose or character. This type of business activity could be a hobby or lifestyle benefit.
Example: identifying a non-commercial loss
Bob is a sole trader who has a business operating machinery. His primary business income comes from helping others plough and prepare their land for growing crops.
Bob acquired a 5-acre block of land situated close to his residence with the intention that, in his spare time, he would upgrade the property from its present run-down condition and develop it into a small pumpkin farm to harvest and sell pumpkins.
The money he spent on developing the small pumpkin farm exceeded the income made from the pumpkins, as the pumpkins are not ready for sale yet. Bob has made a non-commercial loss but will need to work out if he can offset or defer the loss.
Generally, individual taxpayers cannot offset non-commercial losses, and need to defer them until they make a profit from the business activity. However, taxpayers who have been affected by flood, bushfire, or COVID-19 over the past few years may be able to offset their current year’s non-commercial loss (but not their previous year’s deferred losses) without applying for a private ruling.
For more information, refer to the Practical Compliance Guidelines 2022 on the ATO website.
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Ref: ATO website, Small Business Newsroom, 12 September 2023