Not all businesses are a huge hit straight away; it’s common for losses to occur, particularly in the early years. If you operate your business as an individual or a partnership, you can apply the non-commercial loss rules to determine whether you’re eligible to offset your business loss against income from other sources (salary, interest, dividends, etc.) to minimise your tax bill.
How does non-commercial loss work?
In any year that your business makes a net loss you must work out whether you can claim the loss in the current year on your tax return or whether it should be deferred and offset against future profits.
This legislation originally came about as an effort to stop ‘Pitt Street farmers’ (Sydney CBD’s main street) from using their farms mainly as holiday homes and then claiming massive losses on them against income from their salary, wages and other sources.
The ATO requires you to meet one of the following criteria if you wish to offset your business loss against other assessable income:
- you run a primary production or professional arts business and certain exceptions apply
- you earn less than $250,000 and pass one of the four non-commercial losses tests (see below)
- the Commissioner of Taxation allows the claim at their discretion (don’t count on this)
The four non-commercial losses rules mean taxpayers may only offset business losses against other sources of assessable income if they meet at least one of the following criteria:
- the business generates at least $20,000 of assessable income (assessable income test)
- the business has recorded a profit for at least three out of the past five years (profits test)
- the business has property or an interest in real property worth at least $500,000 on a continuing basis (real property test)
- the business has other assets of at least $100,000 being used on a continuing basis (other assets test)
Basically, the ATO wants to see that you are operating a genuine business and don’t have another substantial source of income.
The $250,000 threshold is calculated as your taxable income minus investment losses plus any reportable fringe benefits and superannuation contributions. If you exceed this threshold, the ATO will not allow any claim for business losses, even if you satisfy the other criteria.
- If you record a business loss in any given tax year and you operate as an individual or a partnership, you may be able to offset your business loss against income from other assessable sources
- The non-commercial loss rules are in place to stop individuals from setting up a ‘business’ that operates at a loss just to minimise their taxes elsewhere
- Unless you run a primary production or professional arts business you will only be eligible if you earn under $250,000 and satisfy at least one of the four non-commercial losses rules