If you’re an individual in business as either a sole trader or in partnership, and your business makes a loss, you may be able to offset the loss against other income such as salary and wages. This reduces the tax you would otherwise have paid, but first you must prove to the ATO that the loss is real, i.e. it’s not a non commercial loss.
To show that losses are real, you must meet an income requirement and pass one of four tests.
Eligibility
For your losses to be deductible, you first need to meet an income requirement. If you don’t meet this you cannot offset your losses regardless of whether you pass any of the four tests that follow (unless you apply for the Commissioner’s discretion).
To meet the income requirement for non-commercial loss purposes your other income must be less than $250,000.
Your other income includes:
- taxable income (ignoring any business losses)
- total reportable fringe benefits amounts (these should be shown on your payment summary from your employer)
- reportable super contributions (e.g. salary sacrificed and personal deductible super contributions)
- total net investment loss (e.g. negatively geared property or investment portfolios)
If you pass the income requirement, you must then meet one of the four tests unless either:
- you are covered by an exception to the rules
- the Commissioner exercises discretion to allow you to offset your loss against other income
The four tests
Once you meet the income requirement you must then pass one of the four tests. These are:
- The assessable income test – the business has assessable income of at least $20,000 (can be earnings or capital gains).
- The profits test – the business had a profit for tax purposes in three out of the past five years, including the current year (note that if a business makes a profit for three years running then it will pass the profits test for the next two years regardless of whether it makes a loss, since three out of five consecutive years will be profit years)
- The real property test – the value of real property or of an interest in real property that you used in the business on a continuing basis was at least $500,000. This includes land & buildings, but nothing used for private purposes. It also includes leased property.
- The other assets test – the value of assets (excluding real property, cars, motor cycles and similar vehicles) you used on a continuing basis in carrying on the business was at least $100,000. This can include leased assets.
Deferring losses
If you are not able to deduct your business activity loss in the current year because you don’t pass any of the non-commercial loss rules, you can defer your loss for use in a later year. If your business makes a profit in a following year, you can offset some or all of the deferred loss against this profit, up to the amount of your profit.
You can also claim the deferred loss against other income in a following year if during that year:
- you meet the income requirement and the business passes one of the four tests, or
- the Commissioner has exercised the discretion to allow you to claim the loss
Exceptions
If you don’t meet the income requirement but you meet one of the four tests, you can apply for the Commissioner’s discretion if either:
- special circumstances occurred that were outside your control such as drought, flood, bushfire or some other natural disaster, which prevented your business activity from producing a tax profit, or
- due to the nature of the activity, there is
- a lead time before the business will make a tax profit
- an objective expectation, based on independent evidence, that it will make a profit in a time that is considered commercially viable for that industry
Summary
- If you are a sole trader or in a partnership and your business makes a loss, you may be able to offset your business loss against other income (often wages), reducing your income in that financial year
- To be eligible, you must pass the income requirement and pass one of the four tests
- The income requirement is that your ‘other’ income must be less than $250,000
- The four tests are:
1. The assessable income test – the business has assessable income of at least $20,000
2. The profits test – the business had a profit for tax purposes in three out of the past five years, including the current year
3. The real property test – the value of real property or of an interest in real property that you used in the business was at least $500,000.
4. The other assets test – the value of ‘other’ assets you used in carrying on the business was at least $100,000. - If you are not able to deduct your business activity loss in the current year because you don’t pass any of the non-commercial loss rules, you can defer your loss for use in a later year
- If your business makes a profit in a following year, you can offset some or all of the deferred loss against this profit, up to the amount of your profit
Related blogs:
Company carry back tax losses – what are the rules?
Author: Caleb Datson
Email: caleb@faj.com.au
