Individuals operating a business, as either a sole trader or in partnership, where the business makes a loss, may be able to offset the loss against their other income such as salary and wages. Businesses in start-up phase often operate at a loss for several years with the sole trader supporting the business with their other income – normally their salary income. Deducting the business losses from the salary income normally results in large annual tax refunds.
Sole traders and partnerships that are operating a business at a loss will only be able to offset that loss against other income when they pass the income requirement and one of the four non-commercial loss tests. To meet the income requirement the taxpayer’s income must be less than $250,000. The income is calculated as the taxable income (ignoring any business losses), total reportable fringe benefits amounts, reportable superannuation contributions, and total net investment losses.
The four non-commercial loss tests are:
- The profit test: Requires a business profit in three of the last five years including the current year.
- The assessable income test: Requires a minimum $20,000 revenue or sales pa from the business.
- The real property test: Requires real property used in the business of more than $500,000.
- The other asset test: Requires depreciable assets (excluding cars) of $100,000 used in the business.
As an exception, the non-commercial loss rules do not apply to primary production or professional arts businesses if the taxpayers other income is less than $40,000. In addition, taxpayers that don’t pass any of the four tests can apply to the ATO and request the Commissioner’s discretion.