Non Commercial Losses: Employment income and the Exception to Division 35

Is income from employment, income from an unrelated source when deciding whether the Exception to Division 35 in subsection 35-10(4) of the Income Tax Assessment Act 1997 (ITAA 1997) applies?

Yes. Assessable income from the taxpayer's employment is from an unrelated source for the purposes of applying subsection 35-10(4) of the ITAA 1997. The amount of the employment income is taken into account in determining whether the $40,000 threshold in subsection 35-10(4) of the ITAA 1997 is exceeded.

The taxpayer is an individual who commenced a 'professional arts business', as defined in subsection 35-10(5) of the ITAA 1997, before 1 July 2000. They expect that their otherwise allowable deductions attributable to this activity will exceed the assessable income from this activity for the income year ending 30 June 2001.

During this income year the taxpayer is employed as a lecturer in art at a tertiary institution. It is a requirement of their employment that they practise as an artist and produce and exhibit works of art. Some of these works are sold as part of the taxpayer's professional arts business.

The taxpayer's assessable income for the income year ended 30 June 2001 that is not from either their employment or their business activity, does not exceed $40,000.

Division 35 of the ITAA 1997 will apply to defer a non-commercial business loss from a business activity carried on by a taxpayer who is an individual, unless: • their business activity satisfies one of the four tests in Division 35 • the Commissioner has exercised the discretion in section 35-55 for the activity; or • the individual comes within the Exception to Division 35, contained in subsection 35-10(4).

(refer subsection 35-10(1) of the ITAA 1997)

Subsection 35-10(4) of the ITAA 1997 will apply to preclude a loss from either a primary production business activity or a professional arts business activity being deferred if the taxpayer's total assessable income (excluding any net capital gain) 'from other sources that do not relate to that activity is less than $40,000' (paragraph 35-10(4)(b) of the ITAA 1997).

The taxpayer therefore will be able to exclude employment income from the $40,000 threshold in subsection 35-10(4) of the ITAA 1997 only if their employment income is from a source that does 'relate to' their professional arts business.

Whether a source of income is 'related to' a source of assessable income that is a business activity, is a matter of overall impression. The width of the association or connection called for between the two will depend on the purpose and context of the provision in question (see Tooheys Ltd v. Commissioner of Stamp Duties (NSW) (1961) 105 CLR 602).

The purpose and context of subsection 35-10(4) of the ITAA 1997 does not suggest that any indirect or less than substantial connection between the two will be sufficient. Rather, they point to the relationship between the business activity and the source of the other income needing to be more than a remote one (see Secretary, Department of Foreign Affairs and Trade v. Boswell (1992) 36 FCR 367), in order for the source of the other income to be considered as a source that is 'related to' the business activity.

In this case, the taxpayer's employment is not sufficiently related, as a source of assessable income, to their professional arts business, for the employment income to be excluded from the $40,000 threshold in subsection 35-10(4) of the ITAA 1997. There is some relationship between the two, as borne out by the taxpayer's art production contributing to their ability to lecture on various topics. However, in certain key ways, the two are only indirectly, and less than substantially related, as: • different types of contract are used in the production of the assessable income from the two different sources, with different terms and conditions • different assets are used in producing the different types of assessable income • the nature of the income, (that is, on the one hand, salary or wages produced under a contract of service, compared to on the other, business income from the sale of art produced under contracts for the sale of goods), from the two sources is completely different; and • the level of risk attaching to whether income will be derived from either source is totally unrelated.

As a matter of overall impression therefore, the assessable income from the taxpayer's employment is from 'other sources not related to' their professional arts business. The amount of the employment income is taken into account in determining whether the $40,000 threshold in subsection 35-10(4) of the ITAA 1997 is exceeded.