Non-commercial losses under Division 35

Division 35 of the Income Tax Assessment Act 1997 stops an individual from using a loss from a business activity to reduce their other income, such as salary or investment income, unless the activity meets set conditions. The rules apply to individuals in business as sole traders and to individuals in partnerships, including a partnership that has a company or trust as a partner (s 35-10(1)). They do not apply to companies or trusts carrying on the business themselves. If the conditions are not met, the loss is not lost. It is deferred and carried forward (s 35-10(2)).

The ATO describes a non-commercial loss simply: a side business or activity that costs more than it makes. In practice the rules come up with hobby farms, small creative businesses, side consulting work, and start-ups run alongside a salary. This guide sets out the sequence, the numbers and the evidence. Figures were checked against ATO guidance and Division 35 of the Income Tax Assessment Act 1997 (compilation of 27 August 2026) on 18 October 2026.

The sequence

1. Is the activity a business? If not, Division 35 is not the question. The activity's expenses are generally not deductible as business losses at all.
2. Is it a primary production or professional arts business with other assessable income under $40,000? If yes, the loss can be offset.
3. Is the income requirement met (under $250,000)? If no, defer the loss unless the Commissioner's discretion applies.
4. Is one of the four tests passed? If yes, offset the loss. If no, defer unless the Commissioner's discretion applies.

Step 1: is it a business

The activity must be a business before a loss can be claimed or the Commissioner's discretion sought. The ATO generally treats a business as started once the person has decided to start it, acquired the minimum assets needed, and begun business activities. Similar activities can be grouped and tested together. Dissimilar activities are tested separately, so a person with a cattle operation and a photography business tests each one on its own.

Step 2: the primary production and professional arts exception

If the loss comes from a primary production business or a professional arts business, and the person's assessable income from other sources (excluding any net capital gain) is less than $40,000, the loss can be offset against other income (s 35-10(4)). The income requirement and four tests do not need to be considered.

• Primary production includes plant and animal cultivation, fishing and pearling, and tree farming and felling.
• Professional arts means carrying on business as an author (for example a novelist, artist, sculptor, architect, composer or photographer), a performing artist, or a production associate providing artistic support (such as a director, choreographer, film editor or lighting designer). Technical roles such as camera operators and stagehands do not qualify.

The ATO notes that running a gallery is unlikely to count unless the person creates and sells their own work, and that direct sellers are not performing artists.

Example. Mia is a ceramic artist in her second year of business. She makes a $9,000 loss from her art. Her only other income is $32,000 of part-time wages. Her other assessable income is under $40,000, so she can offset the $9,000 loss against her wages.

Step 3: the income requirement

The income requirement is met if the total of four amounts is less than $250,000 (s 35-10(2E)):

The business loss itself is ignored. That is the point of the test: it looks at the person's income from everything else.

Worked example (based on the ATO's). Joe has a $150,000 salary, a $10,000 net loss on his share portfolio, and a rental property with $25,000 income and $10,000 deductions. His taxable income is $155,000. Adding back the $10,000 net investment loss gives $165,000 for the income requirement. That is under $250,000, so he moves on to the four tests.

Second example. Priya earns $205,000 in salary, salary sacrifices $25,000 into super, has reportable fringe benefits of $12,000 and a $15,000 net rental loss. She runs a weekend design business that lost $8,000. Her taxable income after the rental loss and before the business loss is $165,000 ($205,000 less $25,000 salary sacrifice less $15,000 rental loss). Add $12,000 fringe benefits, $25,000 reportable super and $15,000 net investment loss. The total is $217,000, under $250,000. If her taxable income were $40,000 higher, she would fail the income requirement and the $8,000 would be deferred regardless of the four tests, unless the Commissioner's discretion applied.

Step 4: the four tests

A person who meets the income requirement needs to pass only one test.

Continuing basis matters for the two asset tests. Short-term use, one-off tasks and arrangements for intermittent use (hourly, daily, weekly or monthly hire) do not count.

Estimating a part year. There is no formula. The ATO points to orders received, forward contracts, business size, money invested, industry income patterns, pro-rata annualisation and seasonal trends. An estimate that was reasonable when made stays reasonable even if it turns out wrong.

Example. Tom started a mobile coffee van on 1 February 2026 alongside his job. By 30 June he had $9,500 of sales and a $6,000 loss after setting up. His sales were growing each month and he had a weekly market contract booked through to December. An annualised estimate of $22,800 is reasonable on those facts, so he passes the assessable income test for 2025-26. The van and fit-out cost $68,000, so the other assets test would not help him on value alone. That test also excludes cars, motorcycles and similar vehicles (s 35-45(4)).

Partnerships

The income requirement applies to each individual partner, in the same way as for a sole trader. Three of the four tests are applied at partnership level, where the other partners are individuals:

• Assessable income: the partnership's assessable income must be at least $20,000. Income of company or trust partners is excluded. A partner may add income from their own interest in the same business held outside the partnership, for their own test only.
• Real property and other assets: measured across the partnership business, excluding property of company or trust partners and property owned by individual partners in their own right. A partner may include property they own outside the partnership that the business uses on a continuing basis.
• Profits: tested for each partner, using their income and deductions from the activity, both through the partnership and in their own right. Partners can get different answers.

The ATO's guidance on partnerships refers to TR 2003/3.

The Commissioner's discretion

If a person fails the income requirement, or meets it but fails all four tests, they can apply for the Commissioner's discretion under s 35-55. It is exercised only in limited cases. There are two grounds. The application must be in the approved form (s 35-55(3)).

Special circumstances

Special circumstances outside the person's control stopped the activity from passing a test or making a tax profit. The ATO lists drought, flood, bushfire, cyclones, hailstorms and tsunamis. Other events, such as oil spills, chemical spray drift, government restrictions or illness of key personnel, may qualify on the facts. Ordinary market price movements do not. Buying a poorly run business is generally within the person's control.

The ground is not limited to people who meet the income requirement. A person over $250,000 can still apply if the business is commercial and was prevented from making a tax profit by events outside their control. The ATO's example is a cattle breeder with $300,000 of other income and a long profitable history, hit by drought, for whom the discretion was exercised.

Lead time

The activity is commercially viable but, because of its nature, there is a lead time before it can pass a test or make a profit. The Commissioner must be satisfied there is an objective expectation, based on independent evidence where available, that within a commercially viable period for the industry the activity will pass a test or make a tax profit (or, if the income requirement is not met, make a tax profit).

The ATO's examples include forestry, viticulture and other horticulture. The ground is not available where the delay comes from starting small, building a client base, or choices that depart from industry practice on hours, location, soil, climate or debt. In one ATO example, a red fruit grower planted far fewer bushes than industry advice recommended, and the discretion was refused.

Independent evidence can come from industry or regulatory bodies, universities, industry specialists, trade associations, government agencies, comparable businesses, advisers and banks.

When and how to apply

• Apply through a private ruling, using the private ruling form for non-commercial losses with the evidentiary checklist attached.
• For special circumstances, apply as soon as possible after the event. The ATO accepts applications within the normal amendment period for the year.
• For lead time, apply for the first year in which the person has excess deductions they want to offset.
• If it later becomes clear an application could have been made, it can still be made, and if granted the person can seek an amendment within the normal amendment period.
• The ATO decides case by case and may extend a decision to future years. Where the discretion has been exercised within a product ruling, it applies for the life of that ruling.

The ATO's guidance on the discretion refers to TR 2007/6 and TR 2001/14.

How the ATO examples play out

The ATO's discretion pages include a set of examples that show where the line sits.

Two practical lessons come out of these. First, the discretion rewards a business that would be commercial but for something outside its owner's control, or something built into the industry. It does not rescue an activity that is small by choice. Second, evidence decides the outcome. A vineyard with an independent assessment and industry data got the discretion. A grower whose own plan did not match industry practice did not.

What to collect before applying

For special circumstances, the ATO asks for evidence of the event, why it is special, whether it was the main reason the activity failed a test, whether it was outside the person's control, prior-year test results and expected future effects. For lead time, collect the average time the industry takes to reach commercial operation, the business plan, and independent support for the projected year of profit or of passing a test. Keep it in the client file whether or not the application is approved, because the same evidence carries into later years.

Deferral mechanics

A deferred loss is not offset against other income in the year it arises. It is carried forward with no time limit.

• In a later year when the activity makes a profit, the deferred loss can be applied against that profit, up to the amount of the profit.
• In a later year when the person meets the income requirement and passes a test, or the discretion is exercised, the deferred loss can be offset against other income.
• Net exempt income first reduces other tax losses. Any exempt income left over then reduces the deferred non-commercial loss (s 35-15). Any balance is deferred again.
• Bankruptcy, or release from debts under a bankruptcy law, cancels deferred amounts not yet deducted (s 35-20).

ATO example. Michael's plumbing activity has $15,000 of assessable income and $20,000 of deductions, a $5,000 loss that must be deferred. He has $3,000 of net exempt income. The deferred amount carried forward is $2,000, which he can apply against future income from the activity.

Worked example over three years

Helen, a salaried engineer with income of about $140,000, runs an alpaca breeding activity that is a business. Primary production, but her other income is over $40,000, so the exception does not help.

If in 2026-27 Helen's assessable income from the activity reaches $20,000 and the activity makes another loss, she can offset that loss, and the $14,000 deferred balance, against her salary, provided she still meets the income requirement.

Decision checklist

For the wider return file, see the tax return checklist.