Edited version of your private ruling

Authorisation Number: 1012437602738

Ruling

Subject: Am I in Business

Question 1:

Are you carrying on a business of developing and producing a computer application?

Answer:

No.

Question 2:

Are you entitled to a deduction for video games used during your period of employment as a tutor?

Answer:

Yes.

Question 3:

Are you entitled to a deduction for the decline in value on video games?

Answer:

No.

Question 4:

Are you entitled to a deduction for video games while undertaking a project?

Answer:

Yes.

Question 5:

Are you entitled to a deduction for the decline in value of audio equipment?

Answer:

Yes.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts

You hold a degree from an education facility.

You had undertaken research into developing a computer application (App).

Currently the app is in the research and design phase.

Your intention is to make a profit from the activity.

You commenced the activity a few years ago.

You have prepared a budget but do not know the expected income figures from the sale of the app.

Your have a business plan.

You do not have sufficient time to undertake the activity full-time as you have other income producing activities to attend to.

You undertake the activity at home.

You have kept records for the expenditure in relation to the activity.

You do not advertise this activity.

You have purchased a number of assets to undertake the activity.

You have not received any income for this activity to date.

You do not have a registered business name.

You do not intend to employ anyone in relation to this activity.

You were engaged as a consultant. You carried out a number of duties as a consultant to complete a project. You provided your own audio equipment. You purchased a number of video games. You used the video games as part of a project as a consultant. The company provided some equipment to assist with the project.

You were also engaged with an education facility as a tutor. You purchased some computer games to assist in carrying your teaching duties.

Relevant legislative provisions:

Income Tax Assessment Act 1997 subsection 6-5(1).

Income Tax Assessment Act 1997 section 8-1.

Income Tax Assessment Act 1997 section 40-25

Income Tax Assessment Act 1997 subsection 40-25(7)

Income Tax Assessment Act 1997 subsection 40-95(7)

Reasons for decision

Carrying on a business

There is no single test used to determine whether activities undertaken amount to the carrying on of a business. The facts of each case must be examined and any determination based on the large or general impression gained (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548). 

However, the courts have developed a series of indicators that you can apply to your circumstances to determine whether you are carrying on a business. Taxation Rulings TR 97/11 and TR 2005/1 provide the indicators established by the courts that would need to be considered when determining whether a business is being carried on. It should be noted that TR 97/11 and TR 2005/1 specifically deal with carrying on a business of primary production and carrying on a business as a professional artist, respectively, but the indicators established can be equally applied to most other activities. 

The list of indicators discussed in these rulings includes, but are not limited to:

· whether the activity has a significant commercial purpose or character

· whether the taxpayer has more than just an intention to engage in business

· whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

· whether there is regularity and repetition of the activity

· whether the activity is of the same kind, and carried on in a similar manner, to that of ordinary trade in that line of business

· whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

· the size, scale and permanency of the activity, and

· whether the activity is better described as a hobby, a form of recreation or sporting activity.

No one indicator is decisive. All indicators should be considered in combination and as a whole. Generally, whether a business is carried on depends on the large or general impression given.

Applying the indicators to your circumstances

Does the activity have significant commercial purpose?

The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators.

A way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business and to consider any knowledge, previous experience or skill of the taxpayer in the activity and/or any advice taken by the taxpayer in the conduct of the business.

In your case, you hold a degree and your activity is in the research and design phase. The app is not currently available for sale.

Intention of the taxpayer 

The intention of the taxpayer in engaging in the activity is a relevant indicator; however, a mere intention to carry on a business is not enough. There must be activity. The extent of activity determines whether a business is being carried on. It is a question of fact and degree, as stated by Brennan J in Inglis v. Federal Commissioner of Taxation 80 ATC 4001 at 4004-4005; (1979) 10 ATR 493 at 496-497 (Inglis Case). 

This indicator is particularly related to: 

· whether the activity is preparatory or preliminary to the ultimate activity

· whether there is an intention to make a profit, and

· whether the activity is better described as a hobby or the pursuit of a recreational or sporting activity.

Your intention is to engage in a business activity and to make a profit for this activity. However, at the present time your activity is in the research and design phase.

Do you have a purpose of profit as well as a prospect of profits?

It is important that the taxpayer is able to show how the activity can make a profit. Stronger evidence of an intention to make a profit occurs when the taxpayer has conducted research into his/her proposed activity, consulted experts or received advice on the running of the activity and the profitability of it before setting up the business. This was the situation in Federal Commissioner of Taxation v. JR Walker 85 ATC 4179; (1985) 16 ATR 331. However, it is not necessary for the activities to make a profit in every year of income in order to classify the activities as a business. Thus, a taxpayer may be carrying on a business even though he/she is making a small profit or a loss in any given year of income.

You have prepared a budget and your intention is to make a profit from the activity. Currently no sale activity has been undertaken.

Is there repetition and regularity of activities?

It is often a feature of a business that similar sorts of activities are repeated on a regular basis. The repetition of activities by the same person over a period of time on a regular basis helps to determine whether there is the carrying on of a business. The taxpayer should undertake at least the minimum activities necessary to maintain a commercial quantity and quality of product for sale.

You are currently developing one application for sale to the general public. At present no sales activity has been undertaken. Given these facts the level of your activity is small.

Is the activity of the same kind and carried on in a similar manner as other business in that trade? 

It is relevant whether the manner of operation is consistent with industry norms or with businesses in the same field. An activity is more likely to be a business when it is carried on in a manner similar to that in which other participants in the same industry carry on their activities. Lord Clyde in IR Commissioners v. Livingston at TC 542 said that:

... the test, which must be used to determine whether a venture ... is, or is not, "in the nature of trade", is whether the operations involved in it are of the same kind, and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made.

As discussed above, you are currently developing one application for sale to the general public. While you have undertaken activities such as the development of the app and research into the marketing of the app, your activity is currently still in the research and design phase as no sales activity has been undertaken.

Are the activities carried on in a business like manner?

For example, this may be indicated by:

· business records and books of accounts

· business premises

· licences or qualifications, and

· a registered business name.

Having a registered business name is not compulsory for tax purposes; having a business name does not necessarily mean you are in business. 

You have kept business records in relation to the activity and hold a degree. However, you have no registered business name or ABN and you undertake this activity at home.

The size and scale and permanency of the activities

This factor, of itself, is not decisive. According to TR 97/11 the larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business. However, this is not always the case. A taxpayer can carry on business in a small way: Thomas v FC of T 72 ATC 4094; Ferguson v Federal Commissioner of Taxation 79 ATC 4261. However, as was said by Brennan J in Inglis Case at 4005: 'At the end of the day, the extent of the activity determines whether the business is being carried on.'

Your activity is currently in the development and design phase. The activity is carried out on a small scale. You expect to spend a number of hours per week on the activity. However, you do not have sufficient time to undertake the project full time due to other work commitments.

Is the activity better described as hobby, recreational or sporting pursuit?

The activity could be better described as a hobby or pastime which has arisen out of a keen interest in computer applications.

Conclusion

Whether a business is carried on depends on the large or general impression given and the facts of each case. In your case, there are some elements of your activity that add weight that the activity has a business-like nature such as you have engaged in the activity with the intention of making a profit, undertaken research and sought advice, prepared a business plan and retained business records in relation to the activity. However, there are detracting features which outweigh any positive elements of you carrying on a business such as the activity is currently in the research and design phase, there in no repetition and regularity of your activity as you have yet to produce a an app. In addition, the level of your activity is small and has decreased due to other work commitments.

While you have considered the costs and the expected return on the sale of the application, currently no sales have been undertaken.

After weighing up the relative business indicators and objective facts surrounding the development of the app it is considered that you are not carrying on a business. Therefore any expenses that may be incurred in relation to this activity will not be deductible until you derive assessable income for the sale of the app.

Note: If in the future you develop and sell the app to derive assessable income, a deduction for the cost of developing the app is available under Division 40 of the ITAA 1997 as the creation of the software application is considered an item of intellectual property that is copyright (subsection 40-95(7) of the ITAA 1997). A deduction for the capital expenses incurred in developing the copyright is based on an effective life of 25 years. In working out the cost of developing the app you may include the expenses to develop the app as part of the first element of the cost base of that copyright.

Deductibility of expenses

Under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) you can deduct expenses incurred in gaining or producing your assessable income, or expenses you necessarily incur in carrying on a business for the purpose of gaining or producing your assessable income.

You cannot deduct an expense under section 8-1 of the ITAA 1997 if it is of a capital, private or domestic nature.

You also cannot claim a deduction if the expense is incurred in producing exempt income or a provision of the tax law prevents you from claiming a deduction.

Connection with the income of the taxpayer

To be deductible under section 8-1 of the ITAA 1997, a loss or outgoing must have a sufficient connection with the derivation of the taxpayer's assessable income.

The expense must be incurred in gaining or producing the taxpayer's assessable income.

The sufficiency of the connection is determined on the facts of the case.

Apportionment of deductible expenses

Expenses may have to be apportioned into deductible and non-deductible parts. The inclusion of the words 'to the extent' in section 8-1 of the ITAA 1997 implies that the apportionment of expenses is contemplated.

Process

The general requirement when apportioning expenditure is to assign a percentage to represent the deductible part of a composite expenditure. There is no universally accepted formula that can be applied. As long as apportionment is reasonable in the circumstances and there is some proof of its determination.

Capital versus revenue expense

Capital expenses cannot be claimed under section 8-1 of the ITAA 1997.

An expense will usually be capital in nature where it is incurred with the intention to create an asset or advantage of a lasting and enduring nature (British Insulated & Helsby Cables Ltd v. Atherton (1926) AC 205; (1926) 10 TC 155).

Capital expenditure often produces an enduring benefit, that is, the structure of the advantage or asset.

Revenue expenditure is often repetitious or recurring in nature and often does not produce assets or advantages of an enduring nature.

For a deduction to be allowable, an expense must be actually incurred, meet the deductibility tests and satisfy the substantiation rules.

Generally the deductibility of the videos, DVDs and computer games are considered under section 8-1 of the ITAA 1997.

In the case of audio equipment these items are considered item of a capital nature that is items of plant and equipment and their deductibility is considered under Division 40 of the ITAA 1997.

Decline in value

Division 40 of the ITAA 1997 deals with deductions for the cost of depreciating assets. Section 40-25 of the ITAA 1997 allows a taxpayer to deduct an amount equal to the decline in value of a depreciating asset which is held for any time during an income year and used for a taxable purpose. A taxable purpose includes the purpose of producing assessable income [subsection 40-25(7) of the ITAA 1997].

If equipment is used partly for work-related purposes and partly for other purposes, then the depreciation should be apportioned based on an estimate of the percentage of work-related use. You cannot claim a deduction if the equipment is supplied by your employer or any other person. However, where an employer gives you the item to keep you can claim a deduction for depreciation. Generally, the amount of your deduction depends on the effective life of the equipment.

The effective life of the asset is used in determining the amount of the deduction allowed for the decline in the value of the asset. You calculate this deduction using either the prime cost method (where the deduction is the same every year until it is written off or disposed of) or the diminishing value method (where the deduction is larger in the earlier years but reduces over the life of the asset).

Immediate deduction for items costing $300 or less

Subsection 40-80(2) of the ITAA 1997 allows an immediate deduction equal to the cost of an asset in the first year where the asset cost is $300 (AUS) or less and the asset is used predominantly for the purpose of producing assessable income.

To claim an immediate deduction you must use the depreciating asset more that 50% of the time to produce your assessable income. For immediate deduction of items costing less than $300 please refer to pages 9 to11 of the Guide to Depreciating Assets for 2012.

In-house Software

Paragraph 40-30(2) (d) of the ITAA 1997 provides that in-house software is a depreciating asset. In-house software is defined in subsection 995-1(1) as computer software, or a right to use computer software, that you acquire, develop or have another entity develop that is mainly for you to use in performing the functions for which the software was developed (that is, not for resale).

This could include off-the-shelf software acquired for use by the taxpayer. Computer software is not 'in-house software' if a deduction for its cost is available outside the capital allowance provisions.

For in-house software purchased after 7.30pm (AEST) on 13 May 2008 the statutory period of write-off is four years.

Application to your circumstances:

Employment as a tutor

The Commissioner's view on the deductibility of expenses incurred by employee teachers is contained in Taxation Ruling TR 95/14 (Income tax: employee teachers - allowances, reimbursements and work-related deductions). Although this ruling is not specifically in relation to university lecturers the principles outlined in this ruling can be applied to similar occupations.

Paragraph 205 of the ruling specifies a deduction is allowable under section 8-1 of the ITAA 1997 if an employee teacher purchases teaching aids to be used in the course of carrying out the duties of employment and that expenditure is not of a private, domestic or capital nature. The items purchased must have a direct and relevant use in carrying out those duties.

If an item or article is used for both work-related and other purposes, then the cost must be apportioned and a deduction claimed only for that proportion which is work-related.

You purchased a number of video games and you have used these as part of your teaching duties. Accordingly, you are entitled to a deduction for these video games under section 8-1 of the ITAA 1997 to the extent they are used in your teaching activities. For example, if a game is used for 100 hours, and only 3 hours are work related, then 3% of the cost of the game would be deductible.

You have raised the issue of seeking a deduction for the cost of the video games as part of a professional library. A deduction is allowable under Division 40 of the ITAA for the decline in value of a professional library. Generally for depreciation purposes, reference books may only be included in the professional library if their content is directly relevant to the duties performed. Encyclopaedias and general reference books are too general and no deduction is allowable for their cost.

In Case P26 82 ATC 110; (1982) 25 CTBR (NS) Case 90 , a university lecturer was allowed a claim for depreciation on legal books but denied a deduction for depreciation on general reading and fiction books. The Board of Review stated (ATC at 116; CTBR at 666):

No doubt the illustrations and anecdotes which he was able to use did serve as useful teaching aids but in my view these activities were not plant or articles within the meaning of section 54 of the Act, as they were not used or installed ready for use for the purposes of producing assessable income.'

If the cost of a textbook has been claimed as a deduction, its cost may not be added to the value of a professional library and depreciated.

Note: For income tax years prior to 1997 income tax year deduction for the depreciation was determined in accordance with section 54 of the Income Tax Assessment Act 1936.

Similarly in your case, you have been allowed a deduction for the video games as part of employment. The video games are not considered plant or an article for depreciation purposes nor are they considered in-house software. In the case, of encyclopaedias and general reference books this material is considered general in nature as is the case with the video games which are designed for private enjoyment/entertainment. Therefore a deduction is only available when the video games are used in the course of carrying out the duties of employment or when used in relation to your income producing activities.

Employment as a consultant

In your case you were casually employed as a consultant to undertake a project. You are seeking a deduction for the purchasing of video games and audio equipment.

Video games

You purchased a number of video games to use in the design process as part of your consultancy work. You are entitled to a deduction for the purchase of the video games under section 8-1 of the ITAA 1997. However, you need to apportion the deduction between income producing and private purposes.

Audio equipment

As noted above certain capital costs may be deductible by way of depreciation under Division 40 of the ITAA 1997. In your case, you have used audio equipment as part of your consultancy work. As these assets were used for a taxable purpose you are entitled to a deduction for the decline in value under Division 40 of the ITAA 1997 subject to an apportionment. However, as the audio equipment was not used predominantly for the purpose of producing assessable income an immediate deduction is not available currently if these items cost less than $300. You need to calculate your deduction using either the prime cost or the diminishing value method.

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