Edited version of your written advice

Authorisation Number: 1013122982146

Date of advice: 10 November 2016

Ruling

Subject: Non-commercial losses - Am I in business

Question 1

Are you considered to have been carrying on a business (the activity) in the 201X financial year?

Answer

No.

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses in relation to the activity in your calculation of taxable income for the 201X financial year?

Answer

Not applicable.

This ruling applies for the following periods:

Year ended 30 June 201X

The scheme commenced on:

1 July 201X

Relevant facts and circumstances

You purchased a franchise (the activity) from a franchise agency (the agency).

You had completed the required training prior to purchasing the activity.

You commenced advertising for customers.

You completed approximately X quotes for your services in around a one month period.

You discovered quite quickly that you were disadvantaged in your field of activities because you did not hold the certification to enable you to carry out certain other services as well as the services you offered.

Potential customers preferred to hire someone who could perform all services, rather than get the services carried out by you and then need to hire another person to complete the other services.

You were not aware of this and how it could potentially affect your business until after you purchased the franchise.

You then researched how you may be able to acquire this certification and discovered that no new certifications for this service were being issued at that time.

You also felt that you had disadvantaged yourself by expecting payment for your services at the time the job was to be completed, where other businesses allowed deferral of payment until a later time.

You were not able to engage any customers or enter into any contracts and therefore received no income from the activity in the X weeks you were actively involved.

After a short period, you contacted the agency to advise them that due to the issues you had with the lack of certification, this activity was not going to be able to work for you and so you commenced negotiations with the agency to swap this franchise for another franchise.

Negotiations were completed a short time later when you swapped the activity for a new franchise.

You completed the training for the new franchise.

You have not yet commenced any form of activities for this new franchise as you have now recommenced paid employment so you do not yet have the time to focus on getting this activity started successfully.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 35-10(1)

Income Tax Assessment Act 1997 Subsection 35-10(2)

Income Tax Assessment Act 1997 Subsection 35-10(2E)

Income Tax Assessment Act 1997 Paragraph 35-55(1)(a)

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

For the 200X-X0 and later financial years, Division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless:

● you satisfy the income requirement and you pass one of the four tests

● the exceptions apply

● the Commissioner exercises his discretion

However, for this division to apply, your activity must be carried on as a business.

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

The case of Evans v. Federal Commissioner of Taxation 89 ACT 4540; (1989) 20 ATR 922 stated that whether or not an activity amounts to carrying on business for taxation purposes is a question of fact. There is no exhaustive or determinative definition which can be applied to determine this matter. The facts of each case must be examined. In Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548, Webb J said:

The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.

When does a business activity commence?

The actual date of commencement of a business activity is a question of fact (Goodman Fielder Wattie Ltd v. FC of T 91 ATC 4438; (1991) 22 ATR 26) (Goodman Fielder Wattie).

For a business activity to have commenced a person must have:

● purpose, intention and decision to commence the business activity

● acquired a minimum level of business assets to allow that business activity to be carried on, and

● actually commenced business operations (Calkin v. CIR [1984] 1 NZLR 440)

We must examine the above indicators in light of the characterisation of your business activity.

In Goodman Fielder Wattie, Hill J stated at 4,447:

Critical to the resolution of the present controversy, is the characterisation of the business activity itself which is said to have commenced. It was conceded properly by the applicant that if the business claimed to be carried on by it was to be characterised as one of manufacturing and selling monoclonal antibody products, then that business did not commence until around November 1982...

For example, if your business activity is characterised as a primary production activity, involving the planting and cultivating of trees, then the planting of the trees could be seen as the commencement of that business. Alternatively, if your business activity is characterised as the provision of a service, the business would generally be considered to commence once you have commenced providing this service for remuneration.

In your case it is considered that the business activity you intended to carry on is characterised as the provision of services. We can now consider the indicators set out above to determine whether this business activity has commenced.

Purpose, Intention and Decision

The intention and purpose of a taxpayer in engaging in an activity is relevant to when a business commences. However, an intention to commence a business will not determine that the business activity has actually commenced.

The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity. This is developed by researching the proposed business and, in some instances, by experiment. This process culminates in a final decision on whether to commence business. However, not all businesses commence in such an orderly manner.

It is not clear from the information you have provided that you researched your proposed business activity adequately prior to purchasing it, though you decided on the form of that business and had committed yourself to it.

Acquisition of a minimum level of business assets to allow that business activity to be carried on

Most business activities have a structure that provides the framework of the business. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity.

In Calkin v. CIR [1984] 1 NZLR 440 Richardson J said at 446-447:

Clearly it is not sufficient that the taxpayer has made a commitment to engage in business: he must first establish a profit-making structure and begin ordinary business operations.

For a business activity to commence an appropriate business structure should be in place and ordinary business operations must begin.

As to what the business structure will consist of, and its size, will be a question of fact and degree, and will depend on the nature of the business activity.

Your activity was the provision of services to the general public.

In your case, you are considered to have acquired the necessary capital assets at the time you purchased the franchise to enable you to carry out your activity. However, you did not yet have a client base; it is considered that in your industry, this is an integral part of establishing a profit making structure in order to begin ordinary business operations.

Commencement of Business Operations

As noted by Brennan J in Inglis v Federal Commissioner of Taxation (1979) 10 ATR 493; 80 ATC 4001, the level of activity is important in deciding whether a business is being carried on. Brennan J stated at ATC 4004-4005; ATR 496-497 that:

The carrying on of a business is not a matter merely of intention. It is a matter of activity. Yet the degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the supposed business is being conducted.

In Hadlow and FC of T [2002] AATA 1250; (2002) 2002 ATC 2294; (2002) 51 ATR 1197 the Small Taxation Claims Tribunal considered the amounts incurred by a taxpayer to research and develop a book. The question for decision was whether the activities were merely preparatory and preliminary or whether the activity had reached a stage where it was able to be characterised as a business.

In concluding that the activity was not carried on as a business in the relevant years, member Mowbray stated at paragraph 26:

Clearly Mr Hadlow has the subjective intention to carry on a business, but that is not sufficient. There must be business activity. There is a real question whether the activities to date are merely preparatory or preliminary (see Goodman Fielder Wattie at 4447), and whether the project has reached the stage where it is able to be characterised as a business. There has been much activity but

The concept of business does not equate with being busy (Goodman Fielder Wattie at 4447; 386; 339)

Mr Hadlow has researched, undertaken travel, and visited museums, libraries and farms in pursuit of a particularly interesting topic. He has expended money but has made no sales, received no advances nor signed any contracts.

It is accepted that you have gone beyond merely having an intention to engage in business, however; it is important to evaluate this activity in regards to the characterisation of your business, which is the provision of your services to the general public.

The systematic and regular transactions from which you would expect to produce revenue as part of your business operations, that is, customers actually engaging your services, did not commence. Further you have now sold this activity back to the agency and purchased a new and different activity in its place, which you are yet to commence.

Therefore your activities during the 201X financial year are considered preliminary to the carrying on of your intended business and were directed at conducting advertising and seeking to engage potential clients for your intended business, as well as the construction or establishment of a business structure, rather than actual income producing activities.

As such you are not considered to have been carrying on a business in relation to the activity for the 201X financial year and therefore have no business losses to which the non-commercial loss rules could potentially apply.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).