Edited version of your private ruling

Authorisation Number: 1012056476550

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Carrying in a business

Questions and Answers:

1. Are you carrying on a business of graphic design?

Yes.

2. Is your income 'royalties'?

Yes.

3. Are you able to claim general deductions and depreciation in relation to your business income?

Yes.

4. Are you able to claim a deduction for rent?

No.

5. Are you able to claim a deduction for the establishment of your internet domain?

No.

6. Does the cost of establishing your internet domain form part of the cost base of a capital gains tax (CGT) asset?

Yes.

7. Are you able to claim a deduction for the annual fees incurred in renewing your internet domain?

Yes.

This ruling applies for the following periods:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You have a full-time job in a field not related to graphic design.

You also do graphic design work, where your on various internet sites (including one where you own the url), for which you receive a percentage of the sale proceeds.

You incurred an amount to purchase your url and also additional fees over three years to maintain it.

Your design work is performed at home, in one half of your bedroom.

You use a desk, office chair, shelves and various computer and electronic equipment in your graphic design work.

For the income year ended 30 June 2011, you earned around $X in gross income and, based on your prior personal understanding of tax principles, incurred around $X in expenses.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 6

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 15-20

Income Tax Assessment Act 1997 Section 40-25

Income Tax Assessment Act 1997 Section 40-30

Income Tax Assessment Act 1997 Section 40-65

Income Tax Assessment Act 1997 Section 40-70

Income Tax Assessment Act 1997 Section 40-75

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Carrying on a business as a professional artist

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

The Commissioner's view on whether a taxpayer is carrying on a business as a professional artist is found in Taxation Ruling TR 2005/1 and supported by Taxation Ruling TR 97/11.

The question of whether a taxpayer carries on a business is a question of fact and degree. The indicators used to determine if business activity is being carried on include whether the activity has a significant commercial purpose or character; 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; 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.

These indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the general impression gained and whether these indicators provide the operations with a 'commercial flavour'. However, the weighting given to each indicator may vary from case to case.

For example, 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. The size or scale of the activity is not a determinative test and a person may carry on a business though in a small way (Thomas v. FC of T 72 ATC 4094; (1972) 3 ATR 165).

Where the purpose and prospect of profit is not established, an activity will automatically be disqualified from being a business. Paragraph 17 of TR 19/11 states:

Subject to all the circumstances of a case, where an overall profit motive appears absent and the activity does not look like it will ever produce a profit, it is unlikely that the activity will amount to a business .

Arts businesses typically have different characteristics to those found in other businesses. Often, people who engage in professional arts businesses are motivated by creative purposes and the desire to influence public opinion. Art is not always produced with a pre-existing market in mind. Rather, an innovative artist may have to create a new market for their work. For this reason, a large part of being in business as a professional artist may involve activities directed towards reputation building and audience/market creation.

The courts have recognised the distinct nature of arts activities. Professional artists, similar to sportspeople, have the distinction of pursuing as a business that which many others undertake purely for personal pleasure. Therefore, such taxpayers must be able to distinguish themselves from enthusiastic amateurs. What distinguishes a professional artist or sportsperson is the direction of their artistic or sporting prowess towards commercial ends.

In the case of an arts business, which is a notoriously high risk commercial activity, where there is more variability between the cost of creating the art and its commercial value, it may often be difficult to assess whether a profit motive exists solely from whether a profit has in fact been made by the activity. Therefore, whether a taxpayer is engaged in the following kinds of activities will be relevant in ascertaining whether that taxpayer has a genuine intention to profit from their arts activities:

endeavouring to bring the art work or service to relevant markets;

§ creating or enhancing industry contacts (for example gallery owners, art dealers, literary or performing arts agents, critics);

§ offering art work for sale as well as actual sales of art work to the public;

§ offering expert services through commission or consultancy;

§ related income seeking activities (other than direct sales) including applying for grants, awards, patronage, commissions, and so on;

§ making their art work accessible to the public through activities designed to raise the profile of the taxpayer as an artist; for example: publicly exhibiting art works; creating works for public performance, contributing written work for publication;

§ entering art competitions, residencies and award events;

§ undertaking research into the proposed arts business and consultation of experts (art experts or business advisers) prior to and during the activity; and

§ reputation building as part of an overall intention to make a profit.

In your case, you are carrying on a business as a professional artist, albeit, in a small way. You have undertaken activities to bring your art work to relevant markets, including internationally. You have your own website, which is linked to an international manufacturer. Your activity, although small, has a demonstrated potential for profit. Your body of saleable works is significant, well established, receiving royalty income and requires small, if not negligible costs for its maintenance. In short, your activity has a definitive commercial flavour.

Royalties

Taxation Ruling IT 2660 discusses the ordinary meaning of 'royalty'. At paragraph 10 of IT 2660 it states that at common law, a royalty:

... is a payment made in return for the right to exercise a beneficial privilege or right (eg ... to use a copyright...). ...Amongst other things, copyright can cover music, literary and artistic works...

Section 6-5 of the ITAA 1997 states if you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Ordinary income includes income received as a result of carrying on a business.

In your case, as you receive royalties for your copyrights or designs from carrying on a business, your royalties are assessable income of your business activity.

Deductions

Section 8-1 of the 1997 is about general deductions and provides a loss or an outgoing is an allowable deduction if it is incurred in producing assessable income or in carrying on a business for the production of assessable income (unless that loss or outgoing is capital or of a private or domestic nature).

As royalties are assessable income, relevant deductions can generally be claimed against royalty income.

In your case, relevant deductions include operating expenses, such as the cost of pens, paper and internet access (to be apportioned between business and private use).

Home office expenses

Taxation Ruling TR 93/30 contains the Commissioner's views as what deductions are allowable in relation to a home office. The Ruling recognises the case law authorities (for example, FC of T v Faichney (1972) 129 CLR 38; (1972) 3 ATR 435; 72 ATC 4245) that characterise expenses associated with a taxpayer's home as being inherently private and therefore not deductible. However the Ruling also recognises that an exception to this rule will exist where part of the home is used for income producing activities and/or has the character of a place of business.

Where part of the home can be defined as a place of business, occupancy expenses, such as rent, mortgage interest, rates and insurance as well as running expenses, such as electricity, lighting, heating, cleaning and depreciation, may be claimed.

Where a part of the home cannot be defined as a place of business, but nevertheless is used in connection with income producing activities, only a proportion of running expenses can be claimed. The taxpayer must establish that they have incurred additional expenses as a result of their income producing activities.

Occupancy expenses

The Ruling provides that the question of whether a place of business exists at the taxpayer's home is a question of fact.

The following factors, none of which is necessarily conclusive on its own, may indicate whether or not an area set aside has the character of a 'place of business':

(i) the area is clearly identifiable as a place of business;

(ii) the area is not readily suitable or adaptable for use for private or domestic purposes in association with the home generally;

(iii) the area is used exclusively or almost exclusively for carrying on a business; or

(iv) the area is used regularly for visits of clients or customers.

The absence of an alternative place for conducting income producing activities has also influenced a court or tribunal to accept a part of a taxpayer's residence as a place of business. Examples include:

(i) a self employed script writer using one room of a flat for writing purposes and for meetings with television station staff (Swinford v FC of T (1984) 15 ATR 1154; 84 ATC 4803);

(ii) an employee architect conducting a small private practice from home (Case F53 , 74 ATC 294; Case 65 , 19 CTBR(NS) 452);

(iii) a country sales manager for an oil company whose employer did not provide him with a place to work ( Case T48 , 86 ATC 389; Case 47 , 29 CTBR(NS) 355).

In each of these cases, the taxpayer was able to show that, as a matter of fact, there was no alternative place of business, it was necessary to work from home, and that the room in question was used exclusively or almost exclusively for income producing purposes.

In your case, you have not shown your room in question is used exclusively or almost exclusively for income producing purposes. You work from your bedroom, which is also used by you for domestic purposes as a bedroom. Also, the area is not clearly identifiable as a place of business (as opposed for example, to a private study), it is readily suitable or adaptable for private use and is not used regularly for visits of clients or customers.

Having regard to all of the factors, it is considered that the portion of your bedroom that you use for income earning purposes is not a place of business. It follows you cannot claim a deduction for a portion of your occupancy expenses (including rental expenses).

Running expenses

Although you are not entitled to a deduction for occupancy expenses, you are entitled to deductions for the home office running expenses incurred in earning your business income. For example, the additional electricity you use when working in your home office and the decline in value of depreciating assets you use, in proportion to their business use, such as for computers, and software, over their effective life.

For example, a computer may have an effective life of four years, cost $2,000, be used 50% for a business purpose and was purchased on 1 July. Using the prime cost ('straight line') method, it would be deducted at a rate of $250 per year over four years due to its 50% business use, based on the following formula:

Asset's cost x Days Held x 100% x business use

365 x assets effective life

Alternately, the diminishing value method of depreciation can be used, which is:

Base value x Days Held x 200% x business use

365 x assets effective life

For example, in year 1, based on purchase on 1 July, the depreciation on the above $2,000 computer would be:

$2,000 x 365 x 200% x 50% = $500

365 x 4

In year 2, the depreciation on the above $2,000 computer would be:

$1,000 x 365 x 200% x 50% = $250

365 x 4

In year 3, the depreciation on the above $2,000 computer would be:

$500 x 365 x 200% x 50% = $125

365 x 4

Software is generally depreciated using the prime cost method over 4 years.

Included with this private ruling is the Tax Office publication: Guide to depreciating assets 2011.

Domain

A depreciating asset is defined in subsection 40-30(1) of the ITAA 1997 to be an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used but excludes land, trading stock and intangible assets except for those listed in subsection 40-30(2) of the ITAA 1997.

An internet domain is an intangible asset but not an intangible asset for the purpose of subsection 40-30(2) of the ITAA 1997 and therefore not a depreciating asset for the purposes of Division 40 of the ITAA 1997.

Section 108-5 of the ITAA 1997 states a CGT asset is any kind of property or a legal or equitable right that is not property. Although an internet domain in excluded as a depreciating asset, it is a CGT asset for taxation purposes.

The cost of establishing your internet domain is not deductible under section 8-1 of the ITAA 1997 as it is a capital expense. However, it is included in the cost base of the CGT asset.

As your annual renewal costs are a recurrent cost, they are deductible under section 8-1 of the ITAA 1997 when incurred as part of the ongoing and regular expense of operating a website.