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Ruling

Subject: Am I in business

Question

Are you carrying on a business of selling items?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You are an Australian resident.

You conceived an idea to have a product made which you would sell in a retail store, and via a website you had created which would reach customers worldwide.

During the 2012 financial year you purchased a number of raw products from a factory in Australia.

The product arrived with incorrect dimensions and was made of an inferior product.

The supplier would not accept the return of the goods as they maintain that you did not stipulate your requirements when ordering the product.

You were forced to alter the product yourself. After alteration a number of the items were offered for sale in a retail outlet. However you only sold a small number of the items.

Due to poor quality of the product resulting from the sizing error from the manufacturer and the alterations completed, you are not willing to risk selling the items over the internet due to threat of them being returned from international customers.

You intend on purchasing more of the product when funds become available, as you believe it is a great business opportunity with an international market.

To process and repair the items you are using your residence.

You do not have a business plan.

You have not conducted market research on the economic viability of the activity.

You have not sought advice or assistance on setting up your activity.

You have registered a business name.

You do not have employees.

You advertised the activity initially through business cards, and had a website created to sell the items. The website is not live and has not traded.

You have maintained a computer spreadsheet which records the income and expenses relating to the activity. You have also kept receipts and invoices.

You believe that your activity is a business.

You have received a small amount of income from the sale of the items.

You have purchased equipment to be used for the activity.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

Based on the facts you have provided, your activity does not constitute the carrying on of a business. As such you are not required to include the income received from the sale of your items in your income tax return. Further, any expenses that you incur in relation to this activity are not deductible.

Detailed reasoning

Income is generally assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997). Under subsection 6-5(1) of the ITAA 1997, ordinary income means income 'according to ordinary concepts'. This phrase is not defined under the legislation, but a large body of case law has developed to identify the factors that indicate if an amount is income according to ordinary concepts.

Carrying on 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. Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548, however, provides that the test for determining whether or not a business is being carried on is both subjective, which considers the individuals purpose at the relevant time, and objective, which considers the nature and extent of the activities undertaken.

Taxation Ruling TR 97/11 provides the Commissioner's view of the factors that are considered important in determining if you are in business for tax purposes. The factors are:

· 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. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression gained.

Commercial purpose or character

Generally it can be said that to carry on business means to 'conduct some commercial enterprise systematically and regularly' with 'features of continuity and system' (Hyde v. Sullivan (1956) 73 WN(NSW) 25; Crow v. FC of T 88 ATC 4620; 19 ATR 1565). The usual aim of business is to maximise profits, this is achieved by organising trading activities as efficiently as possible.

The courts are usually satisfied by a lower level of system and organisation where the activities have a genuine commercial feel. That is, where the activities appear to be ordinary or conventional business dealings, a genuine, but inefficient and disorganised venture may be characterised as a business (Case M67 80 ATC 479; 24 CTBR (NS) Case 41).

Where the activities have the feel of a hobby, the courts generally require stronger evidence of system and organisation (Brajkovich v. FC of T 89 ATC 5227; 20 ATR 1570). An activity may have the feel of a hobby where it is intrinsically personally satisfying.

The weight given to the system and organisation will vary depending on the circumstances. As Richardson J said in Grieve v. Commissioner of Inland Revenue [1984] 1 NZLR 101 at 110,

'businesses do 'not cease to be businesses because they are carried on idiosyncratically or inefficiently or unprofitably, or because the taxpayer derives personal satisfaction from the venture'.

Intention of the taxpayer

The intention of the taxpayer in undertaking the activity is important in determining if a business is carried on. Mere intention is not enough, there must be an activity (Inglis v. FC of T 80 ATC 4001, 109 ATR 493).

This indicator is particularly related to:

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

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

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

Profit making purpose

The commercial reality of business means that it is ordinarily carried on for the purpose of profit. A profit making motive is a common feature of business activities.

Profit motive is only one factor to consider. A business may be carried on where there is no profit motive and vice versa (IR Commissioners v. Incorporated Council of Law Reporting (1888) 22 QBD 279; Brajkovich v. FC of T (1989) 89 ALR 408; 89 ATC 5227; 20 ATR 1570).

It is less likely a business will be found to be carried on where there is no reasonable prospect of profit from the activity in question. This is a matter to be considered in the circumstances. A short term lack of profit making potential may not be fatal (Tweedle v. FC of T (1942) 7 ATD 186; 2 AITR 360).

Regularity and repetition

Frequent and regular transactions are the usual feature of business operations. Turnover is maximised if the processes are repeated over a long period. Frequent activity does not necessarily mean a business is carried on but it will support this argument (FC of T v. Radnor 91 ATC 4689; 22 ATR 344).

Regularity, frequency and duration of the activity are considered to be important factors in determining if a business is being carried on. In Inglis v. FC of T 80 ATC 4001 Brennan J, at 4005, said that 'At the end of the day the extent of activity determines whether the business is being carried on'.

Business-like manner

An activity that is carried on in a similar manner to others in the particular industry is more likely a business. To determine if the activity is in the nature of trade it is necessary to see if the operations are of the same kind and carried on in the same way as those in the same line of business (IR Commissioners v. Livingston (1927) 11 TC 538).

Some factors that are useful to compare include:

· the volume of sales or trade - the smaller the number the less likely a business is being carried on

· the types of customers the taxpayer trades with - retailers, wholesalers, the public at large or friends and relatives

· the manner in which the product is marketed

· the sort of expenses incurred by the taxpayer

· the amount invested in capital items

· the previous experience of the taxpayer - If the taxpayer lacks experience then it is expected to have sought advice or done some research, and

· the activity should be compared to that of a keen amateur - the sales may just fund the future pursuit of a personal interest.

Size or scale of the activity

The larger the scale of the activity the more likely it is that the taxpayer is carrying on a business. This is not conclusive and a person may carry on a business in a small way (Thomas v. FC of T 72 ATC 4094; 3 ATR 165).

Where the scale of the activity is small it may still result in more product than are required for the taxpayer's domestic needs. If the taxpayer also has an intent to profit from the activities and there is a reasonable expectation of doing so, a business may be carried on. The size of the activity is not determinative but the smaller the scale of the activity the more important the other indicators will become.

Hobby or recreation

Money derived from the pursuit of a hobby is not regarded as income and is therefore not assessable. If the activity is more properly described as the pursuit of a hobby, recreation or sport then it will not be regarded as a business even where the operation is substantial (Ferguson v. FC of T 79 ATC 4261; 9 ATR 873).

This is not to say that an activity characterised as a hobby can never become a business. The matter will always depend on the facts and a weighing of the indicators.

Often a hobby is being carried on when:

· it is evident that the taxpayer does not intend to make a profit from the activity

· losses are incurred because the activity is motivated by personal pleasure. There is no plan in place (business plan) that shows how a profit can be made

· the transactions are isolated and do not show regularity or repetition

· the activity is not carried on in the same manner as an ordinary business activity

· there is no system to allow a profit to be made

· the activity is carried on a small scale

· the taxpayer intends to carry on a hobby not a business, and

· the taxpayer transacts with friends and relatives not the public at large.

Application to your circumstances

In your case you purchased one batch of the product and sold only a small number since the items were offered for sale. However you have intentions to expand on this activity in the future.

Currently your activity does not have a significant commercial feel, purpose or character. The nature of the activity is not systematic and regular, nor does it have the features of continuity and system.

Your intention is to engage in business of selling the product. However mere intention is not enough, there must be activity. Although you have purchased one batch of the product, the activity has the indicators of one that is preliminary or preparatory to the ultimate activity. There has been no activity for some time, and you advised that you will purchase a new batch some time in the future when you source funding. The lack of regularity and frequency of transactions from the current activity indicate that a business is not being carried on.

Although you intend to make a profit from the activity, the lack of continuity and system, and the activity's preliminary nature precludes that result. Further, there is no reasonable prospect of profit from the current activity, as you are not attempting to sell the items that you have manufactured to date, nor have you sought alternative markets or sales strategies to minimise your losses.

Further, it can be expected that a business engaged in the selling of a product would devote many hours to that activity thus forming regular income, business and sales patterns. Therefore your activity is not considered to be carried on in a similar manner to that of other operators in your industry.

Based on the information you have provided, to date we do not consider that the current activity has the necessary characteristics of a business for taxation purposes. Therefore, any income you receive in relation to this activity will not be assessable under section 6-5 of the ITAA 1997 as ordinary income. In addition, any expenses that you incur in relation to this activity are not deductible.