Edited version of your written advice

Authorisation Number: 1012865273956

Date of advice: 26 August 2015

Ruling

Subject: Am I in business, Commissioner's discretion- non-commercial losses

Question 1

During the 20XX-YY financial year were you considered to be carrying on a business in relation to an activity (the activity) concerned with the manufacturing and selling of a product (the product)?

Answer

No.

Question 2

Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) 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 20XX-YY financial year?

Answer

Not applicable.

This ruling applies for the following periods:

Year ended 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

During the 20XX-YY financial year you developed the product, which is aimed at a particular market.

You resigned from your full time employment in 20YY to devote all of your time to the activity.

You engaged a manufacturer to manufacture the product in early 20YY, and first trials were run several months later. The creation of a new and untested product is a very timely process, as it required:

• the establishment of a new manufacturing process

• the creation of the recipe, and

• extensive testing and trials, as to sell your product in a commercial environment it is crucial that the product adhere to particular storage criteria. The only way to test this is to produce samples and test them at different time intervals.

Once the product was developed, you had to have all nutritional claims and product descriptions professionally reviewed.

As a part of establishing the new brand, you completed product design for containers and label logos, and display units. These were also completed after recommendations from a consultant after the nutritional claims and product descriptions were reviewed.

Sample orders of the product were received towards the end of the 20XX-YY financial year, which have been distributed to prospective clients in order to generate sales leads. This is a part of your marketing campaign.

Late in the 20XX-YY financial year you placed an order for a number of display units.

You purchased a delivery vehicle at the beginning of the 20YY-ZZ financial year.

You applied for a trademark in relation to your activity late in the 20XX-YY financial year, and you have received notification that the application had passed the examination and registration process. It was advertised in the Australian Official Journal of Trademarks and you expect it to be completed by the end of September 20YY.

Once the trademark has been granted you will embark on a campaign to formally launch the product, including a website, additional point of sale material (freezers) and endorsements. The website and social media pages have been created, but are not active.

In September 20YY you will begin manufacturing a commercial quantity of the product, which will available for sale soon after.

You anticipate sales of the product of more than $20,000 for the 20YY-ZZ financial year.

You believe that the activity was being carried on as a business during the 20XX-YY financial year.

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)(b), and

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

For the 2009-10 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 should 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 manufacturing and selling of a product, the business would generally be considered to commence once you have manufactured and begun selling the product.

In your case it is considered that the business activity you intend to carry on is characterised as the manufacturing and selling of a product. 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 clear from the information you have provided that you have researched your proposed business activity, decided on the form of that business and have 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 begin ordinary business operations.

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 is the selling of a product to a target market.

You have samples of the product manufactured for marketing purposes. However during the 20XX-YY financial year you had not manufactured containers, purchased display freezers, a delivery vehicle or a commercial quantity of your product to commence trading to the general public. As such it is considered that you do not yet have the necessary business structure in place for you to commence your business activity.

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 and there has been some activity. For example, you have had samples of the product manufactured for marketing purposes. However, it is important to evaluate this activity in regards to the characterisation of your business, which is the offering of your product for sale to the general public.

The systematic and regular transactions from which you will produce revenue as part of your business operations, that is, customers actually purchasing your product, has not commenced. Further you have not manufactured a commercial quantity of your product for it to be available for commercial sale.

Therefore your activities during the 20XX-YY financial year are considered preliminary to the carrying on of your intended business and are directed at creating a product to be sold in your intended business, and the construction or establishment of a business structure. As such you are not considered to be carrying on a business for the 20XX-YY financial year.