Edited version of private advice

Authorisation Number: 1051584572120

Date of advice: 23 September 2019

Ruling

Subject: Carrying on a business

Question

Is the Company carrying on a business for the purposes of the Australian tax law?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Company was incorporated in 20XX.

All shares in the Company are held by a Trust (the Trust). The Trustee of the Trust is Company B.

The directors of Company B provide funding to the Company.

The Company provides aviation services.

The Company provides services to its shareholder and associates.

The Company does not advertise its services to the public.

Business plan

The Company has a business strategy, including replacing the aircraft.

Assets and hiring fees

The Company owns an aircraft which it uses to provide its services. The aircraft can be hired out at a market rate.

Staffing

The Company employs staff.

Finances

The business strategy shows it is expected to make a profit in a future income year. The Company anticipates that it will make losses in the short term, including depreciation.

The annual turnover of the operation is in excess of $2 million.

Commercial operations

In order to maintain its commercial operations, the Company holds certificates of Airworthiness and Certificates of Registration for its aircraft.

The Company uses a service provider to handle its accounting, administration and legal requirements.

All bookings are placed through the service provider.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 995-1 of the Income Tax Assessment Act 1997

Reasons for decision

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a taxpayer's assessable income includes income according to ordinary concepts. Income according to ordinary concepts includes income derived from a business.

'Business' is defined in section 995-1 of the ITAA 1997 as including 'any profession, trade, employment, vocation or calling but does not include occupation as an employee'. However, this definition simply states what activities may be included in a business. It does not provide guidance for determining whether the nature, extent and manner in undertaking those activities amount to the carrying on of a business.

Where it is not clear that a business is being carried on, consideration must be given to a number of indicators which have been distilled from case law.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production, sets out the Commissioners' view on the indicators of whether a person is carrying on a business of primary production. The indicators in this ruling can be equally applied to non-primary production activities. It states that, whilst each case will turn on its facts, the determination of the question is the result of a process of weighing all the relevant indicators. The following indicators are relevant when considering whether a business is being carried on:

·         a) whether the activity has a significant commercial purpose or character;

·         b) whether there is more than just an intention to engage in business;

·         c) whether there is a purpose of profit as well as a prospect of profit;

·         d) whether there is repetition and regularity to the activity;

·         e) whether the activity is of the same kind and carried on in a similar manner to businesses in the industry;

·         f) whether the activity is planned, organised and carried on in a business-like manner;

·         g) the size, scale and permanency of the activity; and

·         h) whether the activity is better described as a hobby or recreation.

No one indicator is decisive, and all indicators should be considered in combination and as a whole: Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922. Whether a business is being carried on will depend on the 'large or general impression gained' (Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551) from looking at all the indicators, and whether those indicators provide the operations with a 'commercial flavour' (Ferguson v. FC of T 79 ATC 4261; (1979) 9 ATR 873).

Applying the relevant cases and indicators to your circumstances

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. Any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the activity should also be considered.

The Company is providing aircraft services to its shareholder and associates. The Company has a significant asset (the aircraft) that is used in its activities. The Company has a business plan that extends to the year 2026. The Company provides its services at a market rate. The Company has complied with the legal requirements of operating an aircraft service.

Whilst the Company has undertaken a number of activities that a taxpayer who is carrying on a business activity would undertake, the Commissioner considers the prospect of ongoing profit to be tenuous. Although the business plan projects a profit in a future income year, this is principally attributable to the aircraft being fully depreciated in the immediate prior year. A loss will resume once the aircraft is retired and replaced and depreciation resumes as a charge against revenues.

A commercial purpose would be concluded where revenue forecasts were predicted to deliver a profit in the general run of income years and not just as an aberration in income years immediately prior to an aircraft being retired and replaced.

For a commercial purpose to be demonstrated the business plan would need to demonstrate that a profit would accrue over the holding period of an aircraft.

The absence of any advertisement to the general public with a view to growing market share and revenues to a level of sustained profitability is a matter that weighs significantly against a commercial purpose (as it is not the mode of operations undertaken by entities undertaking this type of activity with a commercial and profit making purpose).

Intention of the taxpayer

The stated intention is one of commerciality and profit although as discussed, the current scale of operations in companion with forecast revenues, and historical turnover of aircraft, do not suggest sustainability of profit.

The activity is one that is directed at servicing the air travel needs of the Company's controllers, shareholders and associates. Intention can alternatively be inferred as directed to the utility enjoyed by the private group controllers and shareholders etc. in terms of high end travel and service.

Prospect of profits

This is a critical factor. A taxpayer's stated intention for profit may not align with the activity actually undertaken. This factor requires an examination of whether objectively there is a real prospect of making a profit from the relevant activity.

A business will not be found to be carried on where there is no reasonable prospect of profit from the activity in question. However, if an activity is not profitable, it does not necessarily prevent that activity from being a business, if there is a genuine belief that the business will become sustainably profitable. (Tweddle v. Federal Commissioner of Taxation (1942) 180 CLR 1; 7 ATD 186; (1942) 2 AITR 360).

As has already been discussed, the Commissioner considers sustainability of profit is not reasonably expected given revenues and historical aircraft retirement timelines.

Were an overall profit across the aircraft ownership cycle capable of being demonstrated, then this conclusion would be different.

Repetition and regularity

The taxpayer's activities should involve repetition and regularity and have an air of permanence about them. Frequent and regular transactions are the usual feature of business operations. In Hope v. The Council of the City of Bathurst (1980) 144 CLR 1; 80 ATC 4386; (1981) 12 ATR 231, transactions were entered into on a continuous and repetitive basis which was one factor that supported that the activity in question was a business.

The form and manner of the activity in the present instance plainly involves repetition and regularity. This indicator weighs favourably.

Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business

If a taxpayer carries out their activity in a manner similar to other taxpayers in the industry, it is more likely that their activity amounts to the carrying on of a business. That is, the taxpayer's operations are of the same kind and carried on in the same way as those characteristic of ordinary trading in that particular line of business (IR Commissioners v. Livingston 11 TC 538).

This indicator requires a comparison between the activities of the taxpayer in question and those undertaken by a person in business in the same type of industry. Where the taxpayer's activities are similar in nature to the business, further support is given to a conclusion that a business exists.

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 for example wholesalers, retailers, the public at large or friends and relatives;

·         The manner in which the product is marketed;

·         The sort of expenses incurred by the taxpayer; and

·         The amount invested in capital items.

·         Previous experience

The Company has sought to set a commercial charge out rate. The Company has invested in an aircraft and the expenses it incurs would be similar to those that would be expected of a business providing a like service. However, the Company provides its services only to its shareholder and associates. This is a significant point of distinction in that you do not advertise to the public and therefore your passenger numbers and revenues are constrained compared to a similar scale of business. Overall, this factor weighs adversely.

Organisation in a business-like manner, the keeping of books, records and the use of a system

The activities conducted by, or on behalf of the taxpayer, should be carried out in a systematic and organised manner. This will usually involve matters such as the keeping of appropriate business records by the taxpayer. If the activities are carried out on the taxpayer's behalf by someone else, there should be regular reports provided to the taxpayer on the results of those activities.

Commercial businesses generally operate in an orderly fashion, including organised sales bookings, reliable client base, consistent income stream, continuous commercial activity, control of business expenses and a plan for future growth.

The Company uses a service entity to handle its accounting, administration and legal requirements to support its activity.

All bookings are placed through the service provider.

The Company has a business plan that identifies the future directions strategy, key performance indicators and strategies.

This factor weighs favourably.

The size and scale of the activity

The larger the scale of the activity, the more likely it is that the taxpayer is carrying on a business. However, this is not conclusive as a person may carry on a business in a small way. As the size or scale of the activity is not determinative, it is important that this indicator not be considered in isolation, but rather in conjunction with the other indicators.

An activity conducted on a small scale may constitute the carrying on of a business if the taxpayer has the purpose of making a profit, there is repetition and regularity in the taxpayer's activities, the taxpayer informs itself of market conditions and the taxpayer organises its activities in a business like way through the keeping of books of account.

The Company operates one aircraft for the use of its shareholder and associates. A single aircraft operation can be of a scale where the necessary indicia of a business are present. An activity conducted on a small scale can constitute the carrying on of a business if the taxpayer has a purpose and genuine prospect of a profitable commercial venture.

The scale of the activity here is not fatal to a finding of a business. Rather, as has been discussed, the projected profitability appears an aberration as revenues are not of a scale sufficient to recoup operating costs and depreciation once a replacement aircraft is acquired.

Hobby or recreation

Money derived from the pursuit of a hobby is not regarded as income and is therefore not assessable. Expenses incurred in relation to the hobby activity are not allowable deductions. 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 an operation is substantial.

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 applicable 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;

·         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 or plan to allow a profit to be made;

·         The activity is carried out on a small scale;

·         The taxpayer intends to carry on a hobby and not a business; and

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

The notion of a hobby or recreation does not attach to a private company but as discussed the purpose of an activity may be principally directed at the utility enjoyed by its controllers in terms of the activities conducted by the private company.

This factor is neutral as it is not directly applicable.

Conclusion

In your case, you have established your activity in a form that has similar attributes to a business undertaking. However, based on your submitted business plan you will only make a profit for the first time in a future income year which is the final year of your forecasting. The fiscal performance of the activity will, however, resume to a loss position as soon as the current aircraft is retired and replaced. Such a business model is not consistent with achieving a profit over the aircraft ownership cycle. The activity is loss making as long as an aircraft is depreciated and then only profitable until the aircraft is retired and replaced (when loss making resumes). This is a function of revenues not being of a sufficient scale to cover operating costs including depreciation (during years aircraft cost is written off as depreciation) which in turn is a function of the limited passenger market (being shareholders and associates of the private group).

On balance, when applying the indicators to your circumstances it is considered you have not demonstrated your activity amounts to the conduct of a business.