Edited version of private advice

Authorisation Number: 1051842645528

Date of advice: 10 June 2021

Ruling

Subject: The Commissioner's discretion for non-commercial losses

Question

During the 20XX-XX, 20XX-XX and 20XX-XX financial years were you considered to be carrying on a business in relation to your activity?

Answer

No.

Question 2

Will the Commissioner exercise the discretion to allow you to include any losses from your non-primary production activities in the calculation of your taxable income for the 20XX-XX, 20XX-XX and 20XX-XX financial years?

Answer

Not applicable.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Over the past several years, you purchased a patent for a XXXX and purchased approximately $X worth of product to develop the XXXX to a commercial standard.

You are also working as a full-time employee.

You established a website and social media accounts.

You also reach out to your target market through word of mouth.

Your intent is to provide educators and parents with a resource.

You commenced operations in Month X 20XX. Your first sale was around Month X 20XX which was a private sale.

Each product is sold for around $X which is lowered for a bulk order.

In the financial year ended 30 June 20XX, your sale totalled $X which consisted of X units. Your net loss was $X.

In the financial year ending 30 June 20XX, your sales have totalled $X which consisted of X units. Your net loss was $X.

You are having issues advertising because your target market consists of colleagues and advertising to them would mean a conflict of interest.

You are currently undergoing a process to allow you to advertise your products which is being reviewed and pending approval.

You outsource the manufacturing of the product.

You spend time on your operations everyday but once the product is assembled you do not have to do much else.

You have been talking with lawyers, licensing professionals and attending workshops to get assistance with progressing your operations.

You provided your revenue projections, financial projections, projected profit and loss, a balance sheet and a S.W.O.T analysis in Excel spreadsheets as a business case for your activities. However, you did not provide information to demonstrate how your projected figures were determined.

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 subsection 35-55

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 995-1

Summary

The Commissioner will not allow you to apply a loss from your activities to your assessable income as you are not currently in business.

Reasons for decision

For the 2009-10 and later financial years, Division 35 of the Income Tax Assessment Act 1997 (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, or

§     the Commissioner exercises his discretion.

However, for this division to apply, you must be carrying on 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'.

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

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.

In the Commissioner's view, 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).

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.

You advised that you commenced operations in Month X 20XX. However, you made no sales in 20XX-XX, and 20XX-XX financial years and made sales of only X units in 20XX-XX and X units in 20XX-XX financial years.

Your professional experience is very similar to the knowledge needed to develop the XXXX.

As stated, you commenced operations in Month X 20XX however the business website has only just been established. Even though you have spent $X over a number of years to develop your product, the scale of your activities is not of the level that is typical for a business in the industry. The facts you provided suggest that your activities are still of a 'preliminary or preparatory' nature and do not amount to the carrying on of a business.

Intention of the taxpayer

Your vision is to for the XXXX to be popular across Australia and internationally.

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 your business will become sustainably profitable. (Tweddle v. Federal Commissioner of Taxation (1942) 180 CLR 1; 7 ATD 186; (1942) 2 AITR 360).

You commenced operations in Month X 20XX, your first sale was not made until Month X 20XX. You did not make any sales from the activity in the 20XX-XX and 20XX-XX financial years, however, you incurred expenses from the activity which resulted in a loss of $X and $X respectively. For the 20XX-XX financial year you made a loss of $X. For the current financial year you advised that sales have totalled $X representing the sale of X units. Despite being in operation for a number of years, your sales figures have been very low and there is no strong evidence to suggest that you will increase your sales of make a profit in the coming years.

At this stage, it appears that although you forecast meeting the assessable income test in a future income year, we are unable to see any evidence of an increase in sales.

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.

You informed us that you do some work every day and you spend some time assembling the product but once they are assembled, you do not have much to do. You are also maintaining your employment. At this point in time, it does not seem like your operation is run with the repetition and regularity required for a business.

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 your 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;

§     The amount invested in capital items; and

§     Previous experience.

Your operation does not yet meet a number of these factors. As discussed earlier, even though a number of your clients are distributors and a number of your clients are retailers, your relatively small number of sales suggests a lesser likelihood that a business is being carried on.

We acknowledge that while you are marketing your product using social media, your website and word of mouth, very little response has been forthcoming. You are also struggling to advertise due to a conflict of interest. The volume and sales amounts are also not typical of a business in the industry. It is unlikely that your activities are of the same kind and carried on in a similar manner to another commercial business.

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.

A discussion of your operations has been provided under the significant commercial purpose factor above. Since that factor and this are closely linked according to paragraph 29 of TR 97/11, the conclusion is that your activities are not conducted in a business-like manner.

The size, scale and permanency of the activity

While no indicator is decisive, generally more weight is given to size and scale. 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.

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.

You have sold X units in the financial year to date. Your operation operates on a small scale. 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 small scale of the activity together with other factors discussed earlier, being the lack of significant commercial purpose, lack of income stream, repetition and regularity and prospects of profits denote the activity is not yet having necessary indicators to be characterised as carrying on a business.

Hobby or recreation

You have stated that you are talking with lawyers, other professionals and attending workshops to get assistance with moving forward with your activities This would suggest that your activities are more than just a hobby or for recreation.

Conclusion

We acknowledge you have commenced your operation with the intention of selling the XXXX to every household in Australia and to popularise the XXXX internationally. However, the Commissioner's position is that at this stage your operation is not presently operating in line with what is expected of a business of this type and that you have not demonstrated your activity amounts to the conduct of a business.

On balance, when applying the indicators in TR 97/11 to your circumstances we have determined that you were not carrying on a business in relation to your activity in the 20XX-XX, 20XX-XX and 20XX-XX financial years.