Edited version of private advice

Authorisation Number: 5010085315182

Date of advice: 11 October 2022

Ruling

Subject: Assessable income - business and professional income

Question

Forthe purposes of the loss carry back tax offset in Division 160 of the Income Tax Assessment Act 1997 (ITAA 1997), was X "carrying on a business" within the meaning of that term in Subdivision 328-C of the ITAA 1997 for the 2YXZ financial year?

Answer

Yes.

This ruling applies for the following period: 2YXZ financial year

The scheme commences on:

2YXZ financial year

Relevant facts and circumstances

1) X had operated a Business since 2YYZ. X did not carry on any other business other than the business it operated.

Sale of Business

2)     The Business was sold to new owners in 2YRY under a Contract on a "deferred settlement basis". This meant that even though the date of sale on the (undated and unexecuted) Contract was 2YRY and the sale price was stated as P in the Contract, the calculation of the final sale price was dependent on several conditions that continued until 2YZZ. These conditions included the following:

(a)  reduction of the Business's sale price if current clients did not continue with the new owners of the Business;

(b)  cancellation and release of the bank guarantee that existed on the lease for the office occupied by the Business (Bank Guarantee);

(c)   negotiating the finalisation of the office telephone contracts;

(d)  sale of office equipment as and when required;

(e)  preparation and lodgement of X's business activity statements (BAS);

(f)    calculation of employee entitlements (so it could be adjusted by the new owners).

3)     The first payment under the Contract (comprising Q% of the sale price, as adjusted by some factors listed above at 3(a) to (f) per Contract M) was made by the new owners to X on 30 April 2Y2Y.

4)     The second payment under the Contract (comprising R% of the sale price, as adjusted by some factors listed above at 3(a) to (f) per Contract clause L) was made on the 12 calendar month anniversary of 2YRY (per Contract clause N).

5)     The final payment (comprising R% of the sale price, as adjusted by some factors listed above at 3(a) to (f) per Contract clause L) is expected to be made on the 24 calendar month anniversary of 2YRY (per Contract clause N).

6)     X's owners were actively involved in the process of assisting the new owners with their knowledge of the client base. The new owners were involved in checking client files for accuracy, verification and negotiation before payments were made under the Contract to X.

7)     After 2YRY, X's owners continued to negotiate with the bank for the cancellation and release of the Bank Guarantee and also to transfer the lease for the office occupied by the Business to the new owners. X's owners also had to negotiate and finalise the "make good" component of the lease for the office occupied by the Business (which was not due to expire until 2YSY).

8)     X was still paying wages, superannuation and lodging BAS and paying PAYG tax throughout the 2YXZ financial year.

Events after sale of Business

9)     Once the financial planning business was sold to new owners, the new owners have continued to carry on the Business. The Business has been continuing to operate until the present time.

10)  After the sale of the Business, X's directors will retire.

11)  X has retained earnings which will be progressively paid to its directors as franked dividends over several financial years to fund their retirement.

12)  The X bank account balance is $S (as at 2YZZ) and their accrued income is $S (for the year 2YZZ).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 160-20

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 section 995-1(1)

Reasons for decision

Legislative provisions

1)     Section 160-20 of ITAA 1997 states the following requirements that must be satisfied by an entity (who had a turnover less than $5 billion for the loss year) to obtain the loss carry back (LCB) tax offset:

The entity cannot *carry back an amount of a *tax loss for an income year unless the entity:

(a)  was a *small business entity for the income year; or

(b)  would have been a small business entity for the income year if:

(i)     each reference in Subdivision 328-C (about what is a small business entity) to $10 million were instead a reference to $5 billion; and

(ii)    the reference in paragraph 328-110(5)(b) to a small business entity were instead a reference to an entity covered by this section.

2)     Section 328-110 of ITAA 1997 defines what is a "small business entity":

General rule: based on aggregated turnover worked out as at the beginning of the current income year

328-110(1)

You are a small business entity for an income year (the current year) if:

(a)  you carry on a *business in the current year; and...

3)     Subsection 995-1(1) of the ITAA 1997 defines "business" to include:

any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

ATO view

4) TR 2019/1 Income tax: when does a company carry on a business? (TR 2019/1) considers when a company carries on a business (in the general sense rather than a specific type of business) within the meaning of section 328-110 of the ITAA 1997.

5) Paragraph 18 of TR 2019/1 states that "[w]hether the activities of an entity constitute the carrying on of a business is a question of fact, and must be answered based on a wide survey, and the overall impression gained, of the activities of the entity having regard to the indicia of carrying on a business as a whole."

6) Paragraph 21 of TR 2019/1 sets out the following factors considered by the courts in determining whether the activities carried on by an entity amount to the carrying on of a business:

•                     whether the person intends to carry on a business

•                     the nature of the activities, particularly whether they have a profit-making purpose

•                     whether the activities are

o        repeated and regular

o        organised in a business - like manner, including the keeping of books, records and the use of a system

•                     the size and scale of a company's activities including the amount of capital employed in them, and

•                     whether the activity is better described as a hobby, or recreation.

7) Paragraph 26 of TR 2019/1 states that "any profit-making activities a company conducts are unlikely to have a domestic or personal character, and are likely to be characterised as being commercial in nature".

8) Paragraph 40 of TR 2019/1 provides that "[t]he activities of a company that that holds assets which generate ongoing returns may be limited to the receipt and distribution (or retention) of income and other matters of an administrative nature. While relatively limited, this level of activity is sufficient to amount to the carrying on of a business".

9) Paragraph 55 of TR 2019/1 states that "...care needs to be taken to distinguish situations where the company has ceased a particular business, from the situation where the company has ceased carrying on any business. For example, a company may cease trading operations permanently but retain some investments. For this reason, it may still be carrying on a business in the general sense."

10) Further, paragraph 56 of TR 2019/1 states that "[i]f a company sells the entirety of its former business, it ceases to carry on that business from the date it is sold."

11) At paragraph 58 of TR 2019/1, it also provides that courts have held that a company which receives interest and royalties is carrying on a business.

12) Finally, paragraph 59 of TR 2019/1 states that a company will be considered to carry on business in a general sense (rather than a specific business) "...even if the company's activities are relatively limited, and its activities consist of passively receiving rent or returns on its investments and distributing them to its shareholders".

Application of the law

13)  According to the 'Relevant facts and circumstances' above, X:

(a) had a client base for which it provided financial planning services,

(b) maintained an office (with telephones, office equipment),

(c) employed people to carry out duties and provided these employees with the relevant entitlements (wages, superannuation);

(d) had a lease over the office it occupied and a bank guarantee that existed over this lease;

(e) maintained a bank account;

(f) carried out operations since 2YYZ in a commercial manner by lodging BAS and paying PAYG tax;

(g) sold its operations (via a Contract) on 2YRY;

(h) intend to distribute retained earnings to its directors progressively over a period of time (for their retirement).

14)  Therefore, X can be considered to be carrying on a business in a general sense for the year 2YXZ, as it:

(a)          carried out its activities with a profit-making purpose;

(b)          carried out its activities in an organised and business-like manner;

(c)           invested capital in its operations;

(d)          had returns limited to the receipt or retention of income; (e) had passive investment returns.

15)  Although X sold its main business operations partly through the year (on 2YRY), X was active in managing the transfer of the business in a manner that satisfied the contractual terms of the sale, including the deferred payment arrangement and the requirement to assist with the functioning of the business during the transition.