Australian Taxation Law: Business or Hobby - Assignment Example

Australian Taxation Law: Business or Hobby The determination of whether an activity being carried on is a business or hobby is important because under the tax law, there are certain advantages that are extended to a taxpayer as well as certain obligations imposed on such taxpayer. Whilst a mere hobby is not subject to taxation, this advantage can be a disadvantage because the losses incurred cannot be deducted from assessable business income. The importance of the determination between one from the other is, however, complicated by the fact that the law does not in itself gives a matter-of-fact definition or guidelines as to what actually constitutes a business, but the taxpayer must consider a slew of criteria and indicia from common law, statute law and the ATO that do not make such determination any easier considering that no one principle of law is determinative as to the existence of business. 1. Business as Defined in Common Law Rulings A scrutiny of common law rulings as rendered by the courts reveal certain elements that are commonly designated as indicia of the existence of the concept of carrying on a business. These indicia include the following: commercial purpose or character; intention to engage in business; profit-making as the goal of the activity; repetition and regularity of the activity; conducted in a similar way as that of ordinary trade; organised in a business-like manner; big in scale and size, and; cannot be described better as a hobby, recreation or sports (TR 97/11 8). However, the difficulty lies in that none of the above criteria is determinative and that a criteria may as applied to an activity may qualify the latter as a business, but may not in the another case. This is because a case must take into account the entirety of facts and circumstances before an absolute declaration can be made. Table 1 lays down both positive and negative factors that can be used to determine whether an activity can be equated to carrying on a business or not. Table 1 Positive & Negative Indicators of Carrying Business (CCH 195) The leading case in common law that sets out the case for the determination of the existence of carrying on a business is Ferguson v FCT (1979) 79 ATC 4261. The Court in this case reversed the decision of the Federal Commissioner of Taxation (FCT hereafter), which denied a taxpayer from invoking the tax law to deduct expenditures from his assessable income on the ground that he was not engaged in the carrying on of a business, which in this case is the breeding of cattle through a cattle management firm whilst he was working for the Royal Navy. In finding for the appellant, the Court took the opportunity to cite some of the criteria for determining the existence of ‘carrying on of a business’ activity, which correspond to the criteria discussed in the preceding paragraphs. It was stressed in this case that the lack of profit for a given taxable year does not militate against the idea of carrying on a business as long as there is an expectation of making profits eventually. In the case of Thomas v FCT (1972) 3 ATR 165 the term “significant commercial purpose” as a signifier of a business activity was highlighted. The appellant in this case won huge amounts from gambling, which caused a sudden boost in his wealth. The Commissioner wanted to tax the profits from his gambling on the ground that he was involved in the carrying on of a business. The Court did not agree on the ground that there was no showing that the appellant was engaged in the carrying on of a business as he was not engaged in a significant commercial purpose because he did not maximise his return nor he employed system or organisation in his gambling. In the old case of Smith v Anderson (1880) 15 Ch D 247, the Court held that the carrying on of a business entails repetitious acts and necessarily an association, which had been formed for the purpose of conducting a sole activity, which is not to be repeated. 2. Business as Defined by the Taxation Law Under the Income Tax Assessment Act, business is defined as “any profession, trade, employment, vocation or calling, but does not include occupation as an employee” (sec. 995.1, ITAA 1997). Relative to this definition is the provision that requires that income earned from carrying on a business is assessable taxation as stated in sec. 6.5(1) of said Act. Furthermore, various provisions of the Act significantly relate to the term ‘carrying on a business’ because of the benefits they give to the taxpayer and this includes the following; sec. 8.1 of the ITAA 1997, which allows deduction of expenses from assessable income so long as such expenditures are incurred in the course of carrying on a business; sec. 40.880 of the ITAA 1997, which allows the deduction of capital expenditures from assessable income over five years if they are business related costs, and; se. 35.10, which grants the deferment of deduction for expenses to the next years if the deductible amount exceeds that of the present year. Some of the leading cases under statutory legislation are Hattrick and Commissioner of Taxation [2008] AATA 301 and Peerless Marine Pty Ltd 2006 ATC 2419. In Hattrick, the Tax Commissioner denied the claim for deduction of the appellant on the ground that he was not carrying on a business for the specific period of time in which the deduction claim corresponded to. The appellant in this case bought a boat for a charter business in July 2003, registered it in October for that year and received the boat only in may 2004 after completion of its manufacture. He claimed deductions for the year ending 2004 on the ground that he commenced the business on the day he registered the boat, as well as for the year ending 2005. His claim for deduction for the year ending 2005 was approved, but not for deductions for the year ending 2004. The Court sustained this ruling on the ground that prior to December 2004 the appellant did not start profit-making transactions based on the following evidence: business plan was prepared only in 2005; no reciprocal survey was made until August 2004; reciprocal certificates were issued only in September 2004; no skipper was engaged until December 2004; the use of the boat until December 2004 pointed to private leisure; marketing was planned only in December 2004, and; there were no marketing efforts prior to December 2004. In Peerless, the appellant was a corporation created for the purpose of building luxury catamarans to be sold in the market and was so registered in 2000. The first boat it built was called White Spirit, which went on display in 2002 to promote the corporation’s capacity to build luxury boats as well as to sell it and was eventually sold in 2006 for $1.25 million. In between the corporation incurred losses. It claimed deductions for those losses, but disallowed on the ground that it was not carrying on a business while the boat was merely exhibited to the public and the losses were part of a private or domestic nature. The Court rejected these claims and held that there was a carrying on of business despite the fact that the boat was exhibited for a long time because its purpose was geared towards the efficient conduct of business. 3. Business as Defined under ATO Guidelines The Australian Tax Office (ATO hereafter), which issues periodic guidelines, has also laid down directions to make the distinction between business and other activities, such as a hobby. In TR 97/11, entitled ‘Income tax: am I carrying on a business of primary production?,’ ATO provided some directions in interpreting the terms ‘business of primary production’ under the ITAA 1997, although it does not take into account the detailed rulings of said provisions of the law. It likewise considered whether the following activities can be termed ‘business’ within the context of ITAA 1997: artificial breeding services; kelp harvesting; forest operations; beach worming, and; live sheep export. In TR 2005/1, which is entitled ‘Income tax: carrying on business as a professional artist,’ the ATO renders guidance with respect to the field of professional arts so that artists can determine for themselves whether they are carrying on a business or not, for tax purposes. This guideline is related to sections 6,5, 8.1, Div. 35 and subsection 35.10(04) of the Act. Finally, in TR 2008/2, entitled ‘Income tax: various income tax issues relating to the horse industry; including whether racing, training and breeding activities (carried out as stand-alone activities or in combination) amount to the carrying on of a business (22 June 2011),’ the ATO gives some guidelines in determining whether parties engaged in the conduct of horse racing and breeding and related activities may be deemed carrying on a business for tax purposes. 4. Benefits of a Business Classification As can be gleaned from earlier discussions, especially in the cases decided by the courts, conducting an activity within the context of carrying on a business can bring benefits to the taxpayer although the profits earned from that activity is considered assessable income. Some of these benefits are the privilege to claim deductions from assessable income for expenses or losses incurred for that business. This is so provided in sec. 8.1 of the Act, which allows deduction in two situations: for losses and outgoings incurred while conducting the business, and; for expenses sustained as a consequence of carrying on the business. Moreover, under sec. 40.880 of said law, a taxpayer is allowed deductions from assessable income for a maximum of five years of capital costs. This is allowed at the rate of 20% per annum for those five years. Finally, the provisions of Division 35 describe a deferment scheme of deductions for losses in succeeding years of the year in which the loss occurred allowing the maximisation of deductions. 5. Division 35 of ITAA 1997 and Gearing A negative gearing is a consequence of negative profit from an asset that was bought from funds that were loaned. This situation arises when such an asset’s gain falls below the amount needed to pay the interest to the loan and the costs for its maintenance. The law allows negative gearings to be deductible under sec. 8.1 of the ITAA 1997 and validated in the case of FCT v. Total Holdings (Aust) Pty Ltd 79 ATC 4279, where the Court held that “if a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective income producing activities, whether such activities are properly characterised as a business or not, generally the payment of him of that interest will be allowed deduction.” On the other hand, Division 35 covers business of primary production or professional arts and not passive investments that are usually the objects of negative gearings. In this sense, a negative gearing cannot be the subject of Division 35. Works Cited CCH. Australian Master Accountants Guide. CCH Australia Limited, 2009. FCT v. Total Holdings (Aust) Pty Ltd 79 ATC 4279 FCT v Walker 85 ATC 4179. Ferguson v FCT (1979) 79 ATC 4261 Hattrick and Commissioner of Taxation [2008] AATA 301 Income Tax Assessment Act 1997. Peerless Marine Pty Ltd 2006 ATC 2419 Smith v Anderson (1880) 15 Ch D 247 Thomas v FCT (1972) 3 ATR 165 Read More