Distinguishing between a Business and a Hobby - Assignment Example

Name Professor Course Date Distinguishing between a Business and a Hobby INTRODUCTION For taxation purposes, it is important to distinguish between and a hobby because the law imposes certain obligations as well as extends several benefits. Although taxation legislation has defined the word “business” this is not enough to serve as a guideline in determining what actually constitutes the carrying on of a business for taxation, purposes. The remedy for this is to look at various sources at once-common law rulings, statutory provisions and the Australian Taxation Office (ATO) guidelines. COMMON LAW RULES Although the relevant taxation legislation gives a definition of business, it does not enumerate what constitutes “the carrying on of a business,” which is one of the elements of carrying on a business of primary production, in accordance with §995-1(1) of ITAA 1997. There is a need therefore, to look into what common law rules, through case law, have provided to serve as guidelines in the determination of which activities can be appropriately labeled “carrying on of a business.’ These indicators, as culled from various cases, are indicated in Table 1. The table likewise lays down the indicators on non-business activities. Leading Cases In Martin v. FC of T (1953) 90 CLR 470 at 474, the Court held that the determinative test of a business activity is both objective and subjective. Thus, an activity is not only examined as to its nature, extent and purpose, but also the overall impression it strikes on a person examining it. It is however, the case of Ferguson v FCT (1979) 79 ATC 4261 that gave a comprehensive guideline in determining when an activity is carrying on a business or just a mere hobby. In the case, the appellant was anticipating retirement from service to the Royal Australian Navy in 3 years as a Lieutenant Commander and thus entered into two agreements in 1973, which he intended to be a starting point for an expansion to a commercial herd after retirement. The agreements were: for sublease of five Charolais heifers from a cattle-leasing company at $33 per month for each, and; a management lease for the management of the 5 heifers and their progeny for 10 years for a specific annual amount to cover the heirfers and their progeny, once they breed. One of the issues in this case was whether he was carrying a business. The argument of the Commissioner was that although it was his intention to eventually get into the business of commercial herding the lease agreements he entered into did not yet constitute or commence the business itself. The Court did not agree. On the contrary its position was that the activities of the appellant already constituted a business and therefore his expenses were already deductible under the ITAA. According to the Court although profit-making is an element of conducting a business, the lack of immediate profit in an income year does not deprive an activity of its nature as a business if other elements are present, such as repetition and regularity, organisation, book- or record-keeping, the volume of operations, the substantial amount of capital and use of a system. Even the fact that the appellant was engaged in another employment or the fact that the organised system involved in the activity was done for his him by another, so long as he was periodically apprised of developments, did not subtract from the nature of the activity as a business. It was emphasised, however, in Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922 that no one indicator is determinative whether an activity is being carried on as a business or not. It is the facts of a specific case that assists in the determination of the activity as a business and the presence of certain indicators in a case does not necessarily make it a business. Rather it is all these indicators taken together that make will determine whether an activity is a business or not. In this case, the appellant had racing as a hobby and had won substantial amounts from betting on it. It was held that he was not carrying on a business of the lack of a system or organisation in what he was doing. STATUTORY RULES The significance of the term “business” as opposed to a “hobby” is highlighted in taxation legislation, which in this case is Income Tax Assessment Act of 1997 (ITAA1997). Section 995.1 also defines business broadly by referring to it as including any “any profession, trade, employment, vocation or calling, but does not include occupation as an employee.” This is too broad a definition, however, and does not really provide any inkling as how a business activity can be differentiated from other activities, such as a hobby. The definition of business is made more important in the light of other provisions in said law, such as s.8.1 of the ITAA 1997 or the general deduction provision, s. 44.880 of the ITAA 1997 and provisions under Div. 35, which extend certain advantages to taxpayers. Other relevant provisions are s. 6.5, 6.10 and s. 17.10, which are all about assessable income. The profit from carrying on a business is one of the taxable incomes as laid down in s. 6.5(1). Leading Cases In Black & Ors v Commissioner of Taxation 2007 ATC 2735, the partners claimed deductions incurred in the activities involving horse racing and breeding of horses and sheep carried in one of the three partner’s property. The Commissioner rejected the deduction request on the ground that the activity was not carrying on a business for Goods and Services Taxation (GST) purposes. This was reversed by the Tribunal after it reviewed evidence showing that the horse racing and breeding activities were conducted in an organised and systematic manner where records were kept and prepared by accountants. In Kennedy v FC of T 2005 ATC 2098, the appellant was engaged in the production of film documentaries and claimed deductions arising from carrying on that activity. The Commissioner, however, refused this on the ground that he was not carrying on a business and instead exercised his discretion under s. 35.55 which is to refused to apply Division 35 if he finds it unreasonable. The Court sustained the Commissioner’s ruling on the ground that after reviewing the evidence at hand, it seemed to the Court that the appellant did not intend to earn profit from producing documentaries, but intended only to derive artistic pleasure from it. ATO GUIDELINES The ATO Guidelines that are relevant to the subject of business as differentiated from other activities, such as a hobby, are found in TR 97/11, which is carrying on a business of primary production, TR 2005/1, which is carrying on a business as a professional artist and TR 2008/2 on horse industry. SIGNIFICANCE OF BEING CLASSIFIED AS A BUSINESS The significance of being classified as a business, and not a hobby, is it results in certain advantages extended by the tax law as well as the obligations imposed on the taxpayer. The advantages are: the taxpayer is entitled to deductions for expenditures; capital costs can be written off, and; losses can be forwarded for taxation purposes. Under s.8.1 of the ITAA 1997 or the general deduction provision, deductions are allowed in two limbs, the first limb being deductions for losses and outgoings to the extent they are incurred in producing assessable income, and the second limb being expenses incurred in carrying out a business so that assessable income can be produced. Under s. 44.880 of the ITAA 1997, deductions are allowed to as much as five years of capital costs that is not deductible, unless specifically prohibited by some other provision, at the rate of 20% beginning the year in which the expenditures are incurred and for four years thereafter. Finally, under Div. 35 of the ITAA 1997, losses are allowed to be deducted against profits in later years other than the year it was incurred. This is only applicable, however, to non-commercial business activities. Moreover, profits obtained from an activity that is considered carrying on a business is assessable income. APPLICATION OF DIVISION 35 TO A GEARING Division 35 is not applicable to negative gearings. A negative gearing refers to a concept in taxation that is associated to negative profit from a transaction in which an asset is bought using borrowed funds and the gain from that asset is not able to cover the loan interest as well as the other costs for its maintenance (Forlee 2012). Negative gearing is familiar in property investments and share investments, which can be categorised as passive investments and are therefore, not included within the ambit of Division 35. Moreover, such activities cannot be considered a primary production as defined under s.995.1 or a professional arts business as defined by s. 35.10. This set of provisions set down the rules for deferring the offset of certain losses to a future time other than the year in which the loss was incurred and the purpose of this is to protect the integrity of the taxation system, but it specifically excluded passive investments. This is applicable only if the following elements are present: taxpayer is an individual; taxpayer is carrying on a business activity; loss is incurred from such activity; loss is from a primary production or a professional arts business and assessable income of taxpayer not related to that activity is less than $40,000; taxpayer meets income requirement; does not pass any tests, such as assessable income, profits, real property, or Other assets, and; Commissioner’s discretion has not been exercised favourably under s. 35.55 (Division 35, ITAA 1997). CONCLUSION As can be gleaned from the preceding discussion, no one activity can be declared a business or hobby, unless facts and evidence are reviewed and taken into consideration first using both subjective and objective tests. Works Cited Black & Ors v Commissioner of Taxation 2007 ATC 2735. Evans v. FC of T 89 ATC 4540. Ferguson v FCT (1979) 79 ATC 4261. Forlee, Ron. Australian Residential Property Development: A Step-by-Step Guide for Investors. John Wiley & Sons, Jan 6, 2012. Print. Income Tax Assessment Act 1997. Kennedy v FC of T 2005 ATC 2098. Martin v. FC of T (1953) 90 CLR 470 Thomas v FCT (1972) 3 ATR 165 Read More