Private ruling: Carrying on a business – non-commercial losses
Date of advice: 13 February 2018
Published: June 2018
Ruling period: Income year ending 30 June 2015 | Income year ending 30 June 2016 | Income year ending 30 June 2017
Date scheme commenced: 1 July 2014

Ruling: Q1: Are you carrying on a business? | A1: No | Q2: Can you apply any losses incurred in relation to your activities? | A2: No

Relevant facts and circumstances: You commenced your business activities a number of years ago. You have diversified your business activities recently to include other products. You have undertaken your activities through the following entities: Entity 1 You obtained an Australian Business Number (ABN) and registered this entity. You operate as a sole trader. Activities undertaken include designing patterns and styles, sourcing materials and producing garments (products) for the purposes of selling it on your website. Your products are speciality items not massed produced but individually crafted and made to suit the customer’s specifications. You don’t have a business plan and have not produced any financial forecasts. You didn’t generate any sales in the first income year, as you were undertaking preliminary activities to establish your business including the following: ● producing products and launching the collection through an online website you established; ● testing the product quality before launching the products; ● engaging models to feature in the online website; and ● capturing and editing photographs of models wearing your products to feature online. Through online sales you derived income from the sale of your product and losses over the previous income years. You included income and expenses derived from your activities in your income tax returns. You have embarked on the following activities to build your reputation, audience and reduce your overheads: ● taking your own photographic images of models wearing your products instead of paying a professional photographer; ● designing patterns and sewing the products; ● combining with other labels to undertake joint photo shoots and cross promotional and marketing strategies; ● operating from a studio opened to the public to attract customers for part of the time you have conducted the activities; ● you have spoken to retailers and intend selling products by consignment; and ● you have recently engaged a volunteer which will free up your time to allow you to focus on marketing your products. You have not been successful in stocking your products with local retailers. You have promoted your products in various publications. You have expertise in management and working in an office environment. You have honed your videography and photography skills through your creative interests and designed products influenced by your travel. Your sewing and design skills are self- taught. You are registered with various creative organisations, which allows you to keep up to date with events, research, market strategies, business models and business culture. You record your sales using a relevant Program. You have a separate bank account for your creative/business activities. You have skills in bookkeeping and obtain quarterly advice from your accountant. You have processed several customer orders relating to products that have featured on your website to both domestic and overseas clients. You have invested in multimedia equipment such as video and photographic equipment that allows you to produce professional catalogues for your products that are shown on your webpage and shown to retailers. You promote your products on social media. Other suppliers promote your products on their social media sites. You have invested in equipment necessary to undertake various tasks and product development, as well as IT equipment. Entity 2 In more recent times you diversified your products to include other products. You have an ABN for this entity. You received some government funding in establishing this entity. You have set financial goals for the first couple of years of your operations. You have a business plan in relation to Entity 2 and aim to target a specific client group based on their age. You aim to incorporate creative designs on your products. All your products are hand crafted, unique pieces. You have sold a small number of products and given away others since you commenced your activities. You have researched the need for your product and identified competitors, their prices and their weaknesses. You completed surveys with other businesses and customers from your previous premises as part of your research. You have produced patterns and designs for products and sourced quality materials. You will be launching a website in the future with order and payment facilities. You spend a significant number of hours per week on your activities. including the following: ● pattern making; ● making the product; ● organising photograph shoots with models and cross promotions with other businesses; ● compiling and editing videos; ● liaising with suppliers of material; and ● administration and marketing. You have established accounts with existing and new suppliers. You network with designers and suppliers by attending relevant launches and have attended one trade show. You operate Entity 2 in a shared venue with other businesses. You are fitting out another space to create another work space. You will focus on building up your clientele and online presence. You will visit markets and approach retailers to sell your products by consignment.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Division 35 | Income Tax Assessment Act 1997 Subsection 35-10(5) | Income Tax Assessment Act 1997 Subsection 405-25(2) and (5) | Income Tax Assessment Act 1997 Section 995-1

Reasons for decision: Summary: It is not viewed that you are currently carrying on a business in relation to your Entity 1 and Entity 1 activities and that your activities are preliminary activities aimed at establishing potential businesses. | Detailed Reasoning - Detailed reasoning: Carrying on a business Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. The case of Evans v. Federal Commissioner of Taxation 89 ACT 4540; (1989) 20 ATR 922 stated that whether or not an activity amounts to carrying on business for taxation purposes is a question of fact. There is no exhaustive or determinative definition which can be applied to determine this matter. Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548, however, provides that the test for determining whether or not a business is being carried on is both subjective, which considers the individuals purpose at the relevant time, and objective, which considers the nature and extent of the activities undertaken. Both Taxation Ruling TR 98/11 Income Tax: Am I carrying on a business of primary production? (TR 98/11) and Taxation Ruling 2005/1 Income Tax: Carrying on a business as a professional artist (TR 2005/1) provides the Commissioner’s view of the factors that are considered important in determining if you are in business for tax purposes. The factors are: ● whether the activity has a significant commercial purpose or character; ● whether the taxpayer has more than just an intention to engage in business; ● whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity; ● whether there is regularity and repetition of the activity; ● whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business; ● whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit the size, scale and permanency of the activity; and ● whether the activity is better described as a hobby, a form of recreation or sporting activity. No one indicator is decisive. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression gained. Application to your circumstances Based on the information you have provided we do not consider that your activities have the necessary characteristics of a business for taxation purposes for the following reasons: ● your activities are considered to be preliminary to the carrying on of a business. Preliminary activities being conducted by you include: ● designing patterns and sourcing raw materials; ● creating a website for your products; ● commencing to place designs on your products; and ● identifying retailers to sell your product by consignment. ● you haven’t demonstrated overt and planned activities aimed at commercially exploiting your artistic skills, making your products assessable to the market and realising a profit. You are investigating selling your product by consignment to local retailers and attending local markets. ● the carrying on of a business requires activities to be engaged in for the purpose of profit on a continuous and repetitive basis. You haven’t developed any financial projections in relation to Entity 1 and do not have a business plan. While you have a business plan for Entity 2 you are not meeting your financial projections as you are only in the preliminary stages of manufacturing and marketing your products. As your activities as not viewed as those involved in the carrying on of a business, any income you receive in relation to your activities will not be assessable under section 6-5 of the ITAA 1997 as ordinary income. In addition, any expenses that you incur in relation to these activities will not be deductible. Future years Although it is not viewed that you are currently carrying on a business in relation to your activities, your activities could change to that of being in business over time as your level of activity changes. Therefore you should evaluate your level of activity on a regular basis to see whether you are conducting a hobby or carrying on a business. | Summary: The non-commercial losses provisions will not apply to your Entity 1 and Entity 2 activities because it is not viewed that you are carrying on a business in relation to those activities. | Detailed Reasoning - Detailed reasoning: Losses from a professional art business If your loss making business is a result of carrying on a professional arts business and your assessable income from other sources is less than $40,000, you can offset your losses from your other income. Deferral of losses from non-commercial business activities Division 35 of the ITAA 1997 applies to losses from certain business activities for the 2000-01 income year and subsequent years. A person carrying on a business may be able to defer losses derived from their business activity if they don’t meet one of the four tests or exemption provided for under Division 35 of the ITAA 1997. Division 35 of the ITAA 1997 does not apply to activities that do not constitute the carrying on of a business. Application to your circumstances Your creative activities in operating Entities 1 and 2 don’t have the indicia of carrying on a business. You cannot offset losses derived from Entities 1 and 2 against your other employment income as: 1. You were not carrying on a business; and 2. Your income was greater than $40,000 for some of the income years. You therefore cannot defer and carrying forward the losses derived from these activities to offset against future income connected with these activities as you are not carrying on a business. The non-commercial losses provisions will not apply to your situation.