Private ruling: Income Tax - Deductions
Date of advice: 10 August 2017
Published: November 2017
Ruling period: Year ended 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: Is the taxpayer entitled to claim an income tax deduction? | A1: No.

Relevant facts and circumstances: You were terminated from your employment. You undertook research to identify a business you could purchase or commence. You decided to purchase a commercial franchise business. You initiated the contact and over a period of time you had several communications with a representative, Individual A, via verbal and written communication. You were required to complete forms in order to receive further information regarding the opportunity. Individual A scheduled a meeting with Individual B and advised they were the 'brains behind the operation’. In 20XX you spoke with Individual B and were subsequently offered by Individual B a Commercial Franchise Business. Prior to purchasing the franchise Individual B provided you an extensive amount of background information regarding the business. You registered for GST from 20XX. In 20XX you signed a contract to purchase the commercial franchise business. You paid a sum of money and the franchisor agreed to provide an interest free vendor of an amount. Once you paid the money contact with Individual B become infrequent and difficult and they were regularly traveling overseas. There were a number of events that occurred which you outlined in your private ruling application that resulted in months of delays. As a result you never completed any of the training or received any equipment as stipulated under the contract. The contract did not stipulate the value of the equipment you were to receive. In 20XX you could no longer contact the franchisor and you were now aware that Individual B had been arrested for other fraudulent activities and was currently in Jail in another country. At this time you sought other income earning activities. You subsequently learned the franchise was not genuine but a fraud carried out by a well-known Australian Fraudster. You have provided additional details and evidence of your events in your private ruling application that have been considered as part of this ruling.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 108-5

Reasons for decision: Detailed Reasoning - Allowable Deductions: Section 8-1 of the ITAA 1997 allows a deduction from your assessable income for any loss or outgoing to the extent that: a) it is incurred in gaining or producing your assessable income; or b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. However, you cannot deduct a loss or outgoing under this section to the extent that: a) it is a loss or outgoing of capital, or of a capital nature; or b) it is a loss or outgoing of a private or domestic nature; or c) it is incurred in relation to gaining or producing your exempt income; or d) a provision of ITAA 1997 prevents you from deducting it.’ | Detailed Reasoning - Are you carrying on a business?: Whether a business is being carried on depends on the 'large or general impression gained' ( Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all the indicators of carrying on a business, and no one indicator will be decisive ( Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). These indicators are described in Taxation Ruling TR 97/11. Outlined below are matters that would generally be taken into account in weighing-up the indicators to establish whether a taxpayer is carrying on a business. | Detailed Reasoning - Significant commercial purpose or character: This indicator generally covers aspects of all the other indicators. The business should be carried out on such a scale and in such a way as to show it is being operated on a commercial basis and in a commercially viable manner and that the taxpayer's involvement in the activity is capable of producing a tax profit. | Detailed Reasoning - Purpose and intention to engage in business and nature of the activities: The taxpayer should be able to demonstrate an intention to derive assessable income from the business activity. A taxpayer should also be able to demonstrate that appropriate activities have been carried out by that taxpayer, or on the taxpayer's behalf, to allow this to occur. | Detailed Reasoning - Intention to make a profit and prospect of profits: The taxpayer's involvement in the business activity should be motivated by wanting to make a tax profit and the taxpayer's activities should be conducted in a way that facilitates this. This will require examining whether objectively there is a real prospect of making such a profit from participating in the business, that is, from the carrying on of a business of that taxpayer. | Detailed Reasoning - Repetition and regularity: The taxpayer's activities should involve repetition and regularity and have an air of permanence about them. | Detailed Reasoning - Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business: The taxpayer's activities or those conducted on the taxpayer's behalf should, unless circumstances dictate otherwise, be based around business methods and procedures of a type ordinarily used in ventures that would commonly be said to be businesses. The activities should be carried out using accepted practices. | Detailed Reasoning - Organisation, systematic, business-like manner: 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 someone else carries out the activities on the taxpayer's behalf, there should be regular reports provided to the taxpayer on the results of those activities. | Detailed Reasoning - The size and scale of the activity: The business should be large enough to make it commercially viable. After weighing up the above indicators of whether a business is being is carried on against the information you have provided, the overall impression gained is that your activity was not carried on as a business for income tax purposes. You never received the plant or started any of the business operations. The activity mainly involved the transfer of money to a fraudulent individual. Although you had the intention to engage in a business activity none of the activities undertaken by you amount to the carrying on of a business. In view of the above, we consider that the loss is not deductible as a business expense under section 8-1 of the ITAA 1997. | Detailed Reasoning - Additional information: Generally, the expenses connected with the acquisition, establishment and enlargement of a business or with the acquisition of fixed capital assets, are not deductible under section 8-1 of the ITAA 1997. The costs of establishing a business are not considered as a cost of carrying on the business for the purpose of gaining or producing assessable income, unless it is an operating expense. This is supported by the comments of Menzies J in John Fairfax & Sons Pty Ltd v. Federal Commissioner of Taxation (1959) 101 CLR 30; (1959) 11 ATD 510; (1959) 7 AITR 346: To make a payment to acquire or to defend the acquisition of a favourable position from which to earn income or to enter into arrangements that will yield income, is not in general an outlay incurred either in gaining or in carrying on business for the purpose of gaining assessable income; such a payment in the case of a trading company, occurs at a stage too remote from the receipt of income to be so regarded. To be deductible an outlay must be part of the cost of trading operations to produce income, i.e., it must have the character of a working expense. Expenses associated with the establishment or purchase of a business, are incurred at a point too soon to be regarded as being incurred in carrying on the business. | Detailed Reasoning - Isolated transaction: The term 'isolated transaction', in relation to a non-business taxpayer refers to any transaction entered into by the taxpayer. Taxation Ruling TR 92/4 discusses the circumstances under which losses from isolated transactions are deductible for income tax purposes. A loss from an isolated transaction entered into by a non-business taxpayer is regarded as deductible under section 8-1 of the ITAA 1997 if: i. the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain, and ii. the transaction was entered into, and the loss was made, in the course of carrying out a commercial operation. In your particular case, the information you have provided indicates that you had an intention to make a profit when you entered into the activity. However, we do not accept that the loss was made in the course of carrying out a commercial operation. We consider that, as the activity was fraudulent and fictitious, there was not a bona fide commercial operation. As such, we consider that the loss is not deductible under section 8-1 of the ITAA 1997 and that it is capital in nature.