Private ruling: Am I in business and the Commissioner’s discretion for non-commercial business losses
Date of advice: 7 April 2015
Published: April 2015
Ruling period: Year ended 30 June 2013 | Year ended 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you considered to be carrying on a business in relation to a product you have invented? | A1: No. | Q2: Will the Commissioner exercise the discretion in paragraph 35-55(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses in relation to the product in your calculation of taxable income for the 2012-13 and 2013-14 financial years? | A2: Not applicable.

Relevant facts and circumstances: You are employed fulltime. You have invented a product (the product) which you plan to have manufactured in commercial quantities and sell in Australia and in a country overseas. You have other inventions, however they are in the early research and development phase. You came up with the idea for the product a number of years ago. You have designed and manufactured several prototypes leading up to and including the 2012-13 financial year, and began marketing the product in the 2013-14 financial year. You have had a small number of the product manufactured, which have and will be used for marketing purposes. You have had some interest in your product from parties. However you have not entered into contracts with the parties to stock your product. You are yet to have a commercial quantity of the product manufactured. The delays have primarily been caused by fluid work arrangements with your employer (commitments for months at a time), and the associated delays in confirming your market approach. As a result of these delays you believe that it may appear that activity in relation to the product seems sporadic. However you believe that it in no way reflects on your commitment to the activity. With the assistance of your tax agent, you have provided projected income figures for the activity. You have incurred expenses in the 2012-13 and 2013-14 financial years manufacturing the product prototypes, securing domain names, online marketing, product name, business cards, logo development, travel and home office expenses. You have made a loss in those years. You have sold one unit which was intended to be a display unit for marketing purposes. There have been no other sales of the product. You have a basic business plan that meets needs at this stage. You have not and do not intend to patent the product due to the nature of the product and your business approach. Due to the expenses you have incurred and the effort that has gone into the activity, you believe the activity has advanced beyond the research and development stage and you are carrying on a business.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 35 | Income Tax Assessment Act 1997 Section 995-1

Reasons for decision: Summary: For the 2009-10 and later financial years, Division 35 of the ITAA 1997 will apply to defer a non-commercial loss from a business activity unless: n you satisfy the income requirement and you pass one of the four tests n the exceptions apply n the Commissioner exercises his discretion. However, for this division to apply, you must be carrying on a business. Section 995-1 of the 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. The facts of each case must be examined. In Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548, Webb J said: The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained. When does a business activity commence? The actual date of commencement of a business activity is a question of fact ( Goodman Fielder Wattie Ltd v. FC of T 91 ATC 4438; (1991) 22 ATR 26) ( Goodman Fielder Wattie ). For a business activity to have commenced a person must have: n purpose, intention and decision to commence the business activity n acquired a minimum level of business assets to allow that business activity to be carried on, and n actually commenced business operations ( Calkin v. CIR [1984] 1 NZLR 440). We must examine the above indicators in light of the characterisation of your business activity. In Goodman Fielder Wattie , Hill J stated at 4,447: 'Critical to the resolution of the present controversy, is the characterisation of the business activity itself which is said to have commenced. It was conceded properly by the applicant that if the business claimed to be carried on by it was to be characterised as one of manufacturing and selling monoclonal antibody products, then that business did not commence until around November 1982...' For example, if your business activity is characterised as a primary production activity, involving the planting and cultivating of trees, then the planting of the trees could be seen as the commencement of that business. Alternatively, if your business activity is characterised as the manufacturing and selling of a product, the business would generally be considered to commence once you have manufactured and began selling the product. In your case it is considered that the business activity you intend to carry on is characterised as the manufacturing and selling of a product. We can now consider the indicators set out above to determine whether this business activity has commenced. Purpose, Intention and Decision The intention and purpose of a taxpayer in engaging in an activity is relevant to when a business commences. However, an intention to commence a business will not determine that the business activity has actually commenced. The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity. This is developed by researching the proposed business and, in some instances, by experiment. This process culminates in a final decision on whether to commence business. However, not all businesses commence in such an orderly manner. It is clear from the information you have provided that you have researched your proposed business activity, decided on the form of that business and have committed yourself to it. Acquisition of a minimum level of business assets to allow that business activity to be carried on Most business activities have a structure that provides the framework of the business. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity. In Calkin v. CIR [1984] 1 NZLR 440 Richardson J said at 446-447: Clearly it is not sufficient that the taxpayer has made a commitment to engage in business: he must first establish a profit-making structure and begin ordinary business operations. For a business activity to commence, an appropriate business structure should be in place and begin ordinary business operations. As to what the business structure will consist of, and its size, will be a question of fact and degree, and will depend on the nature of the business activity. Your activity is the selling of a product to the general public. You have created several prototypes and have had manufactured a small number of the final prototype for marketing purposes, and have commenced marketing the product to a number of retailers. However to date you have not entered into contracts with retailers to stock your product, you have not established the number of product required to commence selling to the general public, and you have not manufactured a commercial quantity of your product to commence trading. As such is it considered that you do not yet have the necessary business structure in place for you to commence your business activity. Commencement of Business Operations As noted by Brennan J in Inglis v Federal Commissioner of Taxation (1979) 10 ATR 493; 80 ATC 4001, the level of activity is important in deciding whether a business is being carried on. Brennan J stated at ATC 4004-4005; ATR 496-497 that: The carrying on of a business is not a matter merely of intention. It is a matter of activity. Yet the degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the supposed business is being conducted. In Hadlow and FC of T [2002] AATA 1250; (2002) 2002 ATC 2294; (2002) 51 ATR 1197 the Small Taxation Claims Tribunal considered the amounts incurred by a taxpayer to research and develop a book. The question for decision was whether the activities were merely preparatory and preliminary or whether the activity had reached a stage where it was able to be characterised as a business. In concluding that the activity was not carried on as a business in the relevant years, member Mowbray stated at paragraph 26: Clearly Mr Hadlow has the subjective intention to carry on a business, but that is not sufficient. There must be business activity. There is a real question whether the activities to date are merely preparatory or preliminary (see Goodman Fielder Wattie at 4447), and whether the project has reached the stage where it is able to be characterised as a business. There has been much activity but The concept of business does not equate with being busy ( Goodman Fielder Wattie at 4447; 386; 339) Mr Hadlow has researched, undertaken travel, and visited museums, libraries and farms in pursuit of a particularly interesting topic. He has expended money but has made no sales, received no advances nor signed any contracts. It is accepted that you have gone beyond merely having an intention to engage in business and there has been some activity. For example, you have contacted parties for the purpose of having them stock your product for sale, and have sold a unit to a retailer for display purposes. However, it is important to evaluate these activities in regards to the characterisation of your business, which is the offering of your product for sale to the general public. The systematic and regular transactions from which you will produce revenue as part of your business operations, that is, customers actually purchasing your product, has not commenced. Further you have not manufactured a commercial quantity of your product for it to be available for commercial sale, nor have you contracted retailers to enable you to sell to the public. Therefore your activities to date are considered preliminary to the carrying on of your intended business and are directed at constructing or establishing a business structure. As such you are not considered to be carrying on a business for the 2012-13 and 2013-14 financial years. Please note Once you have contracted with retailers, manufactured a commercial number of the product and actually commenced commercial sales of your product, you may be considered to be carrying on a business.