Private ruling: Income Tax ~~ Assessable income and deductions ~~ carrying on a business
Published: April 2014
Ruling period: Income year ended 30 June 2014 | Income year ended 30 June 2015 | Income year ended 30 June 2016 | Income year ended 30 June 2017 | Income year ended 30 June 2018 | Income year ended 30 June 2019 | Income year ended 30 June 2020
Date scheme commenced: Date of issue of private ruling.

Ruling: Q1: Will profits derived and losses incurred by the taxpayer on the realisation of investments in its venture capital portfolio be respectively included in its assessable income under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) and deductible against its assessable income under section 8-1 of the ITAA 1997? | A1: Yes.

Relevant facts and circumstances: The taxpayer is a resident for tax purposes. The taxpayer undertakes a diverse range of commercial operations, including investments in venture capital. The venture capital operations of the taxpayer are analogous to that of a venture capital or private equity manager of a venture capital or private equity fund. The executives who conduct the venture capital investment activities are engaged in continual discussion regarding the individual venture capital investments, conduct assessments and undertake due diligence of potential additions to the portfolio, actively monitor and times act as directors of investee entities, and participate in deliberations over whether to exit investments. The venture capital team will from time to time also seek guidance from the broader group's advisory board on the merits of undertaking or realising a specific investment. The advisory board's members bring vast transactional experience across all areas of commerce, including the venture capital sector. The taxpayer maintains a separate record and conducts periodic valuations of its venture capital investments so that it can track the performance of each investment as well as the portfolio as a whole. The taxpayer currently holds a number of unrealised investments in its venture capital portfolio, and investments have previously been realised. These investments comprise two types of interests. One type comprises shares in companies or units in trusts which operate or control the operation of a stand-alone business, and the other type comprises interests in intermediary entities such as unit trusts, limited partnerships of other fund structures which undertake multiple venture capital investments. In both types of cases the participation of the taxpayer will generally only constitute a minority interest in the investee entity or vehicle. Each of the investments in the venture capital portfolio has the following characteristics: • For those investments comprising shares or units in entities which conduct or control stand-alone businesses, it is the sole intention of the taxpayer to generate a return by way of resale at a profit. In those cases where the investment is made through an intermediary vehicle, the taxpayer has a dual intention. Firstly, it has the intention of receiving distributions of profits from the realisation of assets acquired for resale at a profit by that vehicle. Secondly, it maintains the flexibility and has a parallel intention to realise the investment in the vehicle itself where this presents as a more effective exit strategy. • There is no expectation of receiving dividends or other analogous distributions of profit generated by underlying businesses. This reflects the predominately start-up/early stage of development of the underlying businesses. • A hurdle rate of X% internal rate of return (IRR) is used as the benchmark for assessing investment opportunities. In some cases a higher IRR is sought reflecting the higher level of risk associated with investments which have a particularly speculative nature. Conversely the portfolio may include an investment made at a lower benchmark of Y% IRR where the inherent level of risk is assessed as relatively low. • The venture capital team will not become operationally involved in the venture capital investments, however where a particular investment presents a directorship opportunity, a member of the team will typically participate as a director of the board of the relevant entity. • The underlying investments will typically have low levels of gearing recognising the start-up/early stage nature of the particular operation. • The intended holding period will mostly be in the range of 2-5 years, depending on the individual business case and the likely timeframe of generating the required rate return. In cases of a more speculative start up nature, there is potentially an expectation of a holding period of less than 2 years, whereas in cases where their investment is made through a an intermediary vehicle, the holding period may be greater than 5 years so as to extract profits from the divestment of multiple investments undertaken by that vehicle.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 6-5(2) | Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision: Summary: Profits derived and losses incurred by the taxpayer on the realisation of investments in its venture capital portfolio will be respectively included in its assessable income under subsection 6-5(2) of the ITAA 1997 and deductible against its assessable income under section 8-1 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: It has been submitted that any profits or losses made on the realisation of each investment in the venture capital portfolio will have been made in the ordinary course of the taxpayer's business, meaning that: • the profits should be included in its assessable income under subsection 6-5(2) of the ITAA 1997, and • the losses should be deductible against its assessable income under paragraph 8-1(1)(b) of the ITAA 1997. For that submission to be considered by the Commissioner to be the case, it is necessary to determine whether the activities undertaken in the taxpayer's venture capital portfolio amount to the carrying on of a business. Subsection 995-1(1) defines 'business' to include 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'. However, this definition simply states what activities may be included in a business. It does not provide any guidance for determining whether the nature, extent, and manner of undertaking those activities amount to the carrying on of a business. For this purpose it is necessary to turn to case law. Paragraph 13 of Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production (although TR 97/11 specifically deals with carrying on a primary production business, the principles discussed in that Ruling apply to any business) states that the courts have held that the following indicators are relevant: 1. Whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators. 2. Whether the taxpayer has more than just an intention to engage in business. 3. Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity. 4. Whether there is repetition and regularity of the activity. 5. Whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business. 6. Whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit. 7. The size, scale and permanency of the activity. 8. Whether the activity is better described as a hobby, a form of recreation or a sporting activity. Accordingly, the Commissioner will now consider each of these indicators to the relevant facts provided. | Detailed Reasoning - 1. Whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators.: Paragraph 29 of TR 97/11 provides that a way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business. As per the relevant facts provided, the venture capital operations of the taxpayer are analogous to that of a venture capital or private equity manager of a venture capital or private equity fund. The taxpayer seeks to allocate a portion of its available capital to the venture capital operations with the aim of attaining a profit equal to a determined rate of return reflective of the predominately start-up/early stage of development of the underlying businesses. Therefore, the Commissioner accepts that the taxpayer's venture capital operations have satisfied this indicator. | Detailed Reasoning - 2. Whether the taxpayer has more than just an intention to engage in business.: Paragraph 39 of TR 97/11 provides that a mere intention to carry on a business is not enough. There must be activity. Brennan J in Inglis v. Federal Commissioner of Taxation 80 ATC 4001 at 4004-4005; (1979) 10 ATR 493 at 496-497 said that: 'The carrying on of a business is not a matter merely of intention. It is a matter of activity. ... At the end of the day, the extent of activity determines whether the business is being carried on. That is a question of fact and degree.' As per the relevant facts provided, it is evident that the venture capital operations of the taxpayer are more than just an intention to engage in business. The taxpayer currently holds a number of venture capital investments, and has recently realised venture capital investments. With respect to the unrealised venture capital investments, these are ideally planned to be realised when the required rate of return from each of the underlying businesses have been met. Furthermore, the taxpayer's venture capital team engage in continual discussion regarding the individual venture capital investments, conduct assessments and undertake due diligence of potential additions to the portfolio, actively monitor and times act as directors of investee entities, and participate in deliberations over whether to exit investments. Therefore, the Commissioner accepts that the taxpayer's venture capital operations have satisfied this indicator. | Detailed Reasoning - 3. Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity.: Paragraph 48 of TR 97/11 provides that stronger evidence of an intention to make a profit occurs when the taxpayer has conducted research into his/her proposed activity, consulted experts or received advice on the activity and profitability of it before setting up the business. As per the relevant facts provided, the taxpayer's venture capital team engage in continual discussion regarding the individual venture capital investments, conduct assessments and undertake due diligence of potential additions to the portfolio, actively monitor and times act as directors of investee entities, and participate in deliberations over whether to exit investments. Furthermore, from time to time they will also seek guidance from the advisory board on the merits of undertaking or realising a specific investment. The members of this advisory board have vast transactional experience across all areas of commerce, including the venture capital sector. Paragraphs 49 and 50 of TR 97/11 provide that short term losses or even the unlikelihood of a profit ever being made, do not preclude that a business is being carried on by a taxpayer. As per the relevant facts provided, higher returns are sought from venture capital investments that are reflective of the higher risk associated with the predominately start-up/early stage of development or speculative nature of the underlying businesses. Whilst the taxpayer may achieve these higher returns, the higher risk does mean that there is a higher likelihood of losses being made upon the realisation of venture capital investments as opposed to the realisation of its investments outside of the venture capital portfolio. Therefore, the Commissioner accepts that the taxpayer's venture capital operations have satisfied this indicator. | Detailed Reasoning - 4. Whether there is repetition and regularity of the activity.: Paragraph 55 of TR 97/11 provides that it is often a feature of a business that similar sorts of activities are repeated on a regular basis. The repetition of activities over a period of time on a regular basis helps to determine whether there is the carrying on of a business. It is noted that the taxpayer is precluded from undertaking a high volume of venture capital investments due to the large sums of money invested. Furthermore, each investment has an exit strategy where the investment, after a defined period (e.g. holding periods of under 2 years, 2 to 5 years, or greater than 5 years), is either planned to be sold upon the required rate of return being achieved or upon there being no realistic chance of the required rate of return being achieved. In other words, none of these investments are held in the manner that an investor would hold them, that being for the purposes of long term capital growth and the receipt of distributions of profit generated by the underlying businesses. Therefore, the Commissioner accepts that the taxpayer's venture capital operations have satisfied this indicator. | Detailed Reasoning - 5. Whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business.: Paragraph 63 of TR 97/11 provides that an activity is more likely to be a business when it is carried on in a manner to that in which other participants in the same industry carry on their activities. As per the relevant facts provided, the venture capital operations of the taxpayer are analogous to that of a venture capital or private equity manager of a venture capital or private equity fund. Furthermore, like other venture capital businesses, each underlying business invested in is at the start-up/early stage of that business and there is no expectation of receiving dividends or other analogous distributions of profit generated by these underlying businesses. Therefore, the Commissioner accepts that the taxpayer's venture capital operations have satisfied this indicator. | Detailed Reasoning - 6. Whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit.: Paragraph 68 of TR 97/11 provides that a business is characteristically carried on in a systematic and organised manner rather than on an ad hoc basis, and that an activity should generally conform with ordinary commercial principles to amount to the carrying on of a business. As per the relevant facts provided, the taxpayer's venture capital team are engaged in continual discussion regarding the individual venture capital investments, conduct assessments and undertake due diligence of potential additions to the portfolio, actively monitor and times act as directors of investee entities, and participate in deliberations over whether to exit investments. Furthermore, the taxpayer maintains a separate record and conducts periodic valuations of its venture capital investments so that it can track the performance of each investment as well as the portfolio as a whole. Therefore, the Commissioner accepts that the taxpayer's venture capital operations have satisfied this indicator. | Detailed Reasoning - 7. The size, scale and permanency of the activity.: Paragraph 77 of TR 97/11 provides that the larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business. As per the relevant facts provided, the size and scale of the taxpayer's venture capital operations are sufficient when considering the large sums of money invested. 'Permanency' is referred to by Hill J in Evans v. Federal Commissioner of Taxation 89 ATC 4555 as being of permanent character, continuity (see paragraph 25 of TR 97/11), although the courts have also recognised that the nature of some businesses may be such that periods of business activity may be intermittent with long intervals in between (see paragraph 39 of Taxation Ruling TR 2005/1 Income tax: carrying on business as a professional artist ). Although actual venture capital investments have not been entered into or exited out of on a high volume basis, this does not mean that there has not been a sufficient degree of permanency in the activities undertaken. Due to the large sums of money invested, the venture capital team are engaged in continual discussion regarding the individual venture capital investments, conduct assessments and undertake due diligence of potential additions to the portfolio, actively monitor and times act as directors of investee entities, and participate in deliberations over whether to exit investments. Therefore, the Commissioner accepts that the taxpayer's venture capital operations have satisfied this indicator. | Detailed Reasoning - 8. Whether the activity is better described as a hobby, a form of recreation or a sporting activity.: Paragraph 86 of TR 97/11 provides that the pursuit of a hobby is not the carrying on of a business for taxation purposes. As the other seven indicators have been satisfied by the taxpayer, it is evident that its venture capital operations are not the pursuit of a hobby. Therefore, the Commissioner accepts that the taxpayer's venture capital operations have satisfied this indicator. | Detailed Reasoning - Conclusion: As the Commissioner accepts that the taxpayer's venture capital operations have satisfied all of the eight indicators, the Commissioner therefore accepts that the taxpayer is carrying on a business with respect to its venture capital operations. In conclusion, all profits derived and losses incurred by the taxpayer on the realisation of investments in its venture capital portfolio will be respectively included in its assessable income under subsection 6-5(2) of the ITAA 1997 and deductible against its assessable income under section 8-1 of the ITAA 1997.