Taxation Law and Practice
Taxation Law and Practice
Activities are classified in terms of a business or a hobby and it is important that the two are separated. The difference depends on whether the activity is being carried for tax purposes or not. It is of great importance for the taxpayer to take into a consideration whether an activity they are involved in is for commercial purposes or whether it is situated in an environment suitable for carrying out business. Individuals have different professions which they actively do and devote much of their time and resources in doing which generate some taxable income.
Engaging in another activity on the side whether in a small scale but with a profit motive or with an intension that profits will be generate from such an activity qualifies it as a business (Braedon Clark DR, 2004). It is therefore important for a taxpayer to consider their intensions before being able to get into an activity and make any commitments in terms of investments. It is their intensions that will differentiate whether such an engagement will be considered as a hobby or business.
A tax payer should be at a position to make a sound decision based on the ATO guidelines, that in order to qualify an activity as a business, the investor should have been driven by a profit motive, that from such an investment he/she expects to profit out of the investment or profits are expected at a later date in future. In certain situations where the taxpayers activity is sustained by activities in the same industry which therefore puts the investor in a position to make a justifiable amount of profit the activity is disqualified from being a hobby and becomes a business (Small Business Development Corporation, 2012).
The Australian business law provides clear guidelines as to whether an activity is a business or a hobby which are determined by using quite a number of indicators. The indicators have to be looked into in totality and not a single indicator should be used independently to make a determinative decision on an activity. The fact that an activity does not fully qualify as a business having looked at the general indicators provided by ATO does not therefore disqualify an activity from being categorized as a business.
A taxpayer’s activity might fail to qualify as a business and as result any incomes generated from such activities are not subjected to tax according to the Australian taxation laws. However, disqualifying an activity from being a business should not be used by the taxpayer to utilize the hobby in pursuit for a business operation since the Australian law makes a provision for not taxing the income generated from hobbies.
Hobbies on the other hand can be carried on for a long time and can be turned into businesses which are taxable the moment the intension changes from that of pursuing pleasure or for recreational purposes to that driven by a profit motive (Australian Taxation Office, 2011). Common law rules The Australian Taxation office outlines several laws which are used as a basis for qualifying activities as either a hobby or a business, the commonly used are the Capital Gains Tax law (CGT) and the taxation ruling law.
The Capital Gains Tax law applies to the gains made mainly from the sale of assets in accordance with the Australian Tax, Office, (2011) where the assets which are stocked for more than one year have the privilege of getting discounted in terms of the profits made from the sale of such assets. Personal assets are however separated from the rest of the assets and losses are minimized to the taxpayer’s advantage where high capital gains are achieved in the process (Australian Taxation Office, 2012).
Taxation ruling on the other hand as a common law illustrated by the Australian Taxation Office takes into consideration a business as a primary production enterprise. The ruling gives an elaborated explanation as to what category of activities in conjunction with the general guidelines are the determinative factors used to consider whether a taxpayer’s business is in line with the primary production as per the Income Tax Assessment Act, (ITAA1997).
The ruling further shades more guidance to the taxpayers on private ruling issues and in determining the relation between the primary rulings and the normal business operations (Australian Taxation Office, 2011). Statutory Rules The Statutory rules that determine whether an enterprise qualifies as a business are provided in the Australian Taxation law and it further outlines the exemptions on activities that do not apply according to the law.
The common statutory rules that can be used to determine whether an enterprise qualifies as businesses are; the Goods and Services Act (GSA) and the Capital Gains Act (CGA), which give guidelines as to how the financial supplies are taxable through the financial institutions and provides clear rules and regulations that can be used to qualify enterprises as business provided an individual acts within the regulations. Exceptions to the statutory rules There are a few exceptions to the ruling which are concerned with the acquisitions connected to issuing of input tax supply.
Where the acquisitions are not connected to supplies that would be input taxed, the exception is applicable. Exception to the ruling is also applicable in scenarios where the acquisitions are specific which therefore limits credit acquisitions. On issues of assets which are owned by the taxpayer all the assets are taxable except the assets that were acquired before the Capital Gains Act was included in the Australian Taxation Office’s constitution and the personal use assets that includes the taxpayer’s house and other valuables.
The Leading cases One of the leading cases was in the case between player and Ors versus FCT. In this case the plaintiff filed a case for the court to find out if the deductions made were falling under section 51(1) (b) of the Income Tax Assessment Act 1936 and also to determine if the tax benefits were obtained by the applicants concerning their business as per the Act.
The tribunal in charge of the case gave a ruling in favor of the deductions and it was decided that the deductions were in order according to the law. The other case was FCT vs. Lenzo in the year 2008. Where the courts had allowed the commissioners appeal from the decision under which it was held that pt IVA did not apply to the deductions as claimed by the taxpayer in relation to his investment in a sandalwood plantation project in Western Australia.
The court had found out that in the previous decision much emphasis was placed on the genuine commercial nature of the project and did not consider whether there was a dominant purpose of obtaining a tax benefit. The court held that the structure of the scheme was only to maximize and bring forward tax benefits (Greenwoods & Freehills, 2008). ATO guidelines The guidelines are in form of indicators which are used to determine whether an activity is a business or a hobby.
The indicators act as the guideline to qualify business as follows; • If activity of the taxpayer has a significant commercial purpose it is a business • If a taxpayer’s intention is more than just engaging into a business activity it qualifies as a business; • If a taxpayer engages in a profit making activities or expects to profit from engaging in an activity; • That there is some regular pattern or repetition in carrying of an activity; • That the activity is carried on in a way that it is a true a replica of the same trade in that particular line of business; • That the activity is conducted in a businesslike manner and all the plans are geared towards making a profit; • That the activity is large in scale and there is an element of permanency where the activity is being carried out(Accounting Tools Online, 2012) Tax Advantages in being classified as a business Being classified as a business has several advantages compared to a hobby.
When an enterprise is classified as a business the advantage is that it can make late payments in terms of tax payments. Enterprises which are classified as hobbies follow a different rule and the methods of payment are not as easy as those classified as businesses. The business also enjoys the reduction in tax due to the exclusion of some of its assets which could have formed part of the financial supply. Enterprises classified as businesses also enjoy several other allowances and they are exempted from several other additional taxes. Impact of Determination by ATO
It is important to determine whether an activity is a business so that the information is made available to the taxation authorities to add to their data base and for ease of tax collection. It also saves on time and resources which could have been used by the tax office in carrying out investigations on activities are businesses which are not compliant which is costly and comes with a cost in terms of penalties and other costs incurred alongside the time wasted in courts which could have been made productive by the taxpayer. It also helps in identifying hobbies which have a likeliness of becoming businesses which would in turn widen the tax base hence an improvement in revenue collection by the ATO.
When most information is made available for the ATO concerning the activities which are carried out by the taxpayers and classified into hobbies and businesses, it is made easier for the authorities to trace most of these activities and ensure there is maximum compliance and a greater collection of returns. The determination by the ATO as to whether an enterprise is a business or a hobby helps the taxpayers in knowing which category they fall under in terms of the activities they are engaged in which helps in improving the returns as well as an improved remittance of taxes where applicable which would also save time for the authorities concerned. The information when shared to the public with clear guidelines and the actions to be taken against the defaulters generally increase the rate compliance among the taxpayers which increases the revenue collection by the authorities.
The determination by the ATO also helps in ensuring that there is a level play ground for all the businesses where they all have the same opportunities to make genuine profits and as a result creates a competitive environment for doing business and other investments which attracts more investors and an improvement in tax collection in the long run (Australian Taxation Office, 2001). Through the use of the available sources the Australian Tax Office has been able to contact more taxpayers and through these sources more activities have been identified and the returns have improved. The authorities are still working on more advanced methods to capture more data and to be able to identify more activities and use those data to translate into returns when identified as businesses.
By determining whether an activity is a business or a hobby, majority of the taxpayers have seen the benefits of being classified as a business are determined to transform their hobbies into businesses and for both start up businesses and the existing businesses, the Australian Taxation Office has created an enabling environment which is aimed at supporting more activities (Australian Treasury, 2007). Division 35 and Negative Gearing Division 35 majorly prevents the losses incurred by the investors due to non-commercial activities checked against other incomes in the same year that the losses are made. The rule is used to assess whether the business activity is non-commercial or commercial. The losses are to be offset by income from the business activities in the later years.
Negative gearing is the situation where the taxpayer acquired a loan to obtain a property in which the cost of maintain the property and the repaying the loan interest is much more then the income being generated from the property. In order for a tax payer to benefit from negative gearing they need to pay taxes at the rates provided by ATO taking into consideration the losses they incur as a result of acquiring the property. The property value may however increase in the future which actually offsets the losses incurred by the investor (Real Estate Institute of Australia, 2005). Some individuals use this as a technique to reduce their taxable income in anticipation for a property hike in value so that the losses can be offset through the sale of the property.