The Importance of the Distinction between Businesses and Hobbies for Australian Tax Law and the Taxation Consequences of This Distinction essay
Today, many businesses are quite difficult to distinguish from hobbies, while often taxpayers feel uncertain about their hobbies, especially, if they bring some profit. In such a situation, the question concerning the distinction between businesses and hobbies arises. Many Australians have hobbies that may bring some profit, for instance, horse-racing and training. They may turn their hobbies in businesses being unaware of such a transformation but they should be aware of their responsibility as taxpayers since the taxation of businesses is quite different from that of hobbies. Hence, the clear distinction between businesses and hobbies is virtually essential to avoid negative legal consequences such as fines and lawsuits. As a rule, Australians, who fail to distinguish their hobbies from businesses and run businesses as if their hobbies, face a risk of paying off fines and taxes owed, while in the most severe cases they may go to prison for tax evasion.
The common law rules of distinguishing between businesses and hobbies
The common law tends to identify business activities to regulate fiscal policies and to set clear and comprehensible rules that allow taxpayers to pay the taxes they owe to pay and fiscal agencies, namely the ATO, to collect taxes properly. In this regard, the common law relies heavily on traditional practices and court cases which help to distinguish businesses from hobbies. Australian courts and legislation provide a solid ground for distinguishing business activities and setting rules which define activities as business ones. However, the problem of distinguishing of businesses from hobbies existed in the past and this problem is not fully resolved today because often Australians face difficulties with distinguishing their hobbies from businesses. Moreover, today, new activities emerge due to the development of internet, online activities and overall progress of the society that makes the elaboration of clear and comprehensible rules essential to distinguish businesses from hobbies. In this regard, it is possible to dwell upon several rules, which help to distinguish businesses from hobbies.
First, if the activity has a significant commercial purpose or character, then this activity is a business one. Obviously, if an individual starts an activity to obtain certain profits and has the business purpose or purposes, then such activity is not hobby but business. Any business project has specific goals, while hobbies have the entertainment or pleasure as the main goal. On the other hand, business activities can also bring pleasure to business owners.
The taxpayer has more than just an intention to engage in business. As a rule, business activities are grounded on the business plan. Business is not an occasional activity. Instead, business is an enterprise, which an individual sets to run to meet his/her business purposes. Therefore, the taxpayer has a purpose of profit as well as a prospect of profit that also are evidence of business activities, while hobbies do not necessarily aim at obtaining some profits.
Furthermore, there is repetition and regularity to the activity in case of a business activity. Any business needs regular activities which repeat over and over again. The business cycle is repeating, while hobbies are rather fragmentary as individuals have hobbies for their entertainment mainly without any regular schedule, for instance, as is the case of business.
The activity of the same kind and carried on in a similar manner to businesses in the industry is the business activity too. Such activity is planned, organised and carried on in a business-like manner. Hobbies are not business-like and they do not have a concise plan that taxpayers follow strictly to reach their business goals. In such a way, the business activity has characteristics of size, scale and permanency.
In fact, it is also possible to distinguish the general rule that the business activity is really better described as a business, rather than a hobby, recreation or sporting activity. However, such a definition is quite subjective and cannot be always applied to distinguish businesses from hobbies. Instead, other rules should be taken into consideration, while distinguishing businesses and hobbies.
The statutory rules regarding whether an enterprise qualifies as business.
Along with the common law rules, there are the statutory rules regarding whether an enterprise qualifies as business in Australia. The statutory rules help to distinguish businesses from hobbies but they are grounded on existing statutes and legal acts, such as A New Tax System (Goods and Services Act) 1999. In terms of the statutory rules, business activities are also quite different from hobbies but these rules basically back up and are similar to the common law rules concerning the distinction between businesses and hobbies.
In terms of the statutory law, the business activity is considered being undertaken for commercial reasons that means that the activity has some distinct commercial purposes, such as gaining profits or establishing a company or brand that can allow its owner to start business, and so on. In this regard, the activity should have the purpose and prospect of making profits as one of the key rule, which helps to distinguish business activities from hobbies. Furthermore, the activity is undertaken regularly and repetitively and is planned, organised and carried on in a business-like manner.
However, there are some exceptions to the statutory rules. For instance, when hobbies are extremely difficult to distinguish from businesses, taxpayers can refer to the local ATO to obtain a binding private ruling from the tax office about the taxpayer’s circumstances. In such a way, the existing legislation allows taxpayers to carry on their hobbies, even if they resemble business activities but are not such by their nature. Such exceptional cases are identified by the tax office specifically and normally such cases are preceded by investigations from the part of the tax office to identify accurately whether the activity under investigation is business or hobby.
The leading cases regarding the status of an enterprise as a business or hobby
Nevertheless, the statutory rules alone are not always enough for the adequate distinction of businesses from hobbies. The common law rules are very important in Australia and court cases are very helpful in distinguishing businesses from hobbies. At this point, it is possible to refer to some cases that preceded the introduction of the Goods and Services Taxation Act of 1999 and were tried after its introduction to understand how the leading cases help to distinguish businesses from hobbies.
First of all, it is possible to refer to the Cooper Brooks Pty Ltd vs. Commissioner of Taxation of the Commonwealth of Australia (Cooper Brooks) case, which has revealed the inaccuracy of the taxation legislation that existed in that time. In this case, judges revealed the fact that if the language of a statutory provision is clear and unambiguous, and is consistent and harmonious with the other provisions of the enactment, and can be intelligibly applied to the subject matter with which it deals, it must be given its ordinary and grammatical meaning, even if it leads to a result that may seem inconvenient or unjust. To say this is not to insist on too literal an interpretation, or to deny that the court should seek the real intention of the legislature… On the other hand, if two constructions are open, the court will obviously prefer that which will avoid what it considers to be inconvenience or injustice[1]. Therefore, the clarification of the taxation legislation was necessary to help the court as well as the ATO to distinguish businesses from hobbies.
Another important case was the CIC Insurance Ltd v. Bankstown Football Club Ltd, which revealed that the problem of distinction between businesses and hobbies raises not only legal but also insurance issues, which are very important in the contemporary business and society. The CIC Insurance Ltd v. Bankstown Football Club Ltd case has revealed the fact that the existing for the time being approach to statutory interpretation (a) insists that the context be considered in the first instance, not merely at some later stage when ambiguity might be thought to arise, and (b) uses “context” in its widest sense to include such things as the existing state of the law and the mischief which, by legitimate means such as those just mentioned, one may discern the statute was intended to remedy. …Further, inconvenience or improbability of result may assist the court in preferring to the literal meaning an alternative construction which, by the steps identified above, is reasonably open and more closely conforms to the legislative intent[2]
Furthermore, it is possible to refer to the HP Mercantile Pty Ltd v. Commissioner of Taxation (HP Mercantile) case as one of the core cases that actually has led to the development and implementation of the Goods and Services Taxation Act of 1999. In fact, the case is having regard to the modern principles of interpretation as enunciated by the High Court in cases such as CIC Insurance Ltd v. Bankstown Football Club Ltd (1997) 187 CLR 384 and s 15AA of the Acts Interpretation Act 1901 (Cth) that the Court will prefer an interpretation of a statute which would give effect to the legislative purpose, as opposed to one that would not. This requires the Court to identify that purpose, both by reference to the language of the statute itself and also any extrinsic material which the Court is authorised to take into account[3]. In such a way, this case helped to elaborate criteria that help to distinguish business activities from hobbies.
In addition, it is also worth mentioning the Sterling Guardian Pty Limited v. Commissioner of Taxation case, which occurred after the introduction of the Goods and Services Taxation Act of 1999. In Sterling Guardian, Justice Stone considered it was necessary to establish whether the applicant’s analysis of the operation of the margin scheme provision – that the cost of construction (upon which the applicant claimed input tax credits) formed part of the original acquisition cost – was consistent with the legislative scheme and context[4]. The EM ignores the fact that improvements may not only have added to the value of the real property but become, in law, part of the real property. It is not the juridical nature of the improvements that is critical but the fact that they have been brought about pursuant to a taxable supply. The clear thrust of the GST Act, both in its wording and as explained in the EM, is that of a practical business tax imposed with respect to elements of commerce[5].
The guidelines or directions issued by the ATO on whether an activity might qualify as a business
Thus, on summarizing existing rules and definitions of businesses activities, as well as their key characteristics, it is possible to identify directions issues by the ATO to distinguish whether an activity may be qualified as a business or the activity is just a hobby. In fact, an activity is more likely to be a business if[6]
there are employees
the activity has been conducted for a long time
there is a large amount of capital
it is conducted full-time
it is connected with other activities that the taxpayer carries on commercially
it involves particular knowledge and skills
there are business premises
if there is a business name
The impact of a determination by the ATO on whether a taxpayer’s activity is actually a business
In actuality, the ATO has to distinsuih businesses from hobbies because they have different types of taxation. Moreover, businesses have not only their specific characteristics and taxation but also businesses need to have accounting systems to allow the ATO to apply existing taxation rules and norms properly. In actuality, the ATO stands on the ground that it is important to distinguish a business from a hobby because any money you receive from a business is assessable income, and you are entitled to an ABN[7]. For instance, if a taxpayer is operating a business which has a turnover of over $75,000 per annum, the taxpayer must also register for GST. Such requirements allow the ATO to monitor and control taxpayers in terms of their responsible and correct observation of existing taxation regulations and policies.
The advantages in terms of tax in being classified as a business and disadvantages
The classification as a business has its advantages because it allows the business to benefit from existing subsidies and to follow existing rules, which put all taxpayers on the equal ground and to maintain the fair competition, which is vitally important for the open market economy and businesses.
On the other hand, the classification as a business may limit hobby activities of individuals, because they may not always enjoy their hobbies, if they are transferred to businesses, while the ATO has to track all activities, which taxpayers do not always perceive as businesses.
The Division 35 ITAA97 provisions and the relevance (if any) of these provisions
- Division 35 was introduced into the ITAA 1997 via the New Business Tax System(Integrity Measures) Act 2000. It applies from 1 July 2000 to each and every income year in which an individual taxpayer carries on a relevant *business activity. The main operative provision in the Division is section 35-10. The major rule in section 35-10 is that unless in each year:
- a) the individual’s *business activity meets one of the four tests, and for the 2009-10 and later income years, the income requirement is also satisfied.
- b) the individual comes within the Exception; or
- c) the individual is covered by an exercise of the Commissioner’s discretion in relation to that *business activity,
a loss from the *business activity will not be deductible in the income year in which it arose. The law applies as if the loss were not incurred in the income year[8].
Conclusion: The importance of the distinction between a hobby and a business for the application of the GST law
Thus, the existing legislation, including the Division 35 of ITAA 97 provisions, makes the taxation obligatory for businesses and individuals should pay taxes annually and declare their profits from their businesses. Otherwise, they face a risk of being accused of tax evasion. Therefore, the distinction of businesses from hobbies is essential and beneficial for both taxpayers and the ATO because, on the one hand, taxpayers pay taxes and meet legal requirements of Australia concerning taxation that prevents any legal prosecution or lawsuits being filed against them, while the ATO managers taxes effectively and collects taxes from businesses within the existing legal framework.
[1] (1980) 147 CLR 297.
[2] (1997) 187 CLR 384 at 408.
[3] (2005) 143 FCR 553 at 564.
[4] [2005] FCA 1166 at [33].
[5] [2005] FCA 1166 at [33].
[6] Kruger, W. (2008). Is It a Business or Is It a Hobby. Retrieved on September 13, 2012 from http://www.thetaxwiseblog.com/business-tax-tips/is-it-a-business-or-is-it-a-hobby/
[7] Hammond, M. (2010). Entrepreneurs Warned Over Business and Hobby Definitions. Retrieved on September 13, 2012 from http://www.startupsmart.com.au/finance/tax/2010-12-01/entrepreneurs-warned-over-business-and-hobby-definitions.html
[8] Income Tax Division 35 – Non-Commercial Business Losses. (2012). Retrieved on September 13, 2012 from http://law.ato.gov.au/atolaw/view.htm?docid=TXR/TR200114/nat/ato/00001
