(1) Concept of a Business

Three areas that need to be determined are:
1. Are you carrying on a business?
2. The precise nature and scope of the business;
3. Establish the relationship between the business and the receipt ie that the receipt is a product of or an incident of carrying on the business – then ordinary income.
If you satisfy all three what you get is income under ordinary concepts, and is included in your assessable income. 

S6(1) ITAA36 AND 995-1(1) ITAA97:

“Business” is defined as “including any profession, trade, employment, vocation or calling, but does not include occupation as an employee”.  Essentially, therefore, income from business is income that is not persona exertion income, is not income from property and is income derived from carrying on a business. The question whether particular activities constitute a business is very much one of fact and degree and is left for the Courts to decide.

Indicators of a Business

Evans v FC (1989) – It is necessary that the activity be undertaken for the purpose of profit

Facts: Taxpayer had credited his successful gambling as the explanation of his sudden increase in wealth during a Tax Office audit of his affairs. This was accepted by the Commissioner who then claimed that the proceeds of his gambling were assessable because Evans was carrying on a business. 

Held: Hill J; that the taxpayer’s activities did not amount to a business because he did not try to maximize his return. On the facts, the court found the taxpayer’s activities lacked system and organization essential to characterize it as a business.

[extra] Hill J went on to say that, “the question of whether a particular activity constitutes a business involves questions of fact and degree. Although both parties referred to comments made in decided cases, each of the cases depends upon its own facts and in the ultimate is unhelpful in the resolution of some other and different fact situation. There is no one factor that is decisive of whether a particular activity constitutes a business. There are a multitude of things which together make up the carrying of the trade.

What the Courts look for to determine whether a business:

(i) the extent to which the taxpayer’s activity is characterized by system and organization
(ii) the scale on which the taxpayer conducts the activities
(iii) the extent to which the taxpayer’s activities involve sustained regular and frequent transactions
(iv) whether talent has been turned to account for profit
(v) whether the taxpayer conducted the operations with a  profit motive
(vi) the commercial character of the transactions themselves
(vii) characteristics or quantities of the property dealt in, and
(viii) inherent characteristics of the taxpayer.

Ferguson v FC (1979) – In distinguishing between a business and a hobby, courts placed considerable importance on the extent of the system and organisation involved.

Facts: Taxpayer was a naval officer who wished to engage in primary production activities upon his retirement.  Whilst still in the navy, Ferguson leased five cows for four years to be pastured and bred by a management company. 

Held: FC; Taxpayer was engaged in a (“preliminary”) business of primary production. Fisher J felt it significant that “the venture as a whole had a commercial flavour, was conducted systematically and…in a business-like manner.

FCT v Walker (1985) – Walker a taxpayer who began with only one angora goat was held to be in the business of goat breeding, largely because the court was satisfied on the facts that the taxpayer was conducting his activities in a “businesslike” way.  The taxpayer was found to be in business even though the venture was not particularly successful and was of such a small scale. 

Thomas v FCT (1972) – Scale of activities

Facts: Taxpayer was primarily a barrister, but he also argued that he was a primary producer.  On land near to the house, he planted macadamia nuts, avocado and pear trees.  He knew when planting the trees that it should be some years before he would get a return, but after that he expected to make about $3,000 pa eventually.  He set up an irrigation system, the trees initially grew fairly well, but later there was a fire and frost and the trees were destroyed.  He claimed the loss. 

Held: HC; that a man may carry on a business even though he does so in a small way.  The court held he was not growing trees as a hobby, they said on the evidence there was a significant commercial purpose involved.  The court formed that view based on the scale the trees were planted, which was much greater than his domestic needs and the fact that he expected to get some return in the future.  In regard to the lack of his business efficiency or competency, the court said that did not lead to the conclusion that he was not carrying on a business.  The court said many persons seek to commence a business of which they have not had any previous experience in the area.  It was held he was carrying on a business, albeit in a small way. As Walsh J observed in Thomas v FC of T, “a man may carry on a business although he does so in a small way”.  Thus, in FC of T v JR Walker the taxpayer was held to be in the business of goat breeding even though he began with only the one goat.  However it is clear that the courts are influenced by the size and scale of a taxpayer’s activities and that, in general, the smaller the sale of the activities the more likely the courts are to characterize them as the pursuit of a mere hobby or pastime, rather than a business.  

(2) Taxation of Business Income
ITAA 1997, ss 6-5, 10-5, 15-15    /      ITAA 1936, s 21A

Having identified a business, the next step is to determine which of the proceeds of that business are assessable as not all business receipts are necessarily income in character.

ITAA 1997 - SECT 6.5

Income according to ordinary concepts (ordinary income) 
 
(1)  Your assessable income includes income according to ordinary concepts, which is called ordinary income.
Note:          Some of the provisions about assessable income listed in section 10 5 may affect the treatment of ordinary income.
(2)  If you are an Australian resident, your assessable income includes the * ordinary income you * derived directly or indirectly from all sources, whether in or out of Australia, during the income year.
(3)  If you are a foreign resident, your assessable income includes:
                     (a)  the * ordinary income you * derived directly or indirectly from all * Australian sources during the income year; and
                     (b)  other * ordinary income that a provision includes in your assessable income for the income year on some basis other than having an * Australian source.
(4)  In working out whether you have derived an amount of * ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.

(a) Normal proceeds of a Business

Gains flowing from “trading” transactions or which are received as the “ordinary proceeds” or “ordinary incidents” of a business activity are generally income in nature. On the other hand, gains arising from the “mere realization of a capital asset” are usually capital in nature.  Where the taxpayer has a profit motive, this will usually point to an activity being a business.  There is, however, no determinative rule as to what is required for activities to constitute a business, and it will always be a question of fact and degree.

In order to determine whether a receipt is the normal product of a business, it is necessary to determine:

1. the precise nature and scope of the business, and
2. the relationship between that business and the receipt (to determine whether the receipt is produced by or is an incident of the business)

GP International Pipecoaters v FCT (1988) – precise nature and scope of the business

Facts: the taxpayer was a joint venture company incorporated for the sole purpose of carrying out a contract with the State Energy Commission of Australia which required the taxpayer to erect a pipe-coating plant complex.  Under the contract, the Commission paid the taxpayer $4.675m “establishment” costs in three equal instalments, to enable the taxpayer to erect the plant complex without having to borrow money for that purpose.  The taxpayer argued that the money was capital in character and therefore not assessable as ordinary income. 

Held: FFC; on the facts held that the $4.675m was assessable income under ordinary concepts, reaching this conclusion basically because of the way it defined the scope of the taxpayer’s business:
 “We believe that, if a company is brought into existence for the sole purpose of performing one contract for profit, and particularly if the life of the contract is comparatively short … then all payments made under the contract are likely to be income rather than capital receipts in the hands of the company.  The business of such a company is the performance of the contract, and the receipts are in the ordinary course of that business.” 
The High Court upheld this decision.