Fix your tax affairs before you start-up a business

Starting a business is a challenging prospect. There are many issues to consider and tax is just one of them. But, getting the tax wrong can prove costly.

For income tax and GST purposes, just when an activity constitutes a ‘business’ is critical to claiming tax deductions, and also for claiming tax credits under the GST system. The GST issue came up for consideration in a recent decision of the Administrative Appeals Tribunal (AAT).

In that case, the AAT has found that two taxpayers were not carrying on an enterprise (or a business) and were therefore not entitled to claim input tax credits.

The taxpayers were registered for GST and claimed input tax credits on a number of purchases made following the acquisition of a rural property in northern NSW in 2003. They claimed they were in a partnership (as evidenced by a partnership agreement) and were in the process of establishing a business focused on eco-tourism in connection with the property.

One of the taxpayers conducted market research and prepared a business plan which featured several components such as: accommodation for visitors, which would be constructed on the property; tours; and the production of bush foods.

However, the Tribunal said progress towards the establishment of the business was slower than the taxpayers had hoped. The local council took ages to process the development application the taxpayers had lodged in respect of several cabins: consent was not forthcoming until January 2008, and even then there were a number of conditions that had to be satisfied at considerable expense before the cabins could be erected and occupied.

In addition, there were fires and floods and drought, and the taxpayers did not have enough working capital. The situation worsened in 2007 and 2008 when the global financial crisis struck.

In 2008, the taxpayers decided to change the focus of their efforts. They re-wrote the business plan to place more emphasis on organising tours on the property and to local areas for wildlife enthusiasts (as opposed to tours pitched at the narrower market of bird-watchers) and the production of bush foods. They also decided to offer environmental consultancy services, like preparing land use and bush-fire management plans. A small orchard was also established in the main paddock of the property.

The Tax Commissioner audited the taxpayers and concluded they were not carrying on an enterprise within the meaning of the GST Act between September 2007 and July 2011. The Commissioner said the taxpayers were not entitled to claim input tax credits, and their GST registration was cancelled. The taxpayers sought review before the Tribunal.

The Tribunal found against the taxpayers, noting that:

• the trees had not yet born any fruit and there was no clear idea as to precisely what products were to be produced or how or where they were to be packaged and sold;
• the taxpayers did not have any paying tourists stay on the property until 2012;
• the cabins have not been built, and there were no plans to erect any accommodation on the site in the foreseeable future in the absence of fresh capital.

After reviewing the evidence, the Tribunal said that while there were a number of features of the taxpayers’ course of conduct that bore the hallmarks of a business, the business had not come into existence by 2011. It was not providing services or generating income, with the exception of one piece of consulting work. The Tribunal said the activities were better described as “preparatory and exploratory in nature”. It said the activities may yet lead to the establishment of an enterprise, but that was not enough to meet the definition in the GST Act.

In the Tribunal’s view, for a variety of reasons – some of them beyond the taxpayers’ control, like the delays in the development application – the activities that occurred prior to 2011 were essentially preparatory in nature. There was no expectation of earning any income in the foreseeable future from the accommodation activities. The bush fruit production process was still in the experimental stage.

Given the Tribunal’s findings that the taxpayers were not carrying on a business during the period of review, and given that it was satisfied from the evidence they were unlikely to carry on an enterprise within 12 months of that period of review, the Tribunal accepted it was appropriate that the GST registration was cancelled. The Tribunal said this meant the taxpayers were not entitled to claim they made creditable acquisitions during that period.

The taxpayers in this case were unfortunate in having encountered a number of circumstances that were out of their control. They clearly intended to establish and run a business, but the facts as found by the AAT did not enable that claim to be upheld. The activities under review were considered too preparatory to constitute a business in the year in question.

Getting a business up and running can take time, and in terms of tax issues, a year can make a whole lot of difference!

Terry Hayes is the Editor-in-Chief of tax news reporting at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.