Is your activity a business or hobby?
It's important to be able to tell the difference. If you're running a business, your income is taxable and your business expenses are deductible. But if it's a hobby, you don't pay tax on your income and your expenses are not deductible. The "business or hobby" issue can be complex. This article gives you general information only. Each case must be decided on the facts, so if you have any questions about your own situation, please contact your tax advisor or Inland Revenue.
What is a business?
The law says that a business: "includes any profession, trade, manufacture, or undertaking carried on for pecuniary profit…"
The courts have held that a person is probably running a business if:
- The activity is carried out in an organised and coherent way, and
- The person is intending to make a profit.
Note that "intending to make a profit" doesn't mean you must make a profit - an activity can make a loss and still be a business - but the intention must be there. Establishing intention involves considering the person's words and conduct.
What is a hobby?
A hobby is an activity conducted primarily for private pleasure or recreation. The hobbyist is not interested in making a profit. They may sell goods, but any sales are of secondary importance.
Business or hobby?
Deciding whether an activity is a business or a hobby is one of the "grey areas" of tax law. It depends on the scale and volume of transactions, the effort and time involved, the dollars generated, the type of activity, whether government regulations have to be followed and your intentions.
Here are two examples of the "business v hobby" decision, taken from actual court cases.
Example 1
A husband and wife partnership purchased a run-down farming property of 216 acres. Over the years they developed the property by clearing it of gorse and refencing it. A Hereford stud herd of a modest size was established. The farming activity made losses over the years 1972 - 1980. The husband and wife, in their income tax returns, each deducted their share of the losses from their other income.
- The Court of Appeal found that the farming activity was a business, despite the ongoing losses. This was because:
- The partnership carried out the activity for a number of years
- The land area was big enough to support a viable business
- The partners put a lot of time, energy and money into the activity
- The activities were in line with usual farming practices
- The development work was organised and systematic
- The partnership kept proper accounts.
Example 2
A dentist owned a launch. He used the launch privately, but also conducted a launch charter activity - which made a loss. The High Court found that the charter activity was not a business for these reasons:
- The dentist didn't fully investigate the feasibility of the activity before he bought the launch
- There were no serious attempts to market the activity
- Over the year there were three charter trips and 21 private trips - this suggested that launch was bought primarily for private use
- The activity never looked like a serious money-making venture
- The launch was not readily available for chartering
- The year after the dentist made the loss, he kept the launch for his own private use.
Developing a business from a hobby
Do you enjoy your hobby so much that you'd like to earn your living at it? Some home businesses did originally start out as hobbies. If you want to develop a business from a hobby, the important thing to remember is expenses you incur prior to starting your business are usually regarded as capital expenses and are non-deductible for income tax purposes.
In most cases your business will "officially" start when:
- You buy or sell stock, or
- You start performing your services for your customers, and
- Both of these activities are at a significant, profit-motivated level.
Example 3
Anne makes teddy bears from home. In any given year she usually makes about 10 bears, keeps one or two for herself and gives the rest to family and friends. Sometimes people pay money to Anne to cover her costs and sometimes they don't.
At this stage, Anne's teddy bear activity is a hobby.
Because her bears are so popular with her friends, she decides to have a go at profiting from the activity. She takes the following steps.
- She approaches a number of retailers to see if they will stock her bears in their shops. Some shops are willing and Anne enters into contracts with them.
- She buys a special sewing machine which will speed up the production process.
- She buys a computer and fax which she will use to manage orders and sales.
- She travels to Auckland to attend a basic bookkeeping course.
- She buys stationery including invoice books and receipts.
- She buys a bulk order of fur, leather and other materials. She starts work on her first production run.
- She sells her first batch of bears to Bears Incorporated, a shop in town.
Because Anne has changed the way she is running the teddy bear activity - it is now organised with an intention to make a profit - the activity has changed from a hobby to a business.
If you are in this situation, get in touch with Nick by email today or call 0800 ASK NICK.