Australia: Hobby or business? What is the difference?

Hobby or business? Whats the difference?

Someone once said that sailing was like standing in a cold shower tearing up $20 notes. It's a hobby, obviously.

But until you start thinking about it, the distinction between a business and a hobby seems pretty clear. If you enjoy it and it costs you money, it must be a hobby, right? Probably yes, although the wreckage of the "fun" business, OneTel, might suggest the contrary. But plenty of people manage to make money out of hobbies, which gives rise to the question of whether the activity might need to be treated as a business for tax purposes.

Is the activity being conducted for commercial purposes?

To tell the difference between a business and a hobby, the first question is often whether the activity is being conducted for commercial purposes. However this is not always an easy question to answer.

For example, it's fair to say that the great majority of rock bands, including stupendously famous and financially successful ones such as the Beatles and the Rolling Stones, started as hobbies. In only a few short years, George Harrison was making his unhappiness plain in Taxman, and the Stones had fled to France in an attempt to avoid tax.

While most hobbies don't follow this kind of trajectory, it's not uncommon for a hobby which starts out producing small and irregular earnings to develop into an activity earning regular and significant income.

A contemporary example is the successful tech start-up: an idea first devised in a teenager's bedroom which develops into a company worth millions. So how does the hobbyist stay on the right side of the tax office?

Tax office treatment of taxable income and non-taxable income

There is a broad general trade-off underlying the way the tax office treats money that people have earned.

If you conduct a business, almost by definition your aim is to produce an income, and that income is taxed. However, because encouraging a thriving private sector is fundamental in any country where capitalism is the economic model, taxation authorities permit certain kinds of tax relief to business operators. Taxable income can be reduced because of business-related expenses, and operating losses – leading to tax deductions.

On the other hand, if your activity is a genuine hobby, the income it produces is not taxable; but neither can you recoup any of your expenses in pursuing the hobby. You don't need to declare the earnings from your hobby in your tax return, but nothing you buy for the hobby will make you eligible to receive a tax deduction.

Avoiding the top tax rate if you don't have an ABN

If you conduct a business, you need an Australian business number (ABN). When a buyer buys something from your business, the buyer generally collects your ABN. If you don't supply your ABN, the buyer will withhold the top rate of tax from the payment if it is more than $75 for tax purposes.

Generally speaking, you can only get an ABN if you are conducting a business, so what can you do if you want to sell the goods or services you produce in your hobby and not have purchasers withholding the top rate of tax? The answer is that you will need to provide some evidence to the buyer that you are conducting a genuine hobby. Standard forms are available to help you do this.

However for most hobbies, income is simply derived from small cash transactions: the sale of handmade children's clothes at a market, or payment for a live performance in a pub. So it is necessary to understand, as best you can, how the ATO decides whether an activity is a hobby or a business.

Bear in mind the point made at the outset: hobbies can develop. If the customers like it, what was once indisputably a hobby can quickly develop into what the ATO will see as a business.

Hobby or business? A simple checklist

The tax office favours "indicia" – individual criteria to assess whether an activity is a hobby or a business. Although no criterion is in itself conclusive, you will have a fairly clear idea if there are enough ticks on the checklist. These criteria include the following.

• What is the reason for the activity? Is it commercial or recreational?
• Is making a profit the intention or purpose of the activity?
• How often do you undertake the activity? Is it occasional or regular?
• Is the activity informal and unstructured? Or is it planned and organised like a business?
• What is the size and scale of the activity?

Additional resources and private rulings

There are also internet-based resources. On the ATO's Are you in business? web page you can find a short video on this topic. The tax office website's Online selling – hobby or business? page contains information and case studies to help online sellers decide what category their activity falls into.

Artists and creatives can consult the Hobby or Business tool on the business.gov.au website. The same website provides access to the Federal government's business advisory service.

You can also seek a "private ruling" from the tax office. While this is not a speedy process, the benefit is that a private ruling shields you from penalties and interest – assuming, of course, that you are open and honest about the details.

If it need be said, this item is not tax advice. If you are conducting an activity of this kind and are uncertain, you should seek expert legal and/or financial advice. No case is likely to be identical to another, and the personal and individual details will always have a bearing on the outcome.

As long as you are careful, earning money from something you enjoy doing can be painless.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.