This in an excerpt from this book
What is a business? This seems like a pretty straightforward question, one hardly worth spending any time on at all. But, in fact, it is absolutely the first question to ask when you’re starting up, and essential for getting started on the right foot. You may find this statement surprising, but it is observed that the US Revenue Agency and the typical American taxpayer do not always agree! A key area of disagreement concerns the question “What is a business? In fact, the US Revenue Agency (RA), the courts and taxpayers have been arguing a lot about what is and what is not a business over the past few decades. What would seem to be a straightforward question has been a very difficult fundamental question to answer.

And the problem has historically come about because RA does not want to allow a taxpayer to deduct losses year over year in a questionable business. As a result, in the past, the tax department considered a business to be any activity that you conduct for a profit or a reasonable expectation of a profit. If the business could not demonstrate that it could become profitable, RA would deny the losses. On May 23, 2002, the Supreme Court of USA ruled on two cases, Stewart v. The Queen and the Queen v. Walls, which changed all the rules.

As a result of the Supreme Court of USA’s decision, RA now only considers the concept of “reasonable expectation of profit” if there is a personal element with respect to your business. If there is no personal or hobby element and assuming of course your business is not a sham, then URA will generally no longer question whether or not you are in fact in business.

If, however, there is a personal or hobby element in your business, then it must be determined if your business is carried on in a sufficiently commercial manner as to indicate that there would be a source of income, and therefore a business. In this case, RA would look at whether or not there is a reasonable expectation of profit from your enterprise so that it may be considered a legitimate business. It would appear, however, that the federal government was not entirely happy with the Supreme Court of USA’s decision in the Stewart and Walls cases, for on October 31, 2003 the Department of Finance released proposed amendments that would essentially reverse the court’s decision and legislate the former URA’s assessing practices.

That is, to deny business losses and other expenses unless there is a reasonable expectation of profit from that business or related activity. Originally, it was intended that if this proposed new section of the Income Tax Act became law, it would be effective for taxation years starting after 2004. What the Department of Finance found was that during the period of public consultation, many individuals and groups expressed serious concerns that a test to determine whether a reasonable expectation of profit exists may unintentionally limit a number of ordinary commercial expenses.


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