Hobby business and tax

When does the IRD see my hobby as a business?

You are probably operating a business if you charge other people for the goods that you have made or the services that you provide. It will also be looked on as a business if you are supplying the goods or services on a regular basis and there is a clear intention to make a profit from your activities.

What can I claim for use of my home?

You can claim a percentage of your home expenses based on the amount of the area of your home that you set aside for your business. For example, if you are using a full room as an office and that is 10% of the total floor area of your home, you will be able to claim 10% of all home expenses such as rates, power, interest on your mortgage, insurance, depreciation, etc.

Does GST affect a non-hobby business?

If you are running a business then your income will be taxable and your expenses deductible. This means you could be liable for GST because you will pay GST on your sales and you claim back GST on the purchases and supplies you paid for. A taxable activity is an activity, which is carried on continuously or regularly and involves the supply of goods and services to other people or organisations. A hobby is therefore not a taxable activity.

Most businesses are taxable activities, although some are not businesses. You can carry on a taxable activity even if you have no intention of making a profit. (E.g. schools and charities often carry out taxable activities.)  If your annual turnover is greater than $40,000 a year, then you have to register for GST if you are conducting a taxable activity. If your turnover is less than $40,000 a year you can register for GST if you want to, but you don’t have to under law.

Common deductions for hobby business at home

You have now determined that your hobby at home is actually a business. What are some expenses you can deduct off the income you earn?

Here is a short list:

  • Home office expenses including rates, power, interest on mortgage, insurance, depreciation etc.
  • Vehicle expenses.
  • Insurance.
  • Internet.
  • Interest on business loan.
  • Certain promotion costs.
  • Advertising and marketing.
  • Subscriptions to professional associations.
  • Travel expenses.
  • Postages and stationery.
  • Furniture and equipment replacement.
  • Business cards and office supplies.
  • Bank fees.

Be ready to provide proof to IRD

You need to be able to provide proof that your hobby is a business if you want to write off any losses you make. For many small business owners their home business is more of a sideline and not really a reliable source of income. This is often the case where the owner has other means of financial support, such as a regular job, or investments, or a spouse who brings in income. This allows the small home business to continue, even if it makes little profit.

For most home businesses, if you don’t make a profit in the course of the year, it does not mean you have to close up shop because most of the time the owner loves what they are doing and there is no real pressure to close the business because the owner is not relying on it as the main source of income.

However, the owner still wants to deduct the losses from the hobby business against other income – and this is where the problem arises. Most people would much rather earn a healthy profit than lose money in their business and the advantage of using the losses as a tax shelter does not always justify continuing in the loss situation. However, the loss write-off can make a difference on the decision of closing up or carrying on.

If this type of tax shelter situation is continuing, you need to be in a position to justify your hobby as a business otherwise the IRD will disallow any expenses you are claiming or any losses that you are trying to offset against your other income.

Why the IRD may disallow expense claims

The deciding factor in determining if it is a business will be whether it is carried on for profit or not for profit. You have to prove to the IRD that you are trying to make a profit, even if you are not succeeding.

Another test the IRD could possibly carry out is determining the period of time you have been running the activity and claiming tax losses. If it appears that you have run the business for two or three years and it has continually made a loss, then the IRD may disallow any expenses you have claimed for the current tax year.

The IRD may also disallow any past claims on losses made from the home business, on the basis that a serious business owner would close up shop if losses were continually being made year after year. The IRD would certainly disallow the activity if it appeared that there was no possibility of making a profit in the future.

If you continue to claim a loss after the third straight year after starting your business, you may be inviting a tax audit or investigation. The IRD has no hard and fast rule as to the period test, but it is a good idea for you to be really clear on your activity in case you have to prove that it is a business.