On 1 April 2018 Aroha and Manu, after winning $1.5 million in Lotto, purchased a large country homestead named Pine Tree Manor for $1.2 million, the balance of the money won being invested in the share market and interest bearing deposits. Pine Tree Manor had been developed and used as a function-centre by its previous owners. While living there, Aroha and Manu clearly intend to continue operating Pine Tree Manor as a profitable function-centre, renaming it 'Rakau Oki Manor'. Aroha and Manu have had no previous experience in hosting functions and started slowly in order to learn how to run such an activity.

During the year ended 31 March 2019 (their first year) they had managed to attract two group luncheons and four Christmas parties. They made a small loss for the year of $6,500. In this first year they also purchased a number of items for the Rakau Oki Manor including two large dining tables, matching chairs and one pool table. In their second year, (the year ended 31 March 2020) they hosted six wedding functions, four group luncheons and two Christmas parties. They made a profit for the year of $85,000. For the year ended 31 March 2021, Aroha and Manu had not been so successful, attracting only three functions for which they received payment of $25,000. They put this down to the impact of COVID-19. They made a net loss for that year (to 31 March 2021) totalled $55,600.

They advertised the function-centre in several newspapers on an irregular basis. Manu has full-time employment in a nearby town. Aroha has part-time employment, also in that town. When the Rakau Oki Manor is being used as a function-centre they do the catering themselves, with waitressing support from the daughter of a friend. They pay the next door neighbours two children to mow the lawn and weed the garden.

Aroha and Manu have come to your accounting firm for advice. Inland Revenue have written to them querying their function hosting activity and whether they are in business.

Required:

You are employed as a tax accountant for a local firm. Your tax manager has asked you for your opinion on whether or not Aroha and Manu have been in business, for tax purposes, for the year ended 31 March 2021 and during the previous two years.

Your manager has asked you to briefly outline relevant legislation, case law and factors to be considered in relation to the Rakau Oki Manor function-centre activity and to make a preliminary conclusion for him to consider.