Horses and Tax - FAQ's - March 2001

If you are a horse industry investor, or intend to become one, in the next few months, this article is certain to contain something of interest.

The answers to the horse taxation queries which provide you, or your tax adviser, with the greatest uncertainty have been noted below in a convenient question and answer format. The questions are well founded - they have been compiled by reference to the common queries that the ATO and I regularly receive. I especially direct you to the Capital Gains Tax ("CGT") questions - some "hot topics" have been raised.

There is another compelling reason why I have chosen a FAQ format for this article - not only is it popular, but many of you, I'm sure, intend to enter the industry for the first time in the next few months, some as breeders, others as racehorse owners, many as both. The article recognises there are differing tax issues for breeders and racehorse owners and thus it has FAQ for each area.

The article will focus on income tax issues, but associated GST issues will be commented upon where relevant. For a similar GST reference, I refer you to my previous December 2000 article, titled "GST and BAS - Your Questions".

HORSES AND TAX - FREQUENTLY ASKED QUESTIONS

1. BREEDERS QUERIES

a) Business v Hobby

Q1. I have just bought some broodmares and intend to run my activities as a taxation breeding business. What factors does the ATO want demonstrated for my activities to be accepted as a business?

Answer

In summary, the business factors the ATO want demonstrated for a horse breeding business to be accepted are listed below and are sourced from the ATO ruling TR 93/26 and case law in this area:

• whether the activity has a significant commercial purpose or character;
• whether the taxpayer has more than just an intention to engage in business;
• whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;
• whether there is repetition and regularity of the activity;
• whether the activity is of the same kind and carried on in a businesslike manner such that it is directed at making a profit;
• the size, scale and permanency of the activity;
• existence of a breeding property;
• if the activity started with limited numbers, is their consistent growth in the scale of the activities (e.g. increase in mare numbers);
• whether the activity is better described as a hobby, a form of recreation or a sporting activity;
• the keeping of proper records;
• the existence of a business plan evidencing viability;
• are mares being regularly serviced;
• are progeny being regularly sold in order to generate a profit;
• are stallion rights (if applicable) being utilised;
• registration of a business name;
• establishing a separate bank account; and
• the use of experts and consultants.

b) Trading Stock/ Write Down Provisions

Q.2 What are the special trading stock write-down provisions that relate to mares and stallions?Do they relate to stallion shares?

Answer

Yes, they do relate to stallion shares, but only if that share is part of an overall taxation breeding business.

A brief summary of the special write down provisions are as follows:

Stallions
May be written off at a maximum rate of 25% on a prime cost basis.

Broodmares
May be written down on a prime cost basis so that the value is not less than $1 by the time the mare reaches 12 years of age, with a maximum write-off of 33.33% of cost price.

Mares acquired at age 12 years of age or older can be written down to $1 in the year of acquisition.

Female stock must be at least three years of age before any write-down is available.

N.B. These provisions are only available to "business" breeders.

Q.3 If I have a taxation breeding business, does the ATO allow me to write-down mares and stallions that I have in training?

Answer

No. To be eligible for the write-down, the stock must be used for "breeding purposes".

Q.4 Can I write-down a mare or stallion that I have bred?

Answer

No. The write-down provisions are only available to horses acquired under "contract", in other words, the horse must have been acquired from an external party.

Mares or stallions that have been bred can be valued at either cost or market selling value.

c) Deductions

Q.5 I'm a taxation breeder, what are the common deductions available to my breeding business?

Answer

The common tax deductions available to horse breeders include:

• agistment;
• tax consultancy/accountancy;
• advertising;
• breeders incentive schemes (e.g. VOBIS);
• computer expenses;
• drugs;
• home office expenses;
• depreciation on stabling and fences;
• farrier;
• fodder;
• interest on related borrowings;
• journals/references;
• leasing of land;
• legals;
• memberships to associations (TBV, etc);
• motor vehicle expenses;
• property utilities (rates, gas, electricity);
• paddock maintenance;
• saddlery, horse gear;
• service fees;
• selling costs;
• telephone/fax;
• travel expenses (e.g. attendance at sales);
• veterinary fees;
• land degradation measures;
• installation of telephone lines;
• costs of conserving or conveying water;
• industry seminars/self-education;
• bank charges; and
• filing fees (e.g. mare returns, business name).

N.B. A GST registered taxation breeder can also claim back any GST paid on legitimate breeding expenses.

Q.6 Can I claim a deduction for the expenses of racing my breeding stock?

Yes. The ATO considers the racing of a breeders stock to be ancillary to that breeding purpose, hence the expenses are deductible for income tax purposes.

Breeders often race horses as an extension of their breeding business. Breeders often retain progeny (for example, well-bred fillies) which are raced and then later added to the breeders broodmare band.

Q.7 I have been told that my breeding losses may no longer be deductible in the year that they were incurred, even though I'm a taxation breeder. Can this be right?When do these new rules apply from?

Answer

Yes. Under the new rules, commencing from 1 July 2000, breeding losses incurred by individuals (including an individual in partnership), which would normally be deductible because the individual is carrying on a "business", will not be deductible unless one of the following criteria is satisfied:

1. The activity produces assessable income of at least $20,000;
2. The activity derives a taxable profit in 3 out of the last 5 years;
3. The greater of the reduced cost or market value of real property (i.e. land and buildings) used in the business on a continuing basis, is at least $500,000;
4. The total value of other assets (excluding cars, motorcycles and similar vehicles), used in the business on a continuing basis, is at least $100,000; or
5. Where all of the above financial tests are not satisfied, the ATO believes it would be unreasonable to deny the losses, because either:
   • the activity has been affected by special circumstances outside the control of the taxpayer (e.g. flood, drought or other natural disaster); or
   • the activity commenced to be carried on, and because of its nature, one of the above four tests cannot be satisfied, but there is an objective expectation that it will either pass one of the above tests, or produce assessable income, within a reasonable time.

d) Capital Gains Tax

Q.8 The ATO has advised me that my breeding activities do not amount to a business. Am I still subject to tax if I sell any of my current stock for a profit?

Answer

Yes, unless you acquired the mare or foal for $10,000 and less.

Q.9 If I acquire a mare "in-foal", how do I work out whether the resulting foal costs "$10,000 or less" for the purposes of my eligibility for the horse capital gains tax exemption?

Answer

Without doubt, one of the trickiest questions in the area of horses and CGT.

Per recent ATO advice, to determine the acquisition cost of the foal, the cost base of the 'original' mare in foal should be apportioned after the foal is born in a reasonable way between the mare and the foal. For example, if the mare had not been in foal and still would have cost $100,000 then it would not be reasonable to apportion any part of the $100,000 to the cost base of the foal. If the mare had cost say, $85,000 if not in foal, then it would be reasonable to apportion $15,000 to the cost base.

Any gain made from its sale will not be subject to capital gains tax if the cost allocated to it is $10,000 or less. In the above example, the $15,000 allocated cost would have made the foal potentially subject to CGT.

Q.10 If I make a capital gain on the sale of one of my breeding stock, can I offset the capital loss on my shares or investment property to reduce or eliminate this gain?

Answer

Yes. Capital losses from other capital assets can be used to offset the capital gain derived on the sale of breeding stock.

Word of warning - a capital loss cannot result from the sale of a racehorse or breeding stock. The rule does not work in reverse.

2. RACEHORSE OWNER QUERIES

a) Business v Hobby

Q.1 All I do is race horses, no breeding. What are the factors the ATO considers when determining if I'm a business or hobby?

Answer

It is considerably more difficult to prove a business of horse racing than a business of breeding. To date there has only been three reported cases in Australia where the racing of horses was held to be a business.

The general ATO rule is that racing horses without training or breeding activities is not accepted as a business. To overcome this general rule, the owner must demonstrate that the racing activity:

• is conducted as a business with the intention of making a profit and not primarily for pleasure;
• is so considerable, systematic and organised as to exceed that of the keen follower of the sport;
• is conducted in such a way that it is reasonable to expect it to become commercially viable; and
• does not rely primarily on chance as distinct from business acumen.
• Deductions

Q.2 If I'm in the business of horse racing, can I depreciate that racehorse?

Answer

Yes. A racehorse is considered an item of "plant" within a racing business.

The ATO's latest depreciation tables suggest a diminishing value rate of 25%, prime cost 17%.

c) Capital Gains Tax

Q.3 Does the special CGT exemption for horses costing $10,000 or less apply to a share in a racehorse, where the total cost of that horse is greater than $10,000?

Answer

Yes. The ATO has confirmed that if the share in the racehorse cost $10,000 or less, that share is also subject to the CGT exemption.

For example, a one-sixth share in a racehorse is acquired for $5,000. Though the total cost of the horse is $30,000 (6 shares @ $5,000), the CGT exemption still applies to the share.

Q.4 I bought a racehorse at auction for $55,000, which included $5,000 GST. In terms of working out the capital gains tax when it is sold, can I include the $5,000 GST in its "cost base"?

Answer

Yes. As a tax deduction or GST credit was not allowed for the $5,000 GST, the owner is considered as having incurred $55,000 in cost, not $50,000. Accordingly, the GST is also included in the CGT cost base.

You are welcome to contact me if you would like me to clarify or expand on any matters I have raised in this article.

PAUL CARRAZZO CPA
CARRAZZO CONSULTING CPAs
22 BLACKWOOD ST, NORTH MELBOURNE VIC 3051
PH: (03) 9329 7044
FAX: (03) 9329 8355
MOB: (0417) 549 347
Email: This e-mail address is being protected from spambots. You need JavaScript enabled to view it

DISCLAIMER

Any reader intending to apply the information in this article to practical circumstances should independently verify their interpretation and the information's applicability to their particular circumstances with an accountant specialising in this area.

Reproduced with permission from the Australian Bloodhorse Review © Copyright, 2001