THE eagerly anticipated final version of the ATO Horse Industry Ruling (TR 2008/2) was issued by the ATO on May 14, 2008.
As I noted in my previous October 2007 article, the first ATO industry ruling in 14 years, issued in August 2007, was only in draft form and, per normal ATO policy, the public were invited to comment on the draft possibly with a view to the ATO taking on board any worthwhile changes suggested.
The most significant change to the draft ruling has been in the subjective area of "Business v Hobby", and the ATO's view as to the factors it will consider in deciding whether a person's breeding and/or racing activities will be accepted.
On the whole, the new ruling does give greater hope to those who want to claim their losses, so got this we must be grateful.
"Block's" principles incorporated in final ruling
IN this regard, the major feature of the ruling is that the ATO has lived up to its pledge and incorporated the principles of the recent landmark "Block's" AAT case into the final ruling.
This case was decided in October 2007 and held that breeders were running a breeding and racing business, even though significant losses were present in the years under review.
The breeders had experienced significant bad luck in the loss years and the case was decided in their favour due to their strong profit intention and other businesslike factors present.
My February 2008 article focused entirely on the decision in Block's case.
The ATO had noted in its Block's "Decision Impact Statement" of December 2007 that it would take account of this new landmark case in its final ruling and, to the relief of the industry, it duly delivered.
The ruling is significant in that it indicates that, per Block's, it is now important to consider why significant losses had been incurred when deciding the income tax status of a horse activity, especially where they occur in the "start-up" phase.
They also comment that allowance will be given for "unforeseen" events and the "need for appropriate business restructuring" as to whether a business can argue "sustainable profits" in the future.
Tax practitioners will welcome this more reasonable ATO view as many have found that horse breeding and racing activities have been regularly rejected during the current audit due to the presence of losses, even where it clearly obvious that the activity is very "business-like" and has a reasonable expectation of viability in the future.
The ATO have also modified some of the other breeding factors, noting, for instance, that mares need not be covered "regularly", a reflection that "unforeseen" events, such as EI, can prevent this from happening.
The draft ruling indicated that horses should be sold to the "general public" in order to generate a cash flow, this being quite limiting to the many breeders who deal with friends and family when selling horses.
Not so harsh on "Stand-Alone" racing
THERE is also some encouraging news for the many high wealth individuals who conduct "stand-alone" horseracing activities.
The previous draft ruling had noted that it would be "a rare case indeed" where such activities would be accepted without the presence of breeding.
It appears as though the ATO have acted upon the submission of our office in that we bought it to their attention that they were too closed in their view of these activities and that each case should be decided on its own merits, especially having regard to case law principles.
The ruling has removed the phrase "rare case indeed" and noted that though there are "difficulties" in demonstrating such a business, they may accept such an activity if it is run in a systematic and organised manner with a reasonable expectation of viability within a time frame consistent with "industry standards". The challenge if for the industry is to develop such "standards".
Unfortunately, though, the ruling does not give a positive example of what a "stand-alone" horse racing business would look like, even though the writer had tried to put a compelling case for them to do so.
Service fees in advance can be deductible
OUR office also welcomed the ruling confirming that horse activities conducted via an eligible "Small Business Entity" can claim service fees paid in advance, a disclosure not noted in the draft ruling. Again, this was another instance where the ATO acted on the submission of this office.
Salary packaging - you can avoid Non-Commercial ("NCL") loss rules
DURING the course of a year I attend many tax seminars to help me keep in touch with the numerous changes that occur.
In a recent FBT seminar I attended, there was a great tip I picked up in the area of tax effective salary packaging between legal spouses (i.e. married or de facto).
What really impressed about this strategy is that it would serve a very useful purpose for the numerous "Mum and Dad" partnership breeders out there, these being the lifeblood of our industry.
The strategy I'm about to share with you will help many of you avoid the operations of the NCL rules. In short, these rules operate to curtail the immediate deduction of legitimate business losses, unless an individual or partnership can meet one of the following four tests:
Why use salary packaging?
WE all know it is very common for a breeding business to generate tax losses in its early years or through various periods of its cycle.
When a partnership is generating losses, there is always the unwelcome chance that the losses will not be immediately deductible to the partners under the NCL rules.
This can be alleviated if a partnership loss could be avoided and yet one of the partners, preferably the higher income earner, could still have the advantage of claiming those expenses. The example below makes this possible.
Example - packaging "Mum and Dad" breeding partnership expenses
MARY and Dave are married and partners in the "MADA" breeding partnership.
Mary is an employee earning $250,000 per annum and her husband, Dave, is responsible for the day-today operations of the partnership and he also stays at home with their children.
During the 2008 tax year MADA derived income of $18,000 (excl. GST) for the sale of a yearling, and incurred breeding expenses of $32,000 (excl. GST). The 2008 MADA partnership tax loss is $14,000 ($18,000 less $32,000). Each partner's 50% share of this loss is $7000.
Mary's accountant tells her that her 50% share of partnership loss cannot be claimed against her wages income as the MADA business has not satisfied the "Non Commercial Loss" rules, i.e. due to sales income being less than $20,000 and none of the other three NCL tests being met.
As such, Mary's $7000 share of loss cannot be claimed in 2008 and must be carried forward until one of the NCL tests can be met.
However, Mary's accountant proposes a solution to these problems. Under the proposal, Mary's employer will reimburse her 50% share of tax deductible partnership expenses (i.e. $16,000) under a salary sacrifice arrangement.
Mary's accountant makes this suggestion on the basis that the NCL rules will not apply, i.e. the reimbursement will have the effect of avoiding NCL rules because the partnership will no longer declare a loss as Mary's employer is reimbursing her 50% share of the expenses, i.e. $16,000.
The partnership now generates a profit of $2000 ($18,000 less $16,000) and the NCL rules are now irrelevant. Yet, the other $16,000 of expenses has been salary packaged against Mary's salary by her employer - in effect the total $32,000 of expenses has been claimed in 2008.
This is surely better than none of the partners being able to claim the expenses in 2008, isn't it?
Readers are welcome to contact me to clarify or expand upon any of the matters raised in this article.
PAUL CARRAZZO CPA
CARRAZZO CONSULTING CPAs
22 BLACKWOOD ST,
NORTH MELBOURNE VIC 3051
TEL: (03) 9329 7044
FAX: (03) 9329 8355
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Web Site: www.carrazzo.com.au
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