If ever a thoroughbred breeder wanted an incentive to enter the industry, they need look no further than the generous mare and stallion write-down provisions.

For the record, tax advising in the past few years has been a thankless task. With the seemingly endless changes in tax laws in areas such as GST, Capital Gains Tax, Non-Commercial losses, Superannuation etc many a client has a left a consultation wondering whether they will have sufficient time (or incentive) left to run their business. Many of my consultations in the past few years invariably end with the defensive quote, "I only advise on the tax laws, I don't create them!"

However, tax advising to breeders in relation to the mare and stallion write-downs is still a welcome relief from the otherwise doom and gloom. It has been over seven years (April 1994) since this column dealt with the topic and I am sure many of you, especially new players to the breeding industry, will appreciate a "refresher" article.

This article will provide a summary of the write-down provisions and will conclude with a series of Frequently Asked Questions ("FAQs") I receive in this area. I will then finish with a brief discussion on the new "Non-Commercial Loss" provisions, specifically in relation to the rules regarding an application to the ATO where your breeding activities do not meet one of the four designated tests. This is a must read if you are an individual or partnership claiming 2001 breeding losses.

General Overview

The ATO provides a basis of valuing horse breeding stock, in addition to the three bases provided to livestock, i.e. "cost", market selling value" and "replacement value".

The additional basis, technically referred to as the "Special Closing Value" provisions (better known as "Write-Down" provisions) is available in respect of horses (e.g. mares and stallions) three years and older acquired under a contract and held (not just capable) for breeding. These provisions were introduced with the 1985 Federal budget and were included so as to provide a "Tax Shelter" for industry investors, especially new entrants.

How do these write-down provisions act as a "Tax Shelter"? Well, if breeding stock has a lower than usual closing stock value, losses in the early years of holding that stock will be greater. Conversely, profits will be reduced. Less tax equates to greater investment available to the activity when it really needs it.

What are the 'write-down' rules?

In broad terms, under the write-down options:

• A stallion is able to be written down on a prime cost basis at a maximum rate of 25%;
• A broodmare is able to be written down on a prime cost basis of 33 1/3%; and
• If the broodmare is 12 years of age or more during a year of income, its closing value is $1

What breeding stock is eligible?

For the write-down provisions to be available, the mare or stallion must satisfy the following conditions:

(1) the horse must be at least three years old by the end of the tax year;

(2) the horse must have been acquired by the taxpayer under a contract (there is no specific requirement concerning when the contract must have been entered into); and

(3) the taxpayer must hold the horse for breeding.

Therefore, the write-down provisions cannot be used, where:

• if the horse is less than three years old at the end of the relevant tax year;
• if the horse was not acquired under a contract, eg if the horse was acquired by natural increase or as a gift; and
• if the horse is not ''held for breeding''. For instance, the provisions cannot be used for a stallion in-training as, though it is capable of breeding, it is not at Stud and being used for breeding.

At this point it is also important to stress that "hobby" breeding stock, which maybe subject to Capital Gains Tax when sold, cannot be written down under these provisions.

What is 'held for breeding'?

It is not necessary for the horse to have been originally acquired as breeding stock but it must be held for breeding purposes to be able to utilise the provisions.

N.B. Where a horse has been acquired for non-breeding purposes (eg racing) but is later held for trading purposes (eg breeding), it has undergone a "change of use" and special rules must be complied with when determining its "write-down" amount for the purpose of these provisions.

It is not sufficient that the horse be capable of breeding (Taxation Ruling TR 93/26). Clearly, however, the horse must be capable of breeding (eg gelded horses would be excluded).

Acquired under a contract

The fact that a horse must be acquired by the breeder under a contract means that a horse acquired in some other way, e.g. by way of gift, inheritance or natural increase, cannot qualify as "horse breeding stock" for the purpose of utilising these provisions.

Age of horse

The age of a horse is to be measured in whole years as at the end of the relevant tax year. If a horse is not born on 1 August, its age is determined as if it had been born on the last 1 August before its actual birth. This has the effect that all horses (except those born on 1 August) are deemed to have been born on the 1 August before their actual birth date.

Examples: At 30 June 2001

• A horse born on 1 September 1999 is deemed to have been born on 1 August 1999 and is one year old.
• A horse born on 31 July 1999 is deemed to have been born on 1 August 1998 and is two years old.
• An imported mare is born on 1 May 1996, to Northern Hemisphere time. It is taken to be born on 1 August 1995 and is five years old.

Election Requirements

A breeder must elect to use the write-down provisions.

As a matter of formality, I suggest that the election to be in writing and included in your tax records for the tax year that this basis is nominated. It does not have to be lodged with your tax return.

A breeder making an election in respect of a stallion must at the same time elect the nominated percentage write-off.

Calculating the 'Closing Value'

Subject to two exceptions, the closing value of horse breeding stock may be ascertained in accordance with the following formula:

horse opening value - horse reduction ("write-down") amount

The exceptions are that the closing value is $1 if (a) the closing value calculated under the above formula gives a result of less than $1 (eg if the horse reduction amount is equal to or exceeds the opening value) or, (b) in the case of a broodmare, the horse is 12 years or over.

Accordingly, a mare acquired at age 12 or above can be written down to $1 in the year acquired - a great tax bonus. This rule also applies to an 11-year-old mare acquired in July of a particular tax year, given that she will turn 12 years of age on 1 August of that tax year.

Meaning of 'horse opening value'

The ''horse opening value'' is the horse's ''base amount'', calculated as the lesser of:

• the cost of the horse; and
• its 'undeducted' cost

'Undeducted cost'

The 'undeducted cost' of a horse is, broadly speaking, the notional depreciated value of the horse. This calculation is required for fillies previously used as a racehorse by the breeder. It is reached by subtracting the following amounts from the cost of the horse: the amount of depreciation deducted or deductible and any amounts of depreciation that would have been deductible had the item been used for income-producing purposes.

Calculating the "write-down" amount

a) Broodmares

If a broodmare is owned by the breeder for the whole of the tax year and the horse is under 12 years of age, the horse reduction amount is calculated as follows:

Mare "write-down"amount = base amount ÷ reduction factor

The 'base amount' is the lesser of the cost of the horse and the 'undeducted cost' (see above)

The 'reduction factor' is the greater of three and the difference between 12 and the horse's age when the breeder acquired it.

Example 1: 6 year old broodmare
Assume that:


1. a breeder acquires a mare under a contract made on 1 September 2000;
2. the cost of the mare is $100,000; and
3. the birth date of the mare is 1 August 1994.
The 'write-down' amount for the year ended June 30, 2001 is:


($100,000 ÷ (12-6)) x (303 ÷ 365) = $13,385


As the mare is acquired part-way through the year (i.e. September 1, 2000), the 'write-down' amount is pro-rated.

The 'write-down' amount for each subsequent year is:


$100,000 ÷ (12-6) = $16,666

b) Stallions

If the stallion (or stallion share) was held for breeding for the whole of the tax year, the reduction amount is calculated as follows:

base amount × nominated percentage

The 'base amount' is calculated in the same way as for a female horse (see above).

The 'nominated percentage' is the percentage, up to 25%, nominated by the breeder. A breeder may vary the nominated percentage in respect of a stallion from year to year. Furthermore a breeder can nominate different percentages for different stallions.

Example 2: Stallions

Assume the same facts as in Example 1 except that the horse is a stallion and its cost is $300,000, not $30,000.

Assume further that the breeder adopts a nominated percentage of 20% for the years ended 30 June 2001 and 2002 and 25% for subsequent years.

The stallion "write-down" amount for the year ended 30 June 2001 is:


$300,000 × 20% × (303 ÷ 365) = $49,808


The stallion "write-down" amount for the year ended 30 June 2002 is $300,000 x? 20% = $60,000 and for subsequent years is $300,000 x 25% = $75,000.

FAQs - 'Write-Down' provisions

Q1. If I have one mare valued under the 'write-down' provisions, do they all have to be?

Answer

No, the other mares can be valued under the other three valuation options available. The same rule also applies to stallions.

Q2.My breeding business owns 50% of a mare, which originally cost me $50,000. The other 50% was recently sold for $200,000. Can I revalue my 50% interest to $200,000 and claim a higher 'write-down' amount?

Answer

No, only unless that mare is being transferred to another breeding entity. Though, tax consequences of such a transfer must be considered.

Q3.MIf I buy a mare 'in-foal' what cost is her 'write-down' based upon? Is her cost reduced by the value of the foal she is carrying?

Answer

The mare's cost for 'write-down' purposes is not reduced to take account of any foal being carried. The trading stock provisions do not differentiate between a pregnant broodmare and one that is not pregnant.

Q4.I have an old mare written down to $1 under the 'write-down' provisions. If I sell her for $200,000 is my profit $199,999 ($200,000 -$1 tax value) or $200,000 less her original cost?

Answer

The profit on this mare, unfortunately, is $199,999. The breeder has already had the benefit of a 'write-down' of the original cost.

UPDATE - 'Non-Commercial Loss' Determinations

At this time last year I warned of the new "Non-Commercial Loss" provisions to apply from 1 July 2000. In summary, an individual or partnership breeder could not claim a loss for the 2000/2001 tax year unless one of the following four tests was 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; and
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.

Grounds for ATO determination

If you are about to prepare your 2000/2001 tax return and now realise that your breeding activities have not met any of the above tests, all is not lost as special application can be made to the ATO to allow the loss. The two circumstances under which an application can be made are as follows:

1. the activity has been affected by special circumstances outside the control of the taxpayer (e.g. equine virus, flood, drought or other natural disaster); or
2. the activity has a lead time before income is produced and will be commercially viable.

It must be stressed that the relevant tax return cannot be lodged unless the ATO have reviewed the determination application and advised that the loss is allowable. If you want more information on the topic, I refer you to my September 2000 article or my web site at www.carrazzo.com.au. For the meantime, the ATO have issued a draft ruling on the topic and I quote below what they consider applicants should consider when seeking a determination, which I'm sure you'll find helpful.

"In order to establish that the taxpayer is pursuing an activity that is commercially viable, the taxpayer will typically need to collect evidence from independent sources showing that the activity will either produce a tax profit or meet one of the tests within the period that this would normally occur in for the industry concerned. Appropriate independent sources include government agencies, an industry body or professional association or a taxpayer with a similar, successful business activity. The evidence collected should concern the nature and extent of the investment required to establish a viable and profitable activity, with specific relevance to growing the activity so that it will eventually produce a tax profit or meet one of the tests. A Business Plan could provide useful evidence where it has been prepared on the basis of this independent evidence and is accompanied by that material"

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

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.



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: carrazzo@ozemail.com.au