Media Releases :: Draft Taxation Ruling – TR 2007 / D9 Relating to the horse industry

INSIDE BREEDING ARTICLE

2008 By ADAM TIMS, Partner, Martin O’Connor & Partners

ATO CONCEDES GROUND –
FINALISATION OF TAX RULING (TR 2008/2) FOR THE HORSE INDUSTRY.

It is a relief that the horse industry now has a final, public tax Ruling (TR 2008/2). It is the first time in 15 years that the ATO have formally offered us their opinion as to how the tax system works as it relates to the horse industry. During the intense tax audits of the horse industry that commenced some three years ago, many horse breeders were on the canvas having to plead their “business” case. TR 2008/2 is probably not a knockout blow, however after much consultation with the ATO through Thoroughbred Breeders Victoria (TBV), the taxpayer (breeders) are in a much better position to assess their unique tax circumstances.

What does the Ruling mainly cover?
The main thrust of the ruling is to again attempt to address the issue of “hobby” vs “business” as it relates to racing, training and breeding. The ruling also clarifies the tax outcome for horse participants based on their characterisation as either a “business” or “hobbyist”. Importantly, what the ruling does not deal with is foal share arrangements, leasing and syndicate arrangements generally. The ATO need to address this omission and we believe it is their intention to do so in the near future.

What does this Ruling mean for racehorse breeders?
For breeders, the ATO has conceded some ground compared to the 1993 ruling and initial audits. For instance, there are no examples specifying (6) broodmares as being an indication of a commercial operation. Also, it is specified that fractional interests in horses are allowable to form part of a breeders’ trading stock. Furthermore, it is stated that the racing of horses may be an integral part of the breeding business “to prove the quality of their breeding stock”.

For the ATO to clarify these “business” aspects should be welcomed by breeders as some uncertainty had been created during the earlier ATO audits surrounding the racing of horses when associated with a breeders’ business.

Is it a business?
There still isn’t a prescribed checklist or hard and fast rule as to what constitutes a horse business (impractical!) and every case still needs to be decided on its own particular facts. Instead the Ruling highlights the general indicators of carrying on a business and refers to the relevant factors specific to the horse breeding industry.

General indicators
The general indicators have not changed and have basically been determined by the courts over the years and summarised in “Taxation Ruling TR 97/11: am I carrying on a primary production business?” and include;

whether the activity has a significant commercial purpose or character;
whether the taxpayer has more than just an intention to engage in business or to commence in the future – an intention alone without commencement of activities is insufficient;
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 out in a similar manner to others in the horse industry;
whether the activity is planned, organised and carried on in a businesslike manner such that is directed at making a profit;
the size, scale and permanency of the activity and
whether the activity is better described as a hobby or a form of recreation.

Specific factors
Factors specific to the horse breeding industry have also been stated in the new Ruling. These may include; • The quality and number of horses;

Whether the taxpayer is selling stock, for example at yearling sales, to generate a cash flow;
Whether the mares are being serviced;
Whether the taxpayer is using their stallion rights and
Whether the taxpayer maintains geldings, barren female horses or other horses which are inappropriate for breeding – excluding horses that are being raced.

Unfortunately, it appears that arguments over what is “quality” could continue for years to come. Yet this is just one factor to consider in the overall “business” assessment for tax purposes.

A timely win
The draft Ruling (TR 2007/D9) was released on 22 August 2007 for industry comment. They say timing is everything, for the horse industry we should be grateful for the favourable decision handed down in MR & SL Block v Federal Commissioner of Taxation (2007) “Block” . The decision in Block in Western Australia on 26 October 2007 has firmly placed the ATO on the ropes. The main difference between the draft and final Rulings have been various specific references to Block. In particular the discussion in the Ruling confirms that the Tribunal implicitly accepted that racing activities were an integral part of the horse breeding business in that case. Also, industry standards are to be taken into account including the effect of unexpected events such as injury and/or death of livestock, drought or floods. In other words, it is acknowledged by the ATO that where horse businesses incur significant losses, especially in the start up phase, it is important to consider why that had been the case.

Proper tax treatment for “business” horses
Importantly, the ATO have changed their view as to the proper tax characterisation of racehorses that are part of the breeding activities of a taxpayer. In 1993 the ruling stated that racehorses were depreciable plant. The new draft ruling states that such horses are livestock and therefore trading stock subject to the trading stock valuation provisions. In effect, the different valuation methodologies can arrive at very different tax outcomes. You should ensure that you or your accountant understands the proper valuation method to apply to your circumstances. Proper tax treatment for “hobby” horses The ATO view regarding the tax treatment of horse activities that are not a business remains largely unchanged. A share in a racehorse is still viewed as a “personal use asset”. It follows that the $10,000 threshold is still relevant in determining if a gain on sale is excluded from the capital gains tax (“CGT”) regime. The cost base in this instance includes the purchase cost of the horse and excludes maintenance type costs incurred to date of the sale.

In a nutshell
With TR 2008/2 and Block, we have some current guidance from the ATO that acknowledges that the horse industry is not simply a hobby for the rich. Genuine horse businesses exist in many varieties albeit that many can take some time to be profitable.

As always we strongly recommend that you discuss this matter with your accountant as the circumstances and end tax result may differ on a case- by –case basis. This article is of a general nature only and is not intended to be relied upon as, nor to be a substitute for, specific professional advice. No responsibility for loss occasioned to any person acting on or refraining from action as a result of this article can be accepted.