Finally, A Stallion Tax Case

Amongst the many horse tax cases I regularly review, it's always frustrated me as to how few involve stallions!.

Stallion investment is the at the top end of the scale for commercial breeders and whatever tax guidance that the courts and ATO can provide is always welcome in this office.

Against this background, I was very thrilled when I was directed to a stallion related tax case that was recently decided at the AAT.

This case, is yet another example of how challenging it is to get the holistic tax strategy of a horse breeding and racing activity correct.

In this case, it was beyond dispute that racing related tax businesses were being run by a group of companies controlled by the taxpayer.

This would mean that any expenses incurred in respect of the business were deductible. However, the ATO demonstrated that an element of the group tax strategy fell down due to how income and expenses of a stallion, owned by the taxpayer personally, were being disclosed and its conflict with the commercial reality of the activity.

A high quality commercial stallion was purchased in the personal name of the taxpayer, rather than by one of the group of companies running the taxpayer's other horse businesses. This stallion was provided by the taxpayer for no consideration to the group of companies. The income and expense from the stallion was disclosed by the companies rather than the taxpayer.

The Facts

After a successful racing career, the stallion in question was retired to stud.

In respect of the income year ending 30 June 2008, the taxpayer claimed a net non-primary production loss of $931,977 of which $512,146 was attributable to depreciation in respect of the stallion. In the 2009 year, the taxpayer had a net non-primary production loss of $619,647 of which $435,324 was attributable to a depreciation deduction in respect of the stallion. The ATO issued notices of assessment to the taxpayer based on the income tax returns that had been lodged.

The taxpayer did so in June 2009 in respect of the 2008 year and on June 2010 in respect of the 2009 year.

In February 2015, the ATO issued two notices of amended assessment that disallowed the taxpayer's claimed non-primary production losses for the stallion in 2008 and 2009.

The ATO issued the amended notices of assessment because it was not satisfied that the taxpayer held the stallion for the purpose of producing assessable income, and so for a "taxable purpose". If the taxpayer did not meet this purpose, there was entitlement to a deduction in respect of the stallion's cost as a depreciating asset in each of those years.

When the taxpayer objected to the amended assessments, the ATO disallowed those objections in an objection decision issued in July 2015. The taxpayer applied for review at the AAT of that objection decision.

The Tax Rule

A deduction for depreciation of the stallion is available to the extent the stallion is used for the taxpayer's taxable purpose. The taxpayer's taxable purpose is the earning of his assessable income or the carrying on of a business for this reason.

What is the problem?

The AAT upheld the ATO's decision to disallow the losses.

The problem is that the taxpayer never declared any income from the stallion and was not personally part of the business of the group of companies that claimed the other income and expenses derived from this stallion.

Instead the taxpayer lent the stallion to his group of companies free of charge, to further the group of companies' business interests.

This meant that when it came time to working out whether the taxpayer could claim the initial purchase price of the horse in the taxpayer's own name, it could not be argued that the taxpayer either made income in his own name from the stallion or used it in a business ran in the taxpayer's personal name.

What could have been done?

Taxpayers in this situation should keep in mind basic income and expense matching principles. Where expenses are being claimed by a taxpayer, advisors should always ask where the income being generated is being declared.

If not by the entity claiming the expense, those expenses are generally not deductible, such as the depreciation and other associated expenses the taxpayer incurred on behalf of the stallion.

The other issue was record keeping for the taxpayer. While the group of companies kept appropriate records and relevant board meeting minutes (and excellent marketing, strategic and business plans), the personal records in relation to the stallion itself were not kept. This was a significant reason why the court found no deduction could be claimed as no support for the taxpayer using the horse in a personal income producing purpose could be made out.

As advisors in the industry we often find the proposed business model of breeding clients has flaws and does not meet ATO criteria, which was the principle problem in this case. Getting the start-up tax strategy right from the beginning is so crucial.

Our Melbourne Horse Tax Seminar – Final Reminder!

Just a final reminder for those who haven't remembered to register for our special Melbourne Horse Tax Seminar @ the Inglis sales complex on Friday 16 June. See details @ www.horsetaxseminar.com. Limited spaces available.

Prepared by:
PAUL CARRAZZO CPA
CARRAZZO CONSULTING CPAs
801 Glenferrie Road, Hawthorn, VIC, 3122
TEL: (03) 9982 1000
FAX: (03) 9329 8355
MOB: 0417 549 347
E-mail: bill@carrazzo.com.au or paul.carrazzo@carrazzo.com.au
Web Site: www.carrazzo.com.au