Whether a horse activity is a ‘business or hobby’ for income tax purposes has long been a subjective and difficult dilemma for tax advisers.
Obviously, our office has had extensive experience in this area, but this is not the case for the overwhelming majority of tax advisers.
If, per the ATO ‘self-assessment’ guidelines, advisers are uncertain in making a call on this issue, they can seek a definitive opinion from the ATO via the “Private Ruling” system.
The ATO publishes these decisions on its web site and is not bound by an edited private ruling version published in the ATO rulings Register in relation to any taxpayer. An edited version is not intended to provide taxpayers with advice or guidance, or a publication approved in writing by the Commissioner. However, a tax case has established that private rulings were “useful” in illustrating the way in which the ATO has applied the relevant legislation and authoritative case law.
Though these rulings are specific to a taxpayer’s situation, they are indeed “useful” in gauging the ATO’s current opinion on this ‘business or hobby’ issue.
I regularly trawl the ATO rulings register to see if a racing related ‘business or hobby’ ruling has been recently issued; especially if the applicant is successful!
In this article I share details, and my comments, relating to the best and most recent private ruling I have come across on this topic (ATO Ruling Authorisation Number: 1051382550813), to do with a husband and wife partnership who were successful in demonstrating that their horse breeding activity was an income tax ‘business’. Pay special attention to the facts and arguments raised if you are uncertain as to your particular status!
This case is especially interesting as the taxpayer was also hoping to have their associated “racing” activities approved as a ‘business’.
THE RELEVANT RULING QUESTIONS
1. Do the horse breeding activities conducted by Mr AX and Mrs BX (“the Taxpayers”), constitute the carrying on of a business?
2. If the horse breeding activities constitute the carrying on of a business, will the horse racing activities constitute part of the horse breeding business?
1. RELEVANT FACTS AND CIRCUMSTANCES
BACKGROUND
Mr AX and Mrs BX (“the Taxpayers”) are husband and wife.
The Taxpayers have an interest in a horse called Horse A. After its racing career was over, Horse A became a stallion. The Taxpayers and the other part owners of Horse A entered into a standing agreement with a Stud Farm Z which manages the day-to-day breeding activities of the horse.
Although most of the decisions in respect of the breeding activities of Horse A are made by Stud Farm Z, the Taxpayers still have active involvement as they need to be consulted on major decisions and have a right to clarify any financial issues.
The Taxpayers each applied for an Australian Business Number (“ABN”) as they were operating an enterprise of horse breeding due to the receipt of income from Horse A’s service activities. Each of the Taxpayers returned their share of income so generated from their respective shares of Horse A. The Taxpayers took the view that for the initial income year they were not carrying on the ‘business’ of horse breeding.
To protect the future income generation of Horse A as a stallion for the horse breeding activities, the Taxpayers retain a Mortality Insurance Policy for their share in Horse A – a strong indicator of profit intention.
For the next tax year, the taxpayers reassessed their activities as to whether they were in fact carrying on the business of horse breeding and came to an affirmative conclusion based on the scale and regularity of conduct of the horse breeding activities at that time.
Significantly, the taxpayers have a Business Plan (a strong ATO business indicator) which outlines strategies for making the horse breeding activities profitable into the future and contains the following elements:
a) A description of the horse breeding activities is given in that it consists of income generated from stallion fees through the ownership interest in Horse A. It also outlines how the horse breeding activities will diversify its income stream by selling progeny from its band of high-quality broodmares that have been recently acquired.
b) It sets out the markets through which the Taxpayers propose to sell and realistic estimates of quantity and volume of sales. In respect of the ownership interest in Horse A, the Taxpayers are in the market of providing a quality stallion for mare owners looking to produce quality foals. Income has already been generated as in the most recent two breeding seasons.
c) In an attempt to diversify their income stream, the Taxpayers have acquired a high quality band of broodmares in order to cater for the market of horse purchasers looking for quality foals. The business plan sets out realistic expectations of quantity and volume of sales. It is the intention of the Taxpayers to sell all yearlings whenever it is possible and commercially sensible to do so. The first of these was in year three, with more yearlings planned for sale in the next income years, in line with expected increase of the broodmare portfolio.
d) The business plan also sets out a reasonable estimate of the income expected to be generated from the band of broodmares. Apart from serving the broodmares with Horse A, the Taxpayers also intend to have them served by some of Australia’s leading stallions.
e) Although the Taxpayers did not acquire their own breeding barn, they have acquired the use of a Horse Farm to conduct the breeding activities of the broodmares owned. This Horse Farm is held in high regard within the Australasian Thoroughbred Industry, attracting international buyers and record high priced yearlings.
2. TAXPAYERS’ ACTIVITES
The Taxpayers devoted themselves fulltime to horse breeding activities.
In the first two income years, income was principally generated from stallions’ fees from Horse A.
In addition to the stallion fees the Taxpayers have generated income from the sale of Horse A’s progeny. This progeny includes weanlings and yearlings in the first few years. A selling mentality is obvious with these activities.
The Taxpayers acquired the broodmares with the intention that they will generate
an additional income stream to that generated from Horse A.
The breeding stock have been bought outright and in partnership with others. The ATO especially noted that the fact the Taxpayers have controlling ownership over most of their stock provides them with an ability to control how the horse will be used now or in the future in the most profitable manner.
The Taxpayers have produced progeny by paying the stallion service fees of Horse A to service their broodmares and keeping the resulting foals. To diversify and minimise risk, in the latter years broodmares have been serviced by a varied array of Stallions.
A Bloodstock Agency was initially appointed to assist the Taxpayers to provide ongoing advice and assist in the management of the Taxpayers’ share in Horse A. Use of consultants and experts is a strong business indicator. The reliance on the advisory services of the bloodstock agency expanded to include the wider breeding activities being undertaken by the Taxpayers’ band of broodmares and this arrangement continues to date.
Any new acquisitions of broodmares for use within the breeding activities are jointly decided by the Taxpayers and typically involve the attendance of both of them at the sales auction house. The Taxpayers jointly undertake numerous visits throughout the year to assess the status and progress of the horses.
Keeping of proper records is present as the taxpayers have a joint bank account into which income generated from the horse breeding activities is deposited and from which expenses and capital outlays are paid. The Taxpayers maintain books of account in their joint names and minutes of meetings are kept. Excuse my ‘victory lap’, but the ATO also noted:
“They employ an accounting firm to review their record keeping and produce a BAS each quarter and a tax return each year. Having a recognised accounting system and practices in place give an indication that the activities are more than what is expected of someone who is merely a keen follower of horse racing.”
The breeding and racing activities are integrated, the racing activities forming part of the breeding. Whilst it is the intention of the Taxpayers to sell the new foals sired by Horse A whenever possible, there will be times when it is deemed appropriate to retain and race a foal to ultimately breed from it in the future. The successful performance on the racetrack of the progeny builds Horse A’s future career as a stallion by enhancing demand for his services, thus supporting the service fee income stream.
The fact the Taxpayers have controlling ownership over most of their stock provides them with an ability to control how the horse will be used now or in the future in the most profitable manner.
Should a colt bred by Horse A from one of the Taxpayers’ broodmares be gelded for any reason but retained for racing, this will always be done with the intention of increasing the value of the horse for future sale. This is sound rationale for keeping geldings as part of an integrated breeding and racing business – too often I hear ‘pub talk’ that the ATO will never accept geldings in a business!
3. REASONS FOR DECISION – ATO ANSWERS
QUESTION 1
Yes, it is a breeding ‘business’
The ATO concluded that from the information the Taxpayers have provided the overall general impression of a ‘business’ after considering all the factors in Taxation Ruling TR 97/11: am I carrying on a primary production business? and TR 2008/2 Income tax: various income tax issues relating to the horse industry, including whether racing, training and breeding activities (carried out as stand-alone activities or in combination) amount to the carrying on of a business is that from inception the Taxpayers have been carrying on the business of horse breeding.
Detailed reasoning
The existence of a business is a matter of fact and degree. It will depend on the number of indicia, which must be considered in combination and as a whole. No one factor is necessarily determinative. Relevant factors include, but are not limited to, the existence of profit making purpose, the scale of activities, the commercial character of the transactions, and whether the activities are systematic and organised, often described as whether the activities are carried out in a business-like manner.
In addition, TR 97/11 states that the following three items, present in this ruling request, are factors that support the main indicators:
· A business plan exists;
· Commercial sales of product; and
· Taxpayer has knowledge and skill
Where the activity being considered is that of horse breeding TR 2008/2 sets out further specific indicators which must also be addressed in determining whether the activity constitutes the carrying on of a horse breeding business, including:
? Quality and number of horses;
? Whether the taxpayer is selling stock, for example yearling sales, to generate cash flow;
? Whether the mares are being serviced;
? Whether the taxpayer is using their stallion rights;
? Whether the taxpayer maintains geldings, barren female horses or other horses which are inappropriate for breeding – excluding horses that are being raced.
The indicators outlined above are taken into consideration below in weighing-up whether all the indicators as a whole establish that the Taxpayers were carrying on a business of horse breeding.
Significant commercial purpose or character
A taxpayer needs to be able to provide evidence showing that the activity is carried out for commercial reasons and in a commercially viable manner. It is particularly linked to the size and scale of the activity, the repetition and regularity of the activity and the profit indicators. Evidence of proper research into the activity to establish its commercial viability is also important, and might include:
? Drawing up a business plan;
? Seeking advice from experts in the industry in which you intend to operate;
? Obtaining any technical data relevant to the industry;
? Consideration of whether a market exists for the activity and the evidence of research into potential markets;
? Proper analysis of the capital required for the activity and how it will be obtained and used;
? Ensuring that research can properly conclude that profits can be expected taking into account the market and expected running costs; and
? Ensuring that the size and scale of the activity is sufficient for a commercial enterprise. The ATO noted that just owning a stallion share was in itself “already quite substantial” in terms of scale of activity.
N.B. It was a real positive that mares were regularly serviced and the numbers were increasing every year.
The ATO is satisfied that the Taxpayers have been carrying on a business of horse breeding and not a hobby for the following reasons:
i. The Taxpayers are already making a profit and intend to make further profits from the horse breeding activities;
ii. The Taxpayers are incurring significant revenue and capital expenses but have a plan in place to show how further profits will be made;
iii. There is repetition and regularity of sales;
iv. The horse breeding activities are being carried on in the same manner as other similar businesses in the horse breeding industry;
v. There is a system in place to allow profit to be produced in the conduct of the activity;
vi. The horse breeding activities are being carried on, on a large scale in relation to Horse A. The horse breeding activities in relation to the band of broodmares started on a small scale but have expanded and will expand further into the future; and
vii. All foals produced from the horse breeding activities are made available for sale at all the leading sales.
QUESTION 2
Yes, the racing activities are an integral part of the breeding business
If any progeny derived from the breeding of Horse A with the broodmares are retained by the Taxpayers for the purpose of racing to improve breeding stock and are later used in the breeding business, the racing activities of these horses will be an integral part of the horse breeding business.
Detailed reasoning
Whether a taxpayer’s activities of racing horses may, of themselves amount to the carrying on of a business is a question of fact, having regard to all the relevant indicia set out in TR 97/11 and TR 2008/2.
As outlined in paragraph 28 of TR 2008/2 it is inherently more difficult to prove that the racing of horses as a stand-alone activity amounts to the carrying on of a business because it is considered that one or more of the following significant non-business features would be present:
i. The significant element of chance meaning that whether or not profit is made will depend very largely on considerations other than system and organisation of the taxpayer; and
ii. The activities are no more than the mere pursuit (albeit vigorous in many cases) of a hobby, recreational pursuit or pastime.
Initial intention – Horse bred initially from Horse A with any of the broodmares and held for racing activities but with an intention for later use in breeding business to improve value of breeding stock
The racing activities of any horse bred and initially held for racing activities, rather than for sale, will be part of the breeding business provided that the intention is to improve the value of the breeding stock for future sales and to use the horse in the breeding business.
The Taxpayers have the intention of selling the new foals produced from the breeding of Horse A with any of the broodmares whenever possible, however there may be times when they wish to retain a horse either to support the breeding activities of Horse A and the broodmares or to ultimately use that horse in the breeding business.
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 CA
CARRAZZO CONSULTING PTY LTD
801 Glenferrie Road, Hawthorn, VIC, 3122
TEL: (03) 9982 1000
FAX: (03) 9329 8355
MOB: 0417 549 347
E-mail: paul.carrazzo@carrazzo.com.au or team@carrazzo.com.au
Web: www.carrazzo.com.au
