Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello MP)
Chapter 2 - Taxation of boating activities
2.1 Schedule 2 to this Bill changes the taxation treatment of boating activities. These changes allow taxpayers who cannot demonstrate that they are carrying on a business using a boat to claim deductions for boating expenses up to the level of their boating income.
2.2 Deductions in excess of the boating income are carried forward to be deducted against assessable income from boating activities in later years.
2.3 These changes do not affect deductions for expenses in carrying on a boating business.
2.4 These changes apply for income years starting on or after Royal Assent.
What is the current taxation treatment of boating activities?
2.5 The current law denies deductions related to income-earning activities associated with using or holding boats unless the taxpayer is carrying on a business of a specified type. For example, it does not allow a deduction where a taxpayer's ownership or use of a boat generates merely passive income. The current treatment is designed to ensure the tax system does not subsidise the private use of boats.
2.6 The law is being changed to ensure that taxpayers are not unfairly treated by taxing their income from boating but denying them deductions for the related expenses, while maintaining restrictions on using the tax system to subsidise the private use of boats.
2.7 The changes allow taxpayers who cannot demonstrate that they are carrying on specified types of boating businesses that involve the use or holding of boats, to claim deductions related to their income-earning boating activities.
2.8 However, they can only use those deductions to the extent that they have assessable income in that year from their boating activities. Any excess deductions are carried forward and deducted against income from their boating activities in future years.
|New law||Current law|
|Taxpayers can deduct amounts related to using or holding boats up to the level of their boating income for that income year. Any excess deductions are carried forward to be deducted against future income from their boating activities.
These changes do not affect deductions for expenses in carrying on specified types of boating businesses involving the use or holding of boats.
|Taxpayers cannot deduct amounts related to using or holding boats unless they are carrying on specified types of boating businesses involving using or holding a boat.|
2.9 Deductions related to using or holding boats are capped at the level of income earned from boating activities. Any excess deductions are quarantined and deferred to later years. [Schedule 2, item 1, subsection 26 - 47(2)]
2.10 Two exceptions to the general rule apply:
- amounts attributable to specified types of boating businesses are not quarantined [Schedule 2, item 1, subsection 26 - 47(3)] ; and
- amounts incurred in providing fringe benefits are not quarantined [Schedule 2, item 1, subsection 26 - 47(4)] .
2.11 The quarantined amount is modified for taxpayers who:
- have boating capital gains [Schedule 2, item 1, subsection 26 - 47(5)] ;
- have profits from a boating business in an income year (being one of the specified types of boating business) [Schedule 2, item 1, subsection 26 - 47(6)] ;
- derive exempt income [Schedule 2, item 1, subsection 26 - 47(8)] ; and
- become bankrupt [Schedule 2, item 1, subsection 26 - 47(9)] .
2.12 A taxpayer earning income from using or holding boats may deduct expenditure relating to the activity up to the amount of assessable income derived. Taxpayers will be allowed to carry forward any excess deductions and deduct them against income generated from boating activities in future years. If income from the boating activities ceases for a year or number of years, the quarantined amount will be carried forward repeatedly and become deductible in the income year when assessable income is next earned from boating activities. [Schedule 2, item 1, subsection 26 - 47(2)]
Example 2.1: Carrying forward and deducting a quarantined amount Ian owns a boat which he leases to a charter operator. In Year 1, Ian has available $100,000 in deductions relating to his income-earning boating activities, including interest, depreciation, running costs and management fees. He earns only $40,000 income from leasing the boat. Therefore he can only deduct $40,000. The remaining $60,000 is carried forward to Year 2 (the quarantined amount).In Year 2, Ian has $95,000 of boating deductions and no income from the boat. Provided the deductions are otherwise allowable, the quarantined amount will accumulate to $155,000 and be carried forward to Year 3. Ian cannot claim any of the $95,000 of boating deductions in Year 2.In Year 3, Ian has $60,000 of boating deductions and $150,000 of income from the boat. The deductions from Year 3 plus the quarantined amount from Year 2 adds up to $215,000. Therefore, Ian can claim a deduction of $150,000 and carry forward $65,000 to Year 4.
2.13 This rule applies to expenses that a taxpayer can otherwise deduct. For example, it does not apply to boating entertainment expenses for which the income tax law would already deny a deduction.
Using or holding a boat
2.14 The quarantining rule applies to all expenses 'relating to using or holding boats' which a taxpayer could otherwise deduct. The rule is intended to quarantine deductions for expenses which the law previously denied; it does not change the scope of the current law. Subsection 26-50(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that a taxpayer cannot deduct a loss or outgoing to the extent they incur it:
- to acquire ownership of a boat;
- to retain ownership of a boat;
- to acquire rights to use a boat;
- to retain rights to use a boat;
- to use, operate, maintain or repair a boat;
- in relation to any obligation associated with ownership of a boat; or
- in relation to any obligation associated with the taxpayer's rights to use a boat.
2.15 Advertising, signage and similar promotional expenditure that is otherwise deductible will generally not be affected by the quarantining rule (eg, if it is incurred in relation to promoting a non-boating business). This is because the expenditure is not in relation to using or holding a boat. However, advertising expenses would be quarantined where the taxpayer holds or uses a boat to earn assessable income from the holding or use of a boat. There is an exception where the taxpayer is carrying on a boating business of the specified type.
Example 2.2: Advertising by a boat owner Phil, a plumber, paints the name of his plumbing business on the side of his private boat. He can deduct the cost of painting the advertisement because it is not an amount 'relating to using or holding the boat' and so is not affected by this measure. He cannot deduct his other boating expenses, such as those for depreciation or interest costs on the boat, because they are private expenses not incurred in gaining income and so not deductible in the first place.
Example 2.3: Advertising by a third party An anti-perspirant company pays $200,000 to have its logo displayed on the spinnaker of a yacht in the Sydney to Hobart yacht race. This payment is strictly for advertising only, and not for any other benefits. For example, it does not entitle persons associated with the anti-perspirant company to any places on the boat during the race or otherwise.The anti-perspirant company may deduct the $200,000 advertising expense. The quarantining rule does not apply to the expense as it is not for using or holding a boat.Had the yacht's owner incurred advertising expenditure in winning the $200,000 contract with the anti-perspirant company, then that expenditure would be quarantined together with other costs from holding or using the boat (assuming the owner was not carrying on a boating business).
Example 2.4: An advertising expense that is not deductible Jonathan, a retiree, hires out his fishing boat to tourists from time to time. He pays to have 'For Hire' painted on the side of his boat. The quarantining rule applies to this expense because it is related to Jonathan's use of the boat - hiring it out to tourists.
Apportionment of deductions that partly relate to using or holding a boat
2.16 Outgoings are only quarantined to the extent they relate to using or holding boats.
Example 2.5: Loan expenses Michael borrows $500,000 from his bank. He uses $250,000 to finance the purchase of a new boat which he hires out during the income year. He uses the remaining $250,000 to invest in shares. He pays $50,000 in interest to the bank in the income year. He earns $2,000 in charter fees from the boat.He apportions the interest expense 50/50 between the boat and the shares. The half relating to the shares - $25,000 of interest expense - is deductible. Of the half relating to the boat he can deduct $2,000 and carry forward a quarantined amount of $23,000 which he can deduct against boating income in future years.
2.17 Two exceptions to the general rule are that amounts are not quarantined if they are:
- attributable to certain specified boating business activities [Schedule 2, item 1, subsection 26 - 47(3)] ; or
- incurred in providing fringe benefits [Schedule 2, item 1, subsection 26 - 47(4)] .
The exception for business use
2.18 A specific exception to the quarantining rule applies if the taxpayer is using or holding the boat in carrying on a specified type of boating business. These amendments specify the particular business uses of a boat that qualify for the exception. These uses are the same as those in current subsection 26-50(5) of the ITAA 1997 and, broadly, require the boat to be at the centre of the business activities (eg, it is trading stock or used to transport goods or passengers). [Schedule 2, item 1, subsection 26 - 47(3)]
2.19 If the taxpayer is carrying on such a boating business, the deductions attributable to those activities can be offset against any assessable income of the taxpayer, in the same way that any other business deductions can be. However, where the taxpayer has deductions in respect of the use or holding of a boat that were not related to one of the specified types of boating businesses, the deductions would be subject to the quarantining rule.
The exception for fringe benefits
2.20 An exception to the quarantining rule applies to expenditure a taxpayer incurs in providing a fringe benefit. The effect is that expenditure in providing a fringe benefit (eg, in providing an employee with a boat as part of a salary package) is deductible regardless of the level of the employer's boating income and so never forms part of an employer's quarantined amount. This is consistent with the general treatment under the income tax law of expenses in providing fringe benefits and continues the exception provided by current subsection 26-50(8). [Schedule 2, item 1, subsection 26 - 47(4)]
Example 2.6: A taxpayer provides a fringe benefit Fiona provides her employee Steve with the use of a boat as part of his salary package. Providing the boat costs Fiona $20,000 per year. As the boat is a fringe benefit, Fiona can deduct the $20,000 as an employee expense - it is not quarantined.
2.21 The amount to be carried forward is modified for taxpayers who:
- have boating capital gains [Schedule 2, item 1, subsection 26 - 47(5)] ;
- have profits from a specified type of boating business in an income year [Schedule 2, item 1, subsection 26 - 47(6)] ;
- derive exempt income [Schedule 2, item 1, subsection 26 - 47(8)] ; or
- become bankrupt [Schedule 2, item 1, subsection 26 - 47(9)] .
Application of the general rule when a taxpayer has boating capital gains
2.22 The quarantining rule is modified for taxpayers who have capital gains from their boating activities. A quarantined amount that is to be carried forward to a future income year is first used to reduce a boating capital gain a taxpayer has for the year. In essence capital gains from boats are treated as if they were income from boating activities. [Schedule 2, items 1 and 4, subsection 26 - 47(5) and section 118 - 80]
Example 2.7: Boating capital gains Greg owns a boat which he leases to a charter operator. In one year, Greg has $50,000 in income tax deductions relating to the boat. He has no boating income but has a $5,000 boating capital gain. The quarantined amount carried forward to future years is $45,000 ($50,000 reduced by the boating capital gain of $5,000). The capital gain is reduced to nil and is not included in working out Greg's assessable income.
2.23 The cost base and the reduced cost base of an asset have to be worked out in order to calculate a capital gain or loss on a capital asset. Deductible expenditure is usually excluded in working out the cost base or the reduced cost base of an asset. Amounts that are quarantined are not included in an asset's cost base or reduced cost base. This treats the amounts as being deductible, even though the deduction is deferred and, so, ensures that the income tax system does not recognise the amount twice. [Schedule 2, items 2 and 3, subsections 110 - 38(5) and 110 - 55(9E)]
Deduction for boat business profits
2.24 The quarantining rule for deferring a quarantined amount is also modified for a taxpayer who has profits from a specified type of boating business in an income year. After it has been reduced by any boating capital gains, a taxpayer can deduct any remaining quarantined amount up to the amount of that profit, and reduce the remaining quarantined amount accordingly. Current year boating deductions are applied first before deducting the quarantined amount. [Schedule 2, item 1, subsections 26 - 47(6) and (7)]
Example 2.8: Boat business profits Adrian owns a boat which he hires out occasionally. In one year, Adrian has $50,000 in deductions relating to the boat and boating income of $80,000, leaving a boating profit of $30,000. Adrian also has a carried forward quarantined amount of $70,000 from the previous year. Adrian can deduct $30,000 of the quarantined amount against his boating income, in addition to the $50,000 in deductions for the current year. The quarantined amount carried forward to the following year is $40,000 ($70,000 reduced by the $30,000 used up).
Application of the quarantining rule when a taxpayer has exempt income
2.25 The quarantining rule for deferring a quarantined amount is further modified for a taxpayer who derives exempt income. After it has been reduced by any boating capital gains or boating business profits, any remaining quarantined amount that is to be carried forward to a future income year is reduced by the amount of any exempt income derived in the current year that has not already been offset against carry-forward amounts from Division 35 (non-commercial losses) or Division 36 (general tax losses) of the ITAA 1997. [Schedule 2, item 1, subsection 26 - 47(8)]
Example 2.9: A taxpayer deriving exempt income Gaurav owns a boat which he hires out occasionally. In a year, Gaurav has $50,000 in deductions relating to the boat and boating income of $10,000. He also derives $5,000 of exempt income. The quarantined amount carried forward to future years is $35,000 ($50,000 reduced by the sum of the boating income ($10,000) and the exempt income ($5,000)).
Exception when a taxpayer becomes bankrupt
2.26 A quarantined amount arising before bankruptcy cannot be deducted afterwards. This includes any quarantined amounts generated in the year that the taxpayer is declared bankrupt. This exception follows the model in Divisions 35 (about deferral of losses from non-commercial business activities) and 36 (about deducting losses generally under the tax law) of the ITAA 1997. [Schedule 2, item 1, subsections 26 - 47(9) and (10)]
Example 2.10: A taxpayer becomes bankrupt Nick hires out his boat using a charter boat operator. In Year 1, Nick has a $50,000 quarantined amount to be carried forward to Year 2.In Year 2, Nick has boating expenses of $20,000 and is also declared bankrupt. Therefore, in Year 2 Nick cannot deduct the quarantined amount brought forward. Nick can still deduct the expenses he incurred in Year 2 but any excess deductions cannot be used in Year 2 or deferred to later years.
2.27 A taxpayer may hold and operate several boats that are subject to the quarantining rules. In such cases, the taxpayer can claim the total deductions relating to all the boats up to the amount of the total income from all the boats. In effect, taxpayers can offset deductions relating to one boat against income from another boat. [Schedule 2, item 1, subsection 26 - 47(2)]
Example 2.11: Grouping boating activities Thomas holds two boats - Nuclear Fishin' and Knot So Fast - which are offered for hire through two different charter operators. He is not carrying on a boating business. Thomas can offset the otherwise deductible expenses he incurs in relation to Nuclear Fishin' against the income from Knot So Fast, and vice versa. The excess of all his boating deductions over his boating income can be deducted against boating income in a future year even if he no longer owns the same boats that generated those deductions.
2.28 These proposed amendments apply to the first income year starting on or after the day on which this Bill receives Royal Assent, and to later income years. [Schedule 2, item 18]
2.29 Section 12-5 of the ITAA 1997 is a non-operative list of provisions about deductions. The item for boats in this section currently refers to section 26-50. With the changes, this is no longer accurate as the deduction provisions for boats are in a different section. Therefore, a consequential amendment changes the reference to the correct section. [Schedule 2, item 6, item in the table relating to boats in section 12 - 5]
2.30 Sections 26-50 and 40-25 specify the tax and depreciation treatment of expenses relating to boats and leisure facilities. Consequential amendments to these sections reflect the fact that they will now only deal with leisure facilities. [Schedule 2, items 7 to 17, paragraphs 25 - 50(1)(a) to (g) and 26 - 50(7)(a), subsections 25 - 50(1) and (5) to (7)]
2.31 A consequential amendment to paragraph 69-5(3)(e) of the A New Tax System (Goods and Services Tax) Act 1999 removes the reference to 'boat'. Section 69-5 denies input tax credits for those expenses that are non-deductible because of listed provisions in the ITAA 1997 (including section 26-50). Removing the words 'or boat' reflects the fact that section 26-50 no longer deals with boating deductions. As a result, entities will be entitled to input tax credits for creditable acquisitions or creditable importations of boats to the extent they acquire them in carrying on their enterprises. [Schedule 2, item 5, paragraph 69 - 5(3)(e) of the A New Tax System (Goods and Services Tax) Act 1999]