Edited version of private ruling

Authorisation Number: 1011489638901

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Ruling

Subject: Carrying on a business of horse breeding

Question

Do the thoroughbred breeding activities of the Trust amount to the carrying on of a business for income tax purposes, so that:

(a) gross proceeds derived from those activities are assessable pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), and

(b) non-capital outlays and other expenses necessarily incurred in carrying on that business are deductible pursuant to section 8-1 of the ITAA 1997?

Answer

Yes. The thoroughbred breeding activities of the Trust amount to the carrying on of a business for income tax purposes, so that:

(a) gross proceeds derived from those activities are assessable pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), and

(b) non-capital outlays and other expenses necessarily incurred in carrying on that business are deductible pursuant to section 8-1 of the ITAA 1997.

This ruling applies for the following periods:

Period ended 30 June 2010

Period ended 30 June 2011

The scheme commences on:

1 July 2009

Relevant facts and circumstances

Background

X Trust ('the Trust) is an Australian resident trust that conducts the breeding and racing interests of its settlor.

The settlor has had extensive business experience for a number of years prior to taking a keen interest in thoroughbred breeding.

The settlor now spends a good part of the week on activities in relation to the racing and breeding of the Trust's stock of horses. This includes:

· Attending popular thoroughbred sales events

· Liaising with the bloodstock agent and trainers in terms of selecting future breeding and racing progeny as well as arranging suitable commercial mating for broodmares retired for stud duties.

· Visiting farms/studs to inspect their horses and stallion prospects.

· Attending race meetings/horse sales;

· Researching bloodlines;

· Keeping abreast of industry activities; and

· Maintaining records in collaboration with their accountant.

The ruling application states that the settlor undertakes the above activities with the clear intention of making potential gains at the commercial end of the thoroughbred market. In particular, the settlor intends to breed thoroughbred horses and sell the progeny for profits.

Details of stock on hand

Since acquiring its first filly a few years ago, for a cost that would be considered as above average in the industry, the Trust has spent considerable amounts to expand its stock substantially. The Trust has a 100% interest in the stock which at the time of lodging the ruling application comprised of mares, fillies which will be future broodmares, and colts, including yearlings.

Mares

The ruling application states that the mares are of quality bloodstock and are ex-race fillies of the Trust. They were acquired as yearlings at prices considered as being in the top range in the industry. One of the mares, purchased as a highly prized filly, is currently the only active broodmare of the lot and has been tested in foal to a stallion from an equally reputed pedigree. She and a second mare have generated race winnings for the Trust based on the information provided.

Fillies

The fillies (including yearlings) were acquired at costs well above the industry norms for the cost of the average yearling, as the settlor, it is stated, is very mindful of the commerciality of broodmare pedigrees.

Based on the information provided, a number of the fillies have commenced racing and have been raced successfully a few times during the period under consideration.

Colts

The colts (including yearlings) that comprise the Trust's thoroughbred stock were also acquired at above average prices based on the information provided. It is stated that the colts have been acquired with the intention of developing high quality racing stock so that any prize money derived from racing them will serve to generate a return on the substantial investments made in the Trust's stock.

The colts are considered to be excellent stallion prospects and it is stated that the Trust intends to generate additional income via stud fees or from sale of the stallion. It is also stated that the Trust is inclined to sell the right colt if an appropriate offer is received.

Horse related activities of the Trust

It is stated that the long term intention of the Trust is to derive profits from its integrated breeding and racing activities. To that end, the following horse related activities have been carried out by the Trust during the period under consideration, as stated in the ruling application.

The Trust has continuously acquired high quality fillies for future breeding purposes. The fillies have been placed into training so that they can prove themselves on the race track and develop into quality broodmares. The Trust utilises trainers for its racing stock and has incurred substantial training fees and other racing costs.

The Trust expects that any racing success will translate into greater prices for breeding stock sold.

The ruling application states that recent acquisitions by the Trust demonstrate a heavy bias towards the acquiring of fillies of reputed bloodlines as the settlor is committed to building up the mare breeding base via the retirement of fillies off the racetrack.

The Trust's only active broodmare, referred to previously, was retired off the racetrack to commence her stud duties during the period under consideration. She was mated to a top stallion for a considerable service fee. The mare is considered to have excellent profit prospects in relation to the sale of her foals.

Following the successful mating of the first mare, a second broodmare has been retired to stud. A mating for both the retired mares has been planned in the upcoming breeding season. It is advised that the two broodmares will be visiting commercial stallions.

A third mare has been earmarked for retirement from racing to join the broodmare band.

It is advised that a stallion, which is expected to be an attractive sire prospect, will be added to the Trust's stock to commence his breeding career.

The settlor has budgeted an extensive amount of money to acquire a racing and breeding property in the next few years. Currently, the Trust uses agistment facilities for a fee.

Financial records

The Trust maintains proper accounts in respect of its horse-related activities and has engaged accountants to prepare the accounts and tax agents to oversee those accounts for preparation of its income tax returns.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 6-5

Income Tax Assessment Act 1936 Section 8-1

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

The Trust's current level of racing and breeding activities, although limited, have a significant commercial purpose. The capital, time and effort contributed to the activities are found to be more than that would occur in a recreational pursuit or hobby. There is evidence of systematic implementation of a plan with the purpose of ultimately deriving sustainable profits from the horse breeding business such as:

· employing a bloodstock agent to assist with the acquisition of appropriate breeding lines and racing stock;

· significant investment in the acquisition of fillies and colts from high quality bloodstock;

· utilising expert trainers for successful racing of the fillies and colts;

· appropriate maintenance of the stock in terms of their overall well being, adequate insurance and quality of agistment facilities as recommended by the trainers;

· the considerable time and effort devoted by the settlor to acquire necessary industry experience. This includes liaising with the network of blood stock agents and trainers; attending horse sales events, race meetings, researching bloodlines and visiting farms/studs to inspect the stock.

· placing fillies into training and racing them to develop and expand the number of quality broodmares;

· acquiring interests in stallions and investing in stallion prospects for the purpose of servicing active brood mares;

· retiring active broodmares from the racetrack and procuring the services of highly bred stallions to impregnate the mares; and

· maintaining detailed financial records in regard to bloodstock purchases and expenses incurred in respect of racing and breeding activities.

The activities are conducted with the level of system and organisation consistent with a business that has a purpose of profit as well as a prospect of profit.

In particular, the activities are in the most part in line with the industry specific factors considered by the Commissioner as indicative of a business of the breeding of horses being carried on.

Detailed reasoning

Section 6-5 of the ITAA 1997 provides that the assessable income of a taxpayer includes income according to ordinary concepts. A gain from horse racing and breeding activities is assessable income under section 6-5 of the ITAA 1997 where the transactions are entered into as an ordinary incident of carrying on a business. Additionally, section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings (except of a capital, capital nature or of a private or domestic nature) to the extent to which they are necessarily incurred in carrying on that business.

Integration of racing and breeding activities

Taxation Ruling TR 2008/2 expresses the Commissioner's views on a number of issues specific to the horse industry.

In respect of horse racing activities, TR 2008/2 states that it would be a rare case where the racing of horses as a stand-alone activity amounted to the carrying on of a business. On the other hand, the ruling considers that if racing activities are an integral part of horse training or breeding business, the horse racing activities will form part of that business.

As regards horse breeding activities, TR 2008/2 lists various industry factors that should be taken into account in determining if the activities amount to carrying on a business of horse breeding. These include:

· the quality and number of horses;

· whether the taxpayer is regularly selling stock to the general public;

· whether the mares are being serviced regularly;

· whether the taxpayer is using their stallion rights; and

· whether the taxpayer maintains horses which are inappropriate for breeding (excluding horses that are being raced).

In the present circumstances the Trust, through its settlor, has invested a vast sum of money in the relevant period to acquire highly priced yearlings that are expected to develop into quality broodmares and commercial stallions.

The fillies owned by the Trust are raced and later taken into the broodmare stock to improve their breeding prospects. A few of the fillies have proven themselves on the race track.

The Trust has in the relevant period retired some brood mares off racing. One of those brood mares from good bloodlines was mated to a commercial stallion and is expected to deliver its first foal soon. A second mare will enter stud duties in the upcoming breeding season. A couple of mares are due to visit highly prized and commercial stallions in the industry.

The Trust has not made any sale of its progeny at the time of lodging the ruling application.

The Trust is currently not using its stallion rights. However, the colts that form part of the Trust's racing stock are considered excellent stallion prospects in terms of generating stud fees in the future. Additionally, a stallion that has enjoyed success on the race track will become part of the Trust's stock to be utilised for breeding purposes in the upcoming breeding season.

The Trust does not maintain horses that are inappropriate for breeding, such as geldings.

In summary, the Trust satisfies the industry factors contained in TR 2008/2, albeit to a limited extent.

Accordingly, in the present case, the question of whether the limited horse related activities of the Trust are carried on as a business in the relevant years need to be considered with regard to the general indicators contained in Taxation Ruling TR 97/11 Am I Carrying on a Business of Primary Production? (TR/97/11)

Carrying on a business

It is a question of fact as to whether a taxpayer's activities amount to the carrying on of a business. TR 97/11 lists the relevant indicators to consider in determining whether a taxpayer's activities amount to the carrying on of a primary production business. These indicators are equally relevant when determining whether a taxpayer is carrying on a business in general.

The relevant indicators compiled from various case authorities are as follows:

· whether the activity has a significant commercial purpose or character,

· whether the taxpayer has more than just an intention to engage in business,

· whether the taxpayer has a purpose of profit as well as profitability of the activity,

· the repetition and regularity of the activity,

· whether the activity is carried on in a similar manner to that of ordinary trade in that line of business,

· whether the activity is planned, organised and carried on in a business-like manner such that it is directed at making a profit,

· the size, scale and permanence of the activity,

· whether the activity could more properly be described as a hobby or recreation.

From the many court and tribunal decisions in regard to the 'carrying on of a business' it is gathered that a determination as to whether particular activities constitute a business in general is a question of fact, degree and impression in each case. The various factors are only matters to be taken into account and weighed up in a given situation and the weight will vary with the situation.

Significant commercial purpose or character

This indicator is linked to some of the other indicators in TR 97/11, and generally requires a taxpayer to have shown that its activities were carried on for commercial reasons and in a commercially viable manner.

Amongst other things, this would require that the size and scale of the activity, the repetition and regularity of the activity, and the intention and prospect of profit from the activity together indicate that the venture has a commercial purpose.

Whilst it is accepted that a formal or written business plan is not compulsory, having a strategy for turning the activities into a viable business is considered to be particularly relevant where a large part of the activities are inherently unprofitable, such as the racing of horses.

In the present circumstances, the Trust has made substantial capital investment, in the order of to acquire high quality bloodstock. Commencing with the purchase of one filly a few years ago, the Trust has expanded its thoroughbred stock.

The settlor of the Trust has a clear intention of breeding thoroughbred horses and selling the progeny for profit by integrating a breeding and racing business. To that end the settlor relies on a business strategy to place the horse related activities on a path to making profits.

The settlor has employed the services of a well known bloodstock agent and trainers to assist with the acquisition of yearlings appropriate for future breeding and racing purposes.

The fillies have been placed in training to race them which in turn will improve their breeding prospects and interest in the stud. In this regard a substantial amount has been invested in training fees

As stated previously, the Trust's only active broodmare was serviced by a highly commercial and well bred stallion and has been tested in foal. The service fee incurred in this regard would be considered in the top range in the industry.

Further, a mating for other broodmares has been planned in the upcoming stud season with 'well respected and commercial' sires in the industry.

A stallion, proven on the race track, will become part of the Trust's stock and utilised to serve the mares.

The colts that form part of the Trust's stock have been acquired with the intention of developing promising racing stock and are considered to be good stallion prospects. The Trust expects to generate additional income via prize money, stud fees or proceeds from the sale of the stallions in the coming years.

The settlor's extensive business experience and his intention to acquire a breeding and racing property is indicative of the permanence and further growth of the Trust's horse related activities.

The Trust maintains detailed financial records in regard to bloodstock purchases and expenses incurred in respect of racing and breeding activities.

Although, the Trust's intention of deriving sustainable profits from carrying on a business of breeding depends on building up a stock of good brood mares, brood mares having progeny and getting the progeny to prove themselves on the race track, it is accepted that the current activities have sufficient commercial character to amount to business operations as a whole.

More than just an intention to engage in business

As indicated in paragraph 39 of TR 97/11, this indicator is about the intention of a taxpayer in engaging in business activities. There must be an intention to engage in business, and there must be activities that support the stated intentions to demonstrate that the taxpayer is carrying on a business.

At paragraph 40 of TR 97/11, the Commissioner considers that this indicator relates to:

· whether the activity is preparatory to or preliminary to the ultimate activity

· whether there is an intention to make a profit, and

· whether the activity is better described as a hobby or a recreational activity.

In considering whether the facts in the present circumstances support an intention for profit, the following points can be noted:

The Trust has invested a significant amount of capital in building up its stock of thoroughbreds.

The settlor for the Trust invests considerable time and effort in the conduct of the Trust's horse-related activities, far more than a person undertaking a recreational pursuit or hobby, with a view to making a profit.

The settlor seeks expert advice from the bloodstock agent and trainers to make appropriate decisions.

.Although on a small scale, the Trust has carried out horse related activities that clearly support its intention to make profits from an integrated breeding and racing business.

It is accepted that the Trust has more than just an intention to engage in the business of breeding thoroughbreds.

Purpose of profit as well as profitability of the activities

To be considered to be carrying on a business, a taxpayer has to demonstrate that the expectation of profit is reasonable (TR 97/11). It will be a question of fact in each case whether available evidence points to an activity being pursued with profit making in mind, or whether the taxpayer is driven solely by the personal enjoyment and satisfaction they derive from their activities, so as not to constitute the carrying on of a business.

It is not necessary that a profit be made immediately and it may be that the activity experiences short term losses. It was observed in Ferguson v F C of T 79 ATC 4261; 37 FLR 310 (1979); 26 ALR 307 (1979); 9 ATR 873 (Ferguson's case) that:

'It may be held a person is carrying on a business notwithstanding his profit is small or even where he is making a loss. The nature of the activities, particularly whether they have the purpose of profit-making, may be important. Repetition and regularity of the activities is also important'.

In respect of the recent income year, the Trust has incurred significant losses. However, the Trust has spelt out as to how it proposed to generate income in the coming years. The Trust is primarily building up the horse breeding business by investing significant capital in all of the relevant activities as explained earlier, to secure future income from the sale of high quality progeny. However, it also has a strategy to maximise the earnings from the diverse income streams afforded through stud fees, profits from sale of promising racing stock and any prize money from racing.

It is accepted that the Trust has demonstrated a reasonable belief of an ability to produce a profit as the activities are adequately planned, systematic and organised in a business like manner and not in the nature of a private recreational pursuit or hobby.

Repetition and regularity of the activities

A common feature of a business is that activities are repeated on a regular basis. Accordingly, this indicator requires that a taxpayer is able to show that they have at least undertaken the minimum level of actions required to maintain the activity at a commercial level.

In the context of breeding thoroughbreds for sale, the level of repetition and regularity should be sufficient to maintain a commercial quantity and quality of saleable progeny.

In the present circumstances, the Trust has, at this point, only one active broodmare in foal and this broodmare has been serviced only once. However, in Ferguson's case it was held that:

'Repetition and regularity of the activities is also important. However, every business has to begin and even isolated activities may in the circumstances be held to be the commencement of carrying on a business'.

It is accepted that the Trust's activities in general are organised in a business like manner. Additionally, there has been regularity in regard to the acquisition of thoroughbreds intended for breeding, the training and racing of the Trust's future broodmares and obtaining advice from bloodstock consultants and trainers in carrying out those activities. As the abovementioned activities are an integral part of the business of breeding it is accepted that the Trust's horse related activities display the required regularity and repetition consistent with carrying on that business.

Activity is carried on in a similar manner to that of ordinary trade in that line of business.

Paragraph 64 of TR 97/11 lists the factors that need to be compared with the characteristics of others engaged in the same type of business in considering this indicator. Relevant factors include:

The volume of sales (it is accepted that in the early stages of an activity, there may be no sales or sales may be low;

The sort of expenses incurred by the taxpayer;

The amount invested in capital items;

Previous experience of the taxpayer. A taxpayer who does not have any knowledge or experience may be expected to have sought advice from experts.

The Trust has not made any sale of foals at this stage.

In Case 54/96 (96) ATC 521 the taxpayers' breeding consultant remarked that 'the development of business in this field was not like having a factory'. A longer term process is involved on account of gestation periods and other factors typical to the industry before a sale of foals can occur. Therefore, the absence of such sales in the present circumstances is considered to be similar to those experienced by other participants in the industry in the early stages of the business.

Based on the information provided, it is accepted that the expenses, in terms of both their nature and extent, are comparable to those incurred by taxpayers engaged in a business of breeding and racing.

Similarly, the capital outlay in terms of acquisition of stock and other horse related activities is consistent with that of businesses engaged in breeding of horses with a serious intent of profit.

As discussed in various instances previously, the settlor has engaged expert consultants and trainers to assist in relation to appropriate breeding lines and other advice necessary to turn the breeding business to profit in the future.

Activity is planned, organised and carried on in a business-like manner such that it is directed at making a profit.

Based on the conclusions arrived in respect of other indicators that include the requirements of business planning and organisation, it is accepted that the horse related activities of the Trust are planned, organised and carried on in a business-like manner such that it is directed at making a profit.

Size, scale and permanence of the activity

As discussed in paragraphs 77 and 78 of TR 97/11, the larger the scale of the activity the more likely it will be that a taxpayer is carrying on a business. However, this is not always the case. It has been established that the size or scale of the activity is not a determinative test and that a person may carry on a business though in a small way.

In FC of T v Walker 85 ATC 4179; (1985) 79 FLR 161; (1985) 16 ATR 331, the court held that the purchase of an angora goat for breeding purposes, together with stud fees and other outgoings, constituted a business. This decision depended largely on a finding that the taxpayer's intention was not to pursue a hobby but to make a profit from the venture on the basis of expert advice.

In the present case, the size and scale the Trust's activities, but for the acquisition of bloodstock, are limited in nature. However, as the Trust undertakes proper research, has invested significant capital, has a reasonable expectation of profit, conducts the horse related activities systematically and with regularity and maintains proper accounts and books, it is accepted that the size and scale of the activities are consistent with a business operation.

In summary it is considered that the general indicators in relation to the carrying on of a business are evident in the activities conducted by the Trust in the period under consideration.

The Trust's only income to date is from race winnings and a considerable amount is expended in training fees to race the fillies and colts. This may be construed as the Trust lacking serious intent in making profits from horse breeding activities.

However, in Block & Ors v FC of T 2007 ATC 2735; 67 ATR 974 (Block's case) the Tribunal in determining whether the taxpayer will secure future income from a business of horse breeding accepted the taxpayer's strategy of increasing the value of its fillies through training and racing them.

It was also accepted in Block's case that the incurring of significant expenses by the taxpayer in the form of training fees for its racing activities and the derivation of the majority of its income (in respect of its horse related activities) from racing proceeds (in the relevant years) did not detract from the taxpayer's intent to profit from breeding horses.

Accordingly for the purposes of the views expressed in TR 2008/2, it is accepted that the Trust's racing activity conducted in a similar vein to the taxpayer in Block's case, is an integral part of and is complementary to its conduct of a horse breeding business.

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