Edited version of your written advice

Authorisation Number: 1013068310522

Date of advice: 9 August 2016

Ruling

Subject: Am I in business -vessel charter

Question 1

Is the vessel charter activity considered to be carrying on a business for the purpose of section 26-47 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX.

Year ended 30 June 20YY.

Year ended 30 June 20ZZ.

The scheme commences on:

1 July 20WW.

Relevant facts and circumstances

You have purchased a vessel for a certain purchase price.

The vessel will be chartered through a vessel charter operator (BCO).

You have entered into a charter agreement with BCO for a number of years.

You have financed the purchase of the vessel through a bank loan.

You have provided a five year and a ten year financial projection and stated your agreement with BCO will be for a number of years. You have said that the vessel will be sold after about five years, for this reason the five year profit forecast has been used for the purposes of this private binding ruling.

You will claim depreciation at a certain percentage using the diminishing value method. You will use the same amount of depreciation in your income tax return as you have used in the profit forecast document.

You will sell the vessel after about five years of charter operation. You will include any assessable balancing adjustment for the disposal of the vessel (estimated to be significant) in your income tax return in the year of sale.

You estimate the vessel will be valued at around a certain percentage of its original value after five years.

You have provided a signed copy of the 'vessel management agreement' between you and BCO.

The charter agreement states that the charter operator, BCO is responsible for the day to day running of the charter activity while acting as your agent.

The charter agreement also shows that all the income belongs to you and that you pay a management fee to BCO in return for the services provided under the agreement. This fee is fixed at a certain percent of the charter income.

You will reimburse BCO for any expenses incurred on your behalf.

You are responsible for all insurance, repairs and mooring costs.

You will be involved with the charter operation on a regular basis, this will include regular discussions with BCO to monitor performance and future plans.

BCO will provide you with monthly reports which itemise all income and expenditure as well as the details of the days that the vessel was chartered.

You will use the monthly reports received from BCO to support the preparation and lodgement of your Business Activity Statements (BAS).

You have used the following information to evaluate the viability of the activity. The income and expenditure projections have been based on estimates from BCO and in consultation with you and your tax agent.

You will review the profitability of the vessel charter activity on an annual basis. If there are significant differences between the projections as provided below and actual figures, you will seek a new private ruling or treat the ongoing activity as non-commercial.

Based on the financial information (the five year income projection), the vessel charter activity becomes profitable from about year four and will make a significant overall cumulative profit year five when the vessel is sold due to the profit from the sale of the vessel.

The following documents are to be read with and form a part of the facts for this private binding ruling:

• Signed copy of the Vessel Management Agreement;

• Five year Profit Forecast;

• Email responses to requests for further information; and

• Loan document for the vessel purchase.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 26-47

Income Tax Assessment Act 1997 sub-section 26-47(2)

Income Tax Assessment Act 1997 sub-section 26-47(3)

Reasons for decision

Question 1

Summary

The vessel charter activity is considered to be the carrying on of a business for the purpose of section 26-47 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Detailed reasoning

Section 26-47 of the ITAA 1997 provides rules for deductions from non-business boating activities. In most cases, costs of vessel charter activities can only be used to reduce assessable income received from vessel charter activities. They cannot reduce assessable income from other sources.

The exception to this is when you use or hold a vessel mainly for chartering it on hire in the ordinary course of a business you carry on.

Taxation Ruling TR 2003/4 Income tax: Relevant hire arrangements (TR 2003/4) discusses the Commissioner's view on vessel hire arrangements and the application of the above provision. Further guidance for determining if you are carrying on a business can be found in Taxation Ruling TR 97/11 Income tax: am I carrying on a business or primary production? (TR 97/11).

Using a vessel mainly for chartering it on hire in the ordinary course of a business that you are carrying on

TR 2003/4 states you may carry on a business of vessel charter and employ the services of a managing agent to aid this task. Where the vessel owner enters into a contract with a charter operator, two issues need to be considered:

• is the vessel being used in the owner's business, or does the agreement represent the lease of the vessel to the charter operator's business; and

• in chartering the vessel to customers, either by you directly, or through the charter operator, does the activity amount to more than the passive receipt of income from vessel rental?

The extent to which you participate in, and the effective control you have over, the operation of the charter activity, as well as the extent to which you share in the risks and rewards of it, will assist in determining the character of the arrangement.

The terms and conditions in the agreement or contract with the charter operator will present the facts that determine the answer.

In your case you have purchased the vessel and entered into a management agreement with BCO. The management agreement confirms the following:

• the charter agreement affirms that BCO are acting as your agent and their activities regarding your vessel will be undertaken on your behalf;

• you are entitled to all hiring fees earned in relation to the charter of your vessel;

• you are required to pay management fees in return for the services provided under the agreement;

• you are required to reimburse BCO for any costs incurred on your behalf for the vessel charter activities;

• you have access to the vessel given appropriate notice and no conflict with any commercial charter;

• BCO are required to consult with you prior to any expenditure for repairs, maintenance or equipment replacement over a certain value;

• you are responsible for the payment of mooring costs, repairs and insurance; and

• the arrangement grants exclusive management of the Vessel to BCO for the term of the agreement.

In light of the above facts the arrangement between BCO and yourself will have the characteristics of a management agreement as opposed to the characteristics of a rental or lease arrangement.

Carrying on a business or passive income

Where the arrangement between you and the charter operator does amount to a management agreement, the question still arises as to whether this activity amounts to the carrying on of a business, or instead involves only the passive receipt of income from chartering the vessel to the vessel hirer.

Paragraphs 55 and 56 of TR 2003/4 explains that whether the charter of a vessel is carrying on a business will depend on the level of additional services provided to complement the charter of the vessel. These services may be provided directly by you, or through the charter operator on your behalf. If this is the case, the extent of those services will be relevant in considering whether the activity amounts to carrying on a business or passive receipt of income.

TR 2003/4 provides examples of complementary services as:

• customer inquiry and booking services;

• issuing of accounts and processing of deposits and payments;

• reception area for charter guests;

• pre-charter briefing including training and assistance in the correct operation of the vessel and safety equipment;

• access to jetties with electric power, hot and cold water, waste disposal facilities and fuelling facilities; and

• support infrastructure for the hirer while the vessel is on charter, including a radio and rescue service.

As part of the activity, additional services will be provided to the hirers of your vessel. These services will be provided through BCO, as your agent, or yourself and include:

• inquiry and booking services;

• pre-charter training and assistance in the correct operation of the vessel and safety equipment;

• support infrastructure for the hirers while the vessel is on charter;

• waste disposal and fuelling facilities;

• cleaning of the vessel prior to charter; and

• arrangement of a qualified skipper and crew if required.

The extent of the services offered in addition to the hire of the vessel is indicative of carrying on a business rather than the passive receipt of income.

Additional indicators of carrying on a business

Throughout TR 2003/4 several indicators of carrying on a business are discussed, which are also found in TR 97/11 with regards to primary production. The principles discussed in TR 97/11 apply equally to determining whether other forms of activity amount to carrying on a business.

TR 97/11 lists the relevant indicators as:

• whether the activity has a significant commercial purpose or character;

• whether you have more than just an intention to engage in business;

• whether you have 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 on in a similar manner to that of the 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 permanency of the activity; and

• whether the activity is better described as a hobby, a form of recreation or a sporting activity.

It is then necessary to apply the criteria as outlined in TR 97/11 to your circumstances to determine if your activities amount to a business being carried on.

Significant commercial purpose or character

This indicator generally covers aspects of all the other indicators and broadly requires that a taxpayer be able to show that the activity is carried on for commercial reasons and in a commercially viable manner. A taxpayer needs to be able to show that the interaction between the size and scale of the activity, the repetition and regularity and the intention and prospect of profit are sufficient to conclude that the activity has a significant commercial purpose.

In your case you:

• have undertaken preliminary research into charter operations in the vessel charter region including evaluation of vessels, charter operators and trends in tourism over time;

• will engage a charter operator with considerable experience under a charter agreement for the day to day operation;

• sought advice from a number of sources within the industry and accounting experts; and

• the vessel charter operation will become profitable at about year four of operation and in each year thereafter.

You satisfy this criterion and have demonstrated the commercial basis for entering into the vessel hire arrangement; a significant profit is expected to be made when the vessel is sold in year five.

Intention to engage in business

Carrying on a business requires activities, not simply the idea, or desire to engage in a business. The extent of activity determines whether a business is being carried on.

In your case you have more than an intention to engage in business.

Prospect of profit

We consider this to be a very important indicator. It is important that you are able to show how the activity can make a profit. This indicator reflects three elements:

• a genuine belief that profit is attainable;

• the intention to produce profits from the Vessel charter activities; and

• that the activities are capable of producing a profit.

It is not necessary for the activities to make a profit in every year of income to classify the activities as a business, and as such, you may be carrying on a business even though you are making a small profit or a loss in any given year of income.

However, where the objective evidence at the time of entering the vessel charter activities shows a significant profit (over the life of operations) is unlikely, this would strongly indicate that entering into the activities was not motivated by profit, and this indicator would not be satisfied (TR 2003/4 paragraph 75).

You have provided a five year and a ten year financial projection and stated your agreement with BCO will be for a number of years. You have said that the vessel will be sold after five years, for this reason the five year profit forecast has been used for the purposes of this private binding ruling.

You have projected you would generate a profit after about four years of operation and in every year thereafter. You will make a significant overall profit when the vessel is sold. This is considered to be at a commercial level.

Importantly your projected profit does take into account all of the expected income and expenses. This has included any decline in value of the vessel while used in the activity (TR2003/4 paragraphs 17 and 78) and interest deductions.

In your case, you have shown that there is a reasonable expectation that you are undertaking this activity with the prospect of making a significant commercial or financial gain from it. Based on the projections you have provided the activity is profitable from about year four and in every year thereafter, the activity makes a significant overall profit. This indicator is passed.

Activities of the kind carried on in a similar manner

A vessel hire activity is more likely to be a business where it is conducted using business methods and procedures similar to those ordinarily used in vessel hire activities said to be businesses.

TR 97/11 and TR 2003/4 state that the following factors may indicate that a vessel hire activity constitutes a business:

• the volume of sales;

• the types of customers - wholesalers, retailers, the public at large, or friends and relatives;

• the manner in which the marketing takes place;

• the sort of expenses incurred by you;

• the amount invested in capital items;

• you own the appropriate licences and permits required;

• you and/or the operator have the appropriate experience;

• you and/or the operator have appropriate indemnity cover; and

• use of the vessel is not primarily directed at private use.

In applying the facts of your case to the above factors:

• the volume of sales you project is comparable to those of other operators;

• your customers are the general public as opposed to mainly friends and family;

• you will market your vessel for charter through your agent, BCO as is common practice in the industry;

• you will have the appropriate licences and permits required;

• you will have appropriate insurance; and

• your private use of the vessel is for only four weeks per year during non-peak periods where possible.

These factors indicate a business activity is being carried on.

Organised, systematic and business-like manner

Paragraph 86 to 88 of TR 2003/4 clarifies that vessel hire activities are more likely to amount to carrying on of a business where they are carried out in a systematic and organised manner. Factors which indicate this include:

• operations are not haphazard and are carried on in a consistent manner;

• profitable activities are pursued and unprofitable activities are discontinued;

• vessel charter transactions and financial arrangements are managed separately and distinctly from personal finances;

• appropriate business records are kept; and

• personal use of the vessel does not take priority over use of the vessel for charter purposes.

These factors may be carried out by you or your manager on your behalf. A taxpayer may still carry on a business despite having poor organisational skills.

In your case:

• you have conducted research into the industry, area of operation, charter operators and financial implications of the activity;

• you will receive monthly reporting from BCO;

• you will hold regular meetings with BCO to review the activity and discuss future growth;

• you will keep records to assist with BAS and tax return preparation, and

• you have signed an agency agreement with BCO.

This represents a moderate level of organisation and a business-like approach.

Repetition, regularity, size and scale

Vessel hire activities are more likely to amount to carrying on a business where they are regular and ongoing. Additionally, the larger the scale the more business-like. However, it is possible for you to carry on a business on a small scale.

In your case, your vessel will be available for hire for the full year other than the private use days and when the vessel is unavailable due to repairs. Your activities are considered to be carried on at a smaller scale. This indicator is not determinative by itself refer paragraph 23 TR 2003/4.

Conclusion

When applying your facts to each of the business indicators it is considered that, as a whole, your vessel hire activity will meet the requirements and the overall impression would be that you are carrying on a business.

TR 2003/4 states that in order to demonstrate that a vessel charter activity amounts to the carrying on of a business, a taxpayer needs to show that it is carried on with the intention of making a significant commercial profit. The income and expense projections that you have supplied demonstrate that over the charter operation period, the vessel hire activity will make a significant overall commercial profit. Consequently, the activity does have significant commercial purpose and a prospect of profit.

Because you are considered to be carrying on a business, sub-section 26-47(3) of the ITAA 1997 will apply so that sub-section 26-47(2) of the ITAA 1997 does not stop you from deducting a loss or outgoing for your boating activity.

The expenses associated with conducting the activity will be deductible under section 8-1 of the ITAA 1997 provided they are not of a capital or private nature.

Note

This private ruling is binding on the facts provided. The main reason this activity as described is qualifying as a business is in regard to its overall profitability particularly when the vessel is sold. You should review the actual figures at the end of the first and second years, should the vessel charter income and expenses vary significantly from the financial information that you provided with this private ruling application, this private ruling decision will have no application. If this is the situation you could apply for a new private ruling based on the different facts if you are unsure of how the ATO view would apply to your circumstances.

Limit to future years rulings

You had requested the Commissioner to provide you with a private ruling for a period until you ceased the vessel charter activity. Due to the possibility of changes in your circumstances (the fact that your income projections and expenses, particularly the income may vary significantly), the possibility of change to the law, and the risk that a subsequently issued public ruling might override a private ruling the Commissioner has issued, the Commissioner has provided a private ruling from for first two full financial years only. You may request a further ruling after this time if you require further binding advice.

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