Edited version of private ruling

Authorisation Number: 1011620004905

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Ruling

Subject: Deductibility of expenses

Question 1

Is a deduction allowable under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the expenses incurred in the ownership and maintenance of Partner Y's horse?

Answer:

No.

Question 2

Is a deduction allowable under section 8-1 of the ITAA 1997 for the expenses incurred in the ownership and maintenance of Partnership X's horse float?

Answer:

In part. Expenses are to be reasonably apportioned between private and business usage, with only the business usage part being an allowable deduction.

Question 3

Is a deduction allowable under section 8-1 of the ITAA 1997 for the expenses incurred in sign writing?

Answer:

Yes.

Question 4

Is a deduction available under section 40-25 of the ITAA 1997 for the decline in value of Partnership X's horse float?

Answer:

In part. The amount of depreciation is to be reasonably apportioned between private and business usage, with only the business usage part being an allowable deduction.

This ruling applies for the following periods:

Year ended 30 June 2010.

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commences on:

January 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Partnership X commenced a business.

Partnership X advertises on a number of websites offering their services.

Other forms of advertising used by Partnership X include newspapers, magazines, radio, leaflets, displays, shows and signage.

Partner Y commenced riding in general horse riding competitions decades before the business commenced. Partner Y competed in various horse activities over the years, including Pony Club, Shows, Dressage, Eventing, Novelties and unofficial and competitive endurance rides.

Partner Y owned numerous horses throughout his riding years and currently owns one endurance horse. Partner Y joined an endurance riding association and commenced competitive endurance riding after the business commenced. Partner Y intends to ride in approximately 12 endurance competitions per year.

Partnership X purchased a new horse float. Aside from transporting the endurance horse to and from competitions, the float's other uses include:

(a) transporting client's horses;

(b) transporting horses to and from static displays;

(c) mobile advertising board at competitions and static displays;

(d) display board at Sunday markets;

(e) transportation of stock;

(f) possible accommodation when attending overnight or week-end events.

The float is garaged at Partner Y's residential premises when not in use at competitions or displays.

Partnership X purchased promotional signage to be applied to the horse float.

Partnership X is also a distributor of products which are sold at Sunday markets around their region.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 90

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 26-45

Income Tax Assessment Act 1997 Section 40-25

Taxation Administration Act 1953 Section 357-85

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies, the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

Reasons for decision

Question 1

Section 8-1 of the ITAA 1997 explains what is an allowable deduction for a resident taxpayer. It allows a deduction for expenses that you incur in gaining or producing your assessable income or that are 'necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.'

However, subsection 8-1(2) of the ITAA 1997 states that you cannot deduct a loss or outgoing to the extent that it is a loss or outgoing of a capital nature or it is a loss or outgoing of a private or domestic nature.

As Partner Y has been riding horses privately in competitions and shows for decades prior to the commencement of the business, it would be unreasonable to claim that the purpose of Partner Y's current involvement in endurance horse riding competitions is predominantly for business purposes. The essential character of expenditure on Partner Y's horse riding activities is private, and is not that of expenditure incurred in gaining assessable income. If Partner Y's involvement in endurance competitions incidentally has a promotional effect in relation to the Partnership X business, it does not change the fundamental private purpose.

Accordingly, no deduction will be allowable under section 8-1 of the ITAA 1997 for the expenses incurred in the ownership and maintenance of Partner Y's horse.

Further, membership fees for a social or sporting club are generally not deductible, regardless of the business use made of the club by the member (section 26-45 of the ITAA 1997).

Question 2

As stated above, the essential character of expenditure on Partner Y's horse riding activities is private, and is not that of expenditure incurred in gaining assessable income. Therefore, all expenses connected with that activity, including use of the horse float, would be private and no deduction will be allowable under section 8-1 of the ITAA 1997.

However, as indicated, the horse float has several uses which are directly linked to the Partnership X business, such as transporting client's horses and transporting products to Sunday markets. It will therefore be necessary to apportion the expenses incurred in using the float. Apportionment should be based on the proportions of business and private travel undertaken with the float.

You may only claim a deduction for that portion of the float expenses that relates directly to the business use of the float. No deduction may be claimed for the float expenses relating to when the float is used for private purposes, either as float expenses or as advertising expenses.

Question 3

Generally advertising expenses necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income are deductible under section 8-1 of the ITAA 1997.

Accordingly, a deduction will be allowed for all costs incurred in relation to the sign writing which is connected with the Partnership X business.

Question 4

The horse float is a depreciating asset. The decline in value of a depreciating asset starts when you first use it, or install it ready for use, for any purpose including a private purpose.

The amount to be depreciated will be the purchase price of float plus any capital expenditure incurred improving the float.

A deduction is only allowable to the extent it is used for a taxable purpose or for the purpose of producing assessable income.

Accordingly, as the horse float will be used for both private and business purposes it will be necessary to apportion the depreciation expense between both usages.

In determining what percentage of the float's usage relates to business, it would be reasonable to adopt the same methodology used to calculate the business expenses in question 3 above.

Detailed reasoning

Section 90 of the ITAA 1936 defines the 'net income' of a partnership as '… the assessable income of the partnership, calculated as if the partnership were a taxpayer who was a resident, less all allowable deductions …'. Therefore, the assessable income and allowable deductions of the partnership are calculated in the same manner as a resident taxpayer.

Section 8-1 of the ITAA 1997 explains what is an allowable deduction for a resident taxpayer. It allows a deduction for expenses that you incur in gaining or producing your assessable income or that are 'necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.'

However, subsection 8-1(2) of the ITAA 1997 states that you cannot deduct a loss or outgoing to the extent that it is a loss or outgoing of a capital nature or it is a loss or outgoing of a private or domestic nature.

The courts have held that expenditure will generally be deductible under section 8-1 of the ITAA 1997 if its essential character is that of an expense incurred in gaining assessable income - in other words, if it is an income-producing expense, see Lunney and Hayley v. FCT of T (1958) 100 CLR 478 at 497, 498; ATD 404 at 412. There must be a sufficient connection between the expense, and the earning of assessable income, such that the expense is incidental and relevant to gaining of the assessable income, see Ronpibon Tin NL v FC of T (1949) 78 CLR 47 at 56; 8 ATD 431 at 435.

The essential character of an expense, and the connection between it and the production of assessable income, are questions of fact to be determined by reference to all the circumstances of the case.

If the purpose of the expenditure has aspects that relate both to earning assessable income and to private activity, apportionment of the expense may be necessary. Taxation Ruling TR 95/33 Income tax: subsection 51(1) - relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings (TR 95/33) states in paragraph 14:

When it is necessary to apportion a loss or outgoing, the appropriate method of apportionment will depend on the facts of each case. However, the method adopted in any particular case must be both 'fair and reasonable' in all the circumstances (Ronpibon Tin (1949) 78 CLR 47 at 59; 8 ATD 431 at 437).

However, if the income producing purpose is merely incidental to the main private purpose, no apportionment is necessary. The expenses relate only to the private purpose, and are therefore not allowable deductions. Conversely, if the private purpose is merely incidental to the main income-earning purpose, apportionment is not appropriate as the whole expense will be deductible.

TR 95/33 provides legislative references that relate to the ITAA 1936. Subsection 51(1) of the ITAA 1936 was re-written during the Tax Law Improvement Project and is now contained in section 8-1 of the ITAA 1997.

Section 357-85 of the Taxation Administration Act 1953 provides that if the Commissioner makes a public ruling about a tax law and that tax law is re-enacted or remade then the ruling is taken to be a public ruling about the re-enacted or remade tax law. This section has effect on TR 95/33. The principles outlined in TR 95/33 apply to section 8-1 of the ITAA 1997 in the same manner as they were applied to subsection 51(1) of the ITAA 1936.

Depreciation

Section 40-25 of the ITAA 1997 allows you to deduct an amount equal to the decline in value for an income year of a depreciating asset that you held for any time during the year.

A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. Depreciating assets do not include land, items of trading stock and most intangible assets.

A holder of a depreciating asset may deduct an amount for its decline in value. The decline in value of a depreciating asset starts when you first use it, or install it ready for use, for any purpose including a private purpose.

A deduction is only allowable to the extent it is used for a taxable purpose or for the purpose of producing assessable income. The deduction amount is based on a depreciating asset's cost, effective life and the number of days the asset is used in the income year for a taxable purpose.

To work out the decline in value of a depreciating asset, you need to know its cost. Under the Uniform Capital Allowance system, the cost of a depreciating asset has two elements. The first element of cost is, broadly, amounts you are taken to have paid to hold the asset, such as the purchase price, and any additional amounts you spend on transporting it or installing it in position. It is worked out at the time you begin to hold the asset. The second element of cost is capital expenditure incurred after that time, such as a cost of improving the asset.