Edited version of private ruling

Authorisation Number: 1011688778288

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Ruling

Subject: Tax break - investment allowance - carrying on a business

Questions:

1. At what time will the boat charter activity constitute carrying on a business for tax purposes?

Answer: Decline to rule. See general information below.

2. Will you be able to claim the tax break investment allowance for the boat that has an investment commitment time in the 2009-10 income year and a first use time in the 2010-11 income year?

Answer: Yes.

This ruling applies for the following periods:

1 July 2009 to 30 June 2010.

1 July 2010 to 30 June 2011.

The scheme commences on:

1 July 2009.

Relevant facts and circumstances

For some time you investigated business opportunities in the boat charter industry. Based on research, business experience and the prior use of similar boats you saw a good business opportunity in a strong and growing industry with long term income potential.

You and others entered into a partnership agreement. The partnership had been registered as a business name prior to this.

Around the same time the partners entered into an agreement with a boat charter operator. This agreement outlines all of the services provided by the charter operator and all requirements of the owner. The agreement was for a period of more than five years with options to extend.

The partners then entered into an agreement with a boat builder for construction of the boat before 31 December 2009. The construction agreement had a delivery date of before 30 June 2010.

The boat was advertised on the website for the charter operator from early 2010 and the partners received a deposit payment before 30 June 2010 for a future charter.

The completed boat was delivered to the charter operator after 30 June 2010 and had its first charter shortly afterwards. There was no private use of the boat before delivery to the charter operator.

You have provided estimates of income and expenses for the next three years.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 subsection 26-50(5)

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 section 40-25

Income Tax Assessment Act 1997 section 40-30

Income Tax Assessment Act 1997 section 40-40

Income Tax Assessment Act 1997 Division 41

Income Tax Assessment Act 1997 subsection 41-10(1)

Income Tax Assessment Act 1997 section 41-25

Income Tax Assessment Act 1997 section 41-35

Income Tax Assessment Act 1997 section 328-110

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 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 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 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.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

General Information

Whether carrying on a business

The meaning of business is comprehensively considered in Taxation Ruling TR 97/11. Although TR 97/11 deals with carrying on a primary production business, the principles discussed in that ruling apply to any business.

Determining whether a taxpayer's boat charter activities amount to the carrying on of a business involves considering the general indicators of when a business exists. While no single indicator is determinative and the determination is based on the large or general impression gained (Martin v. FC of T (1953) 90 CLR 470; 5 AITR 548), the prospect of profit is highly significant when assessing if an activity has the character of a business.

TR 97/11 discusses the main indicators of carrying on a business and provides examples for the indicators. Paragraph 26 of TR 97/11 states that the indicators are:

· Does the activity have a significant commercial purpose or character?

· Does the taxpayer have more than a mere intention to engage in the activity?

· Is there an intention to make a profit from the activity or a genuine belief that a profit will be made? Will the activity be profitable?

· Is there repetition and regularity in the activity?

· Is the activity of the same kind and carried on in a similar way to that of the ordinary trade?

· Is the activity organised in a businesslike manner?

· What is the size or scale of the activity?

· Is the activity better described as a hobby, recreation or sporting activity?

However, where an overall profit motive appears absent and the activity does not look like it will ever produce a profit, it is unlikely that the activity will ever amount to a business.

Taxation Ruling TR 2003/4 Income Tax: Boat hire arrangements also discusses when a taxpayer's activity amounts to the carrying on of a business in relation to a boat for the purposes of subsection 26-50(5) of the Income Tax Assessment Act 1997 (ITAA 1997). TR 2003/4 states that, in order for deductions to be claimed in respect of a boat, the activity must be more than the passive receipt of income from property.

Significant commercial purpose or character

This indicator generally covers aspects of all the other indicators. A business is generally carried out on such a scale and in such a way as to show it is being operated on a commercial basis and in a commercially viable manner and with an intention of producing a significant commercial gain. The existence of a business plan or consideration of viability using projected income and expenses are factors that would support a commercial purpose.

Prospect of profit

This indicator is directed at determining whether the boat owner entered into the boat hire activity with an intention to make a significant commercial or financial gain from it. The intentions of the boat owner are ascertained from looking objectively at their actions, including any arrangement entered into with a charter operator. All of the income expected to be received from, and all of the costs associated with, the boat hire activity is taken into account to determine what profit, if any, is expected. The expenses necessarily include the decline in value of the boat over the intended term of the activity and any interest incurred.

Activities of the kind carried on in a similar manner to those of ordinary trade

The boat hire activity is more likely to be a business where it is carried on in a similar manner to other businesses in the industry. Features indicating that the activity is similar in this sense include:

· the boat is available for charter on an arm's length basis

· the charter operators (whether the boat owner operates the activity directly or through another party) have:

· appropriate licences

· appropriate permits (for example, for marine parks, boat surveys, etc)

· appropriate experience

· appropriate insurances

· the owner and/or operator have appropriate indemnity cover, and

· the use of the boat is not primarily directed at private use.

Organised, systematic and business-like manner

Boat hire activities are more likely to amount to the carrying on of a business where they are carried out in a systematic and organised manner. This usually involves matters such as advertising for customers in a consistent and systematic manner, maintaining operations on a consistent basis, retaining and pursuing profitable activities, discontinuing unprofitable activities, and keeping appropriate business records.

Repetition and regularity

A boat hire activity is more likely to amount to the carrying on of a business where it displays repetition and regularity in its conduct.

The size and scale of the activity

Generally the larger the scale upon which the boat owner conducts the boat hire activity the more likely it is that it will amount to the carrying on of a business. However this indicator is not determinative.

Intention of the taxpayer

The intention of the taxpayer in engaging in the activity is a relevant indicator. However, a mere intention to carry on a business is not enough. There must be activity. The extent of activity determines whether a business is being carried on. It is a question of fact and degree, as stated by Brennan J in Inglis v. FC of T 80 ATC 4001; (1979) 10 ATR 493 (Inglis).

This indicator is particularly related to:

· whether the activity is preparatory 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 the pursuit of a recreational or sporting activity.

When will the business commence?

Your intended business activity is to receive a fee from customers who wish to charter your boat, which is best characterised as a trading activity. The costs associated with the establishment of a trading entity (that is, prior to commencement) are capital in nature as they relate to the structure of the business rather than the daily activities from which the business gains its assessable income. Any costs related to establishing that business structure are not an allowable deduction under section 8-1 of the ITAA 1997 as they are of a capital nature.

In determining when a business commences, there are three indicators that must be present before it can be said that a business has commenced. These are:

· purpose, intention and decision;

· acquisition of a business structure; and

· commencement of business operations

Purpose, intention and decision:

The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity. This is developed by researching the proposed business and, in some instances, by experiment. This process culminates in a final decision on whether to commence business.

Acquisition of a business structure:

Most business activities have a structure that provides the framework of the business. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity.

For a business activity to commence, an appropriate business structure should be in place. As to what this structure will consist of, and its size, this will be a question of fact and degree, and depend on the nature of the business activity.

Commencement of Business Operations:

As noted by Brennan J in Inglis, the level of activity is important in deciding whether a business is being carried on. Brennan J stated that:

The carrying on of a business is not a matter merely of intention. It is a matter of activity... At the end of the day, the extent of activity determines whether the business is being carried on. That is a question of fact and degree.

It is important in evaluating these activities to have a proper regard to the characterisation of your business. For example, if your business activity is characterised as a primary production activity, involving the planting and cultivating of trees, then the planting of the trees could be seen as the commencement of that business. Alternatively, if your business activity is characterised as a trading activity, the business would generally be considered to commence once you began conducting the services for a fee.

Application to your circumstances

Your proposed business activity is a boat charter business. That is, offering your boat for charter to the public for a fee using a charter operator as your agent.

It is accepted that you have more than a mere intention to engage in business and you have gone beyond research and planning.

You entered into agreements in relation to the partnership, with a charter operator and with a company to construct the boat before December 2009. The boat was advertised for charter in early 2010 and you received a payment before 30 June 2010.

There is no doubt that you will be a small business entity when the boat is delivered to the charter company.

However, the point in time that the business will commence is a point of fact and will not be determined in this ruling.

Small business tax break

Under the Tax Laws Amendment (Small Business and General Business Tax Break) Act 2009 a deduction is available for eligible expenditure on new investment in tangible, depreciating assets.

Small business entities are able to claim a 50% bonus tax deduction (the tax break) for eligible assets costing $1,000 or more that they:

· commit to investing in between 13 December 2008 and 31 December 2009, and

· start to use or have installed ready for use by 31 December 2010.

To qualify for the 50% rate you need to meet the definition of a small business entity in section 328-110 of the ITAA 1997. This generally means that the taxpayer is carrying on a business and has an annual turnover of less than $2 million.

Businesses can commit to investing in an asset by:

· entering into a contract under which they will hold the asset, or

· starting to construct the asset.

Section 41-35 of the ITAA 1997 states that the new investment threshold for an income year in relation to an asset is $1,000 if you are a small business entity during any of the following income years

· the income year in which occurs the investment commitment time

· the income year in which occurs the first use time, or

· the relevant income year.

Eligible assets

The tax break is available for new tangible, depreciating assets for which a deduction is available under Subdivision 40-B of the ITAA 1997 and new investment in existing eligible assets.

Section 40-25 of the ITAA 1997 allows you to deduct from your assessable income an amount equal to the decline in value of a depreciating asset you hold to the extent in which it is used to produce assessable income. Whether you hold a depreciable asset is determined by applying section 40-40 of the ITAA 1997. Paragraph 10 of Taxation Ruling TR 2005/20 provides that the default or general rule is that a taxpayer holds an asset when he, she or it is the owner of the asset.

A depreciating asset, under section 40-30 of the ITAA 1997, is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. There are exceptions to that rule such as land, an item of trading stock and some intangible assets.

Under section 40-25 of the ITAA 1997 a deduction from your assessable income is only available for depreciating assets that you hold.

When is an investment considered to occur?

In order for an amount to be a recognised new investment amount, its 'investment commitment time' must be between 13 December 2008 and 31 December 2009.

Where an amount is included in an asset's first element of cost, the investment commitment time will be the time at which you:

· enter into a contract under which you hold the asset or will start to hold at some point in time

· start to construct the asset, or

· start to hold the asset in some other way (section 41-25 of the ITAA 1997).

Claiming the tax break

The deduction will be claimed by the taxpayer who holds the asset for the purposes of Division 40 of the ITAA 1997; that is, the same person who claims capital allowance deductions in relation to the asset is entitled to the tax break.

The bonus deduction provided by the tax break is on top of the usual capital allowance deduction claimable for the asset as part of the taxpayer's income tax return. The tax break has no impact on deductions for an asset's decline in value claimed under Division 40 of the ITAA 1997.

The deduction is claimable as part of the taxpayer's income tax return for the income year in which the asset is installed ready for use (subsection 41-10(1) of the ITAA 1997).

If a taxpayer commits to investing in an asset in the 2008-09 income year but does not take delivery of the asset until the 2009-10 income year, the tax break will be claimable as part of the taxpayer's 2009-10 tax return (provided all of the eligibility criteria are satisfied).

Application to your circumstances

You entered into a contract to construct a boat before 31 December 2009 which was within the investment commitment time. The boat was delivered to the charter company and used to derive income before 31 December 2010. The boat was not used for any private purpose prior to being delivered to the charter company.

You were carrying on a business of boat hire when the boat was delivered to the charter operator and your annual turnover for the 2010-11 income year is expected to be less than $2 million.

As you meet the requirements of Division 41 of the ITAA 1997, you are eligible to claim the tax break in relation to the boat in the 2010-11 income year.