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Ruling

Subject: Availability of deductions in relation to a charter boat

Questions

Does your charter boat activity constitute carrying on a business for tax purposes, so that the exception in subsection 26-47(3) will apply?

Answer: Yes

Is a deduction available for decline in value of a boat to be used in a charter boat business run for the year ended 30 June 20XX, when construction of the charter boat was completed and the boat was physically able to sail before 30 June 20XX, but did not have a valid Maritime Survey Certificate until 3 July 20XX?

Answer: No

Is a deduction for interest available on funds borrowed to acquire a charter boat to be used in a business run for the year ended 30 June 20XX when construction of the charter boat was completed and the boat was physically able to sail before 30 June 20XX, but did not have a valid Maritime Survey Certificate until 3 July 20XX?

Answer: Yes

This ruling applies for the following period

Year ended 30 June 20XX

The scheme commenced on

29 June 20XX

Relevant facts

The arrangement that is the subject of this ruling is described below. The following documents have been relied upon to reach a decision:

· your application for private ruling dated XX August 20XX

· further information provided in a letter dated X January 20XX; including details of the boat, purchase contract, finance contract, survey certificate, insurance details, description of activities conducted to date, details of income and expenses for 20XX and 20XX financial years

· further information in letter dated XX January 20XX including a copy of the Charter Boat Management Agreement

· further information in a letter dated X November 20XX

You entered into a contract with the manufacturer to construct catamaran sailboat to be used in a charter boat business operation.

The intended completion date for construction of the boat was April 20XX.

Due to unforseen delays in the construction of the boat, the boat was not completed until XX June 20XX.

The charter boat was completed and was physically able to sail prior to XX June 20XX, but it did not receive a maritime survey certificate until X July 20XX.

The charter boat was insured from XX June 20XX.

An agreement to charter the boat between charter operator was signed in May 20XX.

The term of the charter agreement was from June 20XX to January 20XX. This agreement was made with the view that the boat would be "Installed ready for use" by June 20XX, and it was only due to the delay in construction that the boat was unable to be chartered at this date.

Income from the charter boat operation was first received by you in October 20XX.

You have provided a copy of your business plan which was developed after conducting research through a number of avenues. You developed a number of financial models and based on this modelling the yacht should produce a profit and in the initial ten years of operation, this represents 10.8% return on capital invested.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

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

Income Tax Assessment Act 1997 Subsection 26-47(3)

Income Tax Assessment Act 1997 Section 40-25

Income Tax Assessment Act 1997 Subsection 40-60(1)

Income Tax Assessment Act 1997 Subsection 40-60(2)

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary

You are considered to be carrying on a business with regards to your boat hire activity in the year ended 30 June 20XX, from when the boat was legally available to be hired. The conditions in Taxation Ruling TR 2003/4 indicating that a business is being carried on have been met. Subsection 26-47(3) will apply to allow the deductions.

A deduction for decline in value in the year ended 30 June 20XX is not allowed. The boat has not been used and is not installed ready for use during the year.

The interest incurred in relation to the purchase of the boat is deductible in the year ended 30 June 20XX, to the extent that it was incurred to derive assessable.

Detailed reasoning

Is a business being conducted?

A boat hire activity must amount to the carrying on of a business to claim an amount that exceeds the assessable income from the use of the boat. The excess deductions are not allowed where the activity is only a passive receipt of income from property.

If you only provide a boat under a lease then generally you are not carrying on a boat hiring business and so you would not be entitled to the excess deductions for your boat. If a boat owner receives money from hiring out their boat directly, or under a management agreement with a charter operator, it is still a requirement for this activity to amount to the carrying on of a business in order to claim the excess deductions under section 26-47 of the ITAA 1997.

Indicators of a management agreement can include:

· the boat owner shares in the risks and rewards of the business activity

· the contract for the provision of the boat to the hirer highlights that the charter operator is acting as the agent of the boat owner in the boat hire arrangement

· the boat owner derives the income and incurs expenses relating to the charter of the boat to third parties

· the boat owner maintains a sufficient level of control over the boat.

You have entered into a management agreement that meets the above indicators.

The factors to be considered in determining if you are carrying on a business under this boat hire arrangement are:

· significant commercial purpose or character

· prospect of profit

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

· organised, systematic, businesslike manner

· repetition and regularity

· size and scale of activity

In these activities the prospect of profit is highly significant when assessing if the activity has the character of a business. Where it is clear from the objective evidence that a taxpayer cannot show the existence of a genuine belief that the activity can be profitable, they will not have the requisite intention of profit.

'Profits' implies a comparison between the state of a business at two specific dates usually separated by an interval of a year. If the total assets of the business at the two dates are compared, the increase which they show at the later date compared to the earlier date represents the profits of the business during the period in question.

You have entered into a management arrangement for a period of five years. However you intend on running the charter operation for 10 years. You have developed a 10 year income projection which indicates that you can expect a profit that represents a 10.8% return on capital invested. In this model the decline in value is calculated using a rate of 2%. The actual tax deductions for the decline in value have been taken into account for determining this accounting profit.

When applying your facts to each of the other factors, it is considered that your activity meets these requirements and the overall impression would be that you are carrying on a business. The business will have commenced in the year ended 30 June 20XX when the boat was legally available for hire.

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 a 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.

Deduction for decline in value

Broadly, section 40-25 of the ITAA 1997 provides that you can 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 starts to decline in value from when its start time occurs (subsection 40-60(1) of the ITAA 1997). Subsection 40-60(2) of the ITAA 1997 provides that the start time of a depreciating asset occurs when it is first used, or installed ready for use, for any purpose.

'Used' is a word of wide import and its meaning in any particular case will depend on the context in which the word is employed and the purpose for which the thing in question has been acquired or created (Newcastle City Council v. Royal Newcastle Hospital (1956) 96 CLR 493). In the context of Division 40 of the ITAA 1997, the use of a tangible depreciating asset requires the actual use or employment of the asset in such a way that it can reasonably be expected to decline in value through and over the time of that use (see Taxation Determination TD 2007/5). Putting a depreciating asset in readiness for use for a purpose is not itself to use the depreciating asset for that purpose (Bert Needham Automotive Company Pty Ltd v. FCT (1976) 6 ATR 469; 76 ATC 4249).

In this case, the boat was acquired for the purpose of providing it to clients in a charter boat business conducted under a management contract. However, prior to 30 June 20XX it had not been used for that purpose and it could not legally be used for that purpose before 3 July 20XX, when the valid maritime survey certificate was obtained. The boat had been built and outfitted with the necessary equipment for the purpose of it being chartered out, but this of itself does not constitute actual use of the boat for that purpose. Accordingly, the boat was not used for the purposes of subsection 40-60(2) of the ITAA 1997 before 30 June 20XX.

Consideration must now be given to whether the boat was installed ready for use. 'Installed ready for use' is defined in section 995-1 of the ITAA 1997 to mean installed ready for use and held in reserve. A depreciating asset is installed ready for use 'when it is on hand and in such a state that it is ready to perform its function'. It is held in reserve 'if it is set aside for future use, upon the happening of some contingency occurring, in the taxpayer's existing income producing activities. In other words to keep back or save for future use in those present income-producing operations' (AAT Case 5877 (1990) 21 ATR 3411; Case X46 90 ATC 378). The taxpayer's only purpose in acquiring the boat was for the charter use that requires the obtaining of a valid maritime survey certificate. Therefore until the certificate was obtained under the relevant legislation it was not in the state required for it to be ready to perform its function and would not be installed ready for use, for the purposes of subsection 40-60(2) of the ITAA 1997.

Therefore, the boat that was acquired specifically to operate in this charter boat business has not had the necessary maritime survey certificate and has not been used as a charter boat at 30 June 20XX. It is not used or installed ready for use for the purpose of establishing the asset's start time under subsection 40-60(2) of the ITAA 1997 at XX June 20XX. No deduction for decline in value is allowed in the year ended XX June 20XX.

Interest deduction prior to use of boat

Interest is deductible to the extent to which it is incurred in gaining or producing assessable income or in carrying on a business for that purpose and is not of a capital, private or domestic nature(section 8-1 of the ITAA 1997).

In determining the deductibility of interest, the courts and tribunals have looked at the purpose of the borrowing and the use to which the borrowed moneys have been put (Taxation Ruling TR 2004/4).

Interest on funds used to purchase property which the taxpayer intends to use to derive assessable income may be deductible from the time of acquisition of the property. Provided the necessary connection can be shown.

In your case the boat was completed on XX June 20XX, insured from that date and available for charter from X July 20XX. You had entered into the agreement with the charter boat operator on X May 20XX. It was clearly your intention to use the boat for the purpose of deriving assessable income as soon as it was available to be used. Therefore the interest incurred in the year ended XX June 20XX is deductible to the extent that it was incurred to derive assessable income.