Edited version of your private ruling

Authorisation Number: 1012365184185

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Ruling

Subject: business expenses and agistment

Question 1

Is the partnership considered to be carrying on a business of livestock breeding?

Answer

No

Question 2

Are the livestock considered trading stock?

Answer

No

Question 3

Is the partnership entitled to claim losses in the relevant financial years?

Answer

No

Question 4

Are expenses allowed to be claimed as deductions against agistment income?

Answer

Yes, up to the level of income received.

This ruling applies for the following period

Year ended 30 June 2009

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commenced on

1 July 2008

Relevant facts

The partnership (you) consists of a number of partners.

You purchased a small property which is used for livestock activities.

As well as income received from your breeding program and agistment, you have other employment.

You commenced actively marketing your livestock via your website. You also advertise, by word of mouth on other websites and via industry publications.

When the activity is in full production you expect to have a small number of breeding stock and a small number of offspring produced per year.

The activity has produced a small number of offspring from the breeding activity since it commenced. You have sold a small number and have others ready for sale.

You spend a small amount of time on the activity due to your employment elsewhere.

No staff are employed.

The property is only used for your residence, agistment and breeding of livestock.

You have been involved in the industry for many years.

You have sought the advice from local vets on breeding cycles, pregnancy issues, and injuries etc.

Your expenses have far outweighed your income from the breeding activity. You have received some regular income from agistment.

Assumptions

Nil

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 36-10

Income Tax Assessment Act 1997 Section 70-10

Reasons for decision

Question 1

Detailed reasoning

Am I in Business

The issue in question is whether the breeding of horses is carried on as a business for tax purposes (and whether associated expenses are deductible). This is always a question of fact. Each case turns on its own particular circumstances.

The courts have, however, identified certain indicators that are relevant in determining whether a taxpayer's activities amount to the carrying on of a business. These indicators are outlined in Taxation Ruling TR 97/11 and include:

· whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators set out below;

· whether the taxpayer has more than just an intention to engage in business or to commence in the future; an intention alone without commencement of activities is insufficient;

· whether the taxpayer has 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 out 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.

No one indicator is decisive. The facts of each case must be examined and the determination is based on the large or general impression gained (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548).

A general observation is made at paragraph 17 of TR 97/11 that 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 amount to a business.

In essence, whether a business is being carried on will depend upon whether the indicators, as a whole, provide the activities with a commercial flavour: Ferguson v. Federal Commissioner of Taxation (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884 (Fergusons case).

Specific application of business indicators to the horse industry

Taxation Ruling TR 2008/2 provides the Australian Taxation Office (ATO) view about the indicators of business as they relate to the industry. Although the ruling relates primarily to racing, training and breeding or a combination of those, some of the same principles may be applied in this instance.

We consider below the relevant indicators from TR 97/11 and TR 2008/2 in the context of your activities.

1. Significant commercial purpose or character

This indicator is linked to some of the other indicators in TR 97/11, and generally requires the 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 or scale of activity, the repetition and regularity of activity, and the intention and prospect of profit from the activity together indicate that the adventure has a commercial purpose.

To demonstrate that the activities carried out by an entity have a significant commercial purpose, we consider the following points from paragraph 30 of TR 97/11 to be relevant:

· a business plan

· advice sought from others knowledgeable in the industry

· obtaining technical information relating to the activities

· analysis of potential markets

· analysis of capital required for the activities, including planned acquisition and use of capital

· research which properly confirms that you can expect to profit from the activity, taking into account the particular market and expected running costs

· the size and scale of the activity being sufficient for a commercial enterprise

· compliance with regulatory requirements necessary for commercial operations, and

· intention to make a profit, and a reasonable belief that the activity will generate a profit.

Although it is accepted that a formal or written business plan is not compulsory, the principal of planning that is, having a strategy for turning the activities into a viable business is considered to be particularly relevant where the taxpayers activities have resulted in a loss for a relatively long period of time, or where a large part of the activities are inherently unprofitable.

In other words, where there is a genuine intention to profit but there has been a regular and continuous loss incurred from the activities, we consider it would be natural in business that there would be a strategy put in place to minimise the losses with a view to making a profit.

Such a plan may emanate from research which confirms the applicant's expectation to profit from the activity, based upon expected income and running costs.

Expected operating costs could be extrapolated from the actual operating costs from the records kept over time. It is up to the taxpayer, therefore, to demonstrate that the activities are evolving to increase its likelihood of profit.

To be in business, it is expected that efforts be directed towards making a profit from regular sales. 

The size and scale of this activity are carried on in a very small way. There is repetition and regularity in this activity but on a very small scale given the lack of time you devote to the activity due to your outside employment. It doesn't appear that profit is a high priority and there is no prospect of a profit being made as indicated by your projections.

Each of the dot points above will now be addresses:

You have a business plan

You have sought advice from others with industry knowledge

You have obtained technical information

You have analysed potential markets

You have analysed the capital required for this activity

You have conducted research in the form of professional advice which was outlined in the business plan. The business plan stated the enterprise appears not to be viable without the wages contributions. Cash flow statements have indicated the business would not be cash flow profit for the many years shown in the statements.

You have not demonstrated that the activities are carried out in a commercially viable manner. With only a very small number of foals to be sold in a year, it is highly unlikely that the activity will ever be profitable. This scale of activity is not considered to be of a commercial quantity

Given the limited sales it is very unlikely that the activity will ever be profitable

It does not appear that there is a genuine intention of profit as there have been losses since the activity commenced and there has been no evidence of a strategy which has been put in place to minimise the losses with a view to making a profit.

It doesn't appear that the activities were carried on in a commercially viable manner.

2. The intention of the taxpayer

As indicated by paragraph 39 of TR 97/11, this indicator is about the intention of the taxpayer in engaging in the activity. There must be an intention to engage in business, and there must be activity that supports 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

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

You have articulated an intention to establish and develop a livestock breeding business but it is in the early stages and it takes some time to establish. It is clear that you have an interest in the livestock and you have been involved with these for quite a number of years.

It appears that profitability is not a high priority of this activity as it is only mentioned once briefly in the business plan. It appears that the overarching reason for the activity is to provide quality livestock to the industry and not necessarily profitability.

No indication has been supplied as to how, and when, this activity will produce a profit into the future.

3. Prospect of profit

Paragraph 17 of TR 97/11 stresses that, 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. In other words, you must demonstrate that the expectation of profit is reasonable.

It is not necessary that a profit be made immediately and it may be that the activity experiences short term losses. In these cases, an activity could still be regarded as carrying on a business, notwithstanding those losses.

It will be a question of fact in each case whether the 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 to not constitute the carrying on of a business.

You have provided cash flow statements for your activities. Those statements indicate the activities will not be cash flow positive for a number of years. This is due to the low sales income as a result of only having a very low number of breeding stock with and even smaller number of offspring to be born each year.

The main barrier to commerciality for your activities is whether you will make sufficient income to cover your costs.

As previously stated, it is recognised that activities from which a profit is intended to be derived can nevertheless result in a loss for a short term. This is not necessarily conclusive of lack of intent to profit where it is believed that the activity will become profitable.

This would mean that where a taxpayer genuinely believes that activities will be profitable, but due to particular circumstances it is unlikely a profit will ever be made, the taxpayer may still be carrying on a business.

The Commissioner considers that, for there to be a reasonable expectation of profit or gain, there must be an even chance that a profit or gain will be made over the long term (Miscellaneous Taxation Ruling MT 2006/1).

Thus the test is an objective one. This means that the determination of whether there is a reasonable expectation is not solely based on the subjective view of the individual concerned. It is determined by whether a reasonable person looking at all the circumstances would come to the conclusion that there is a reasonable expectation of a profit or gain.

The recognition by the courts that a profit does not necessarily have to be made in every year (or at all) has usually been made in particular contexts. For example, there could exist a lack of business acumen on the part of the business person (see Thomas v. FC of T 72 ATC 4094; (1972) 3 ATR 165) or there could be unforeseen factors such as natural disaster which could make it difficult for the business person to profit (such as in Tweddle v. Federal Commissioner of Taxation (1942) 180 CLR 1; (1942) 7 ATD 186). In these cases it was noted that the effects of these factors did not necessarily mean that the intent to profit did not exist.

You have not demonstrated a reasonable belief of an ability to produce a profit, based on the number of livestock produced annually.

4. Repetition and regularity

It is a common characteristic of business that activities are repeated on a regular basis.

A common feature of business is that activities are repeated on a regular basis. You should be able to show that you have at least undertaken the minimum level of actions required to maintain the activity at a commercial level.

However, an enterprise must start somewhere and the first step or steps may be minor. In Fergusons case, Bowen CJ and Franki J expressed the point in this way:

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 business.

What constitutes repetition and regularity is a question of fact and degree.

In the context of the industry, the level of repetition and regularity should be sufficient to maintain a commercial quantity and quality of saleable livestock.  We also need to consider the regularity of the revenue producing activities and the regularity of sales of stock to generate cash flow as noted at Paragraph 11 of TR 93/26.

You have shown some repetition and regularity in a very minor way in that since the activity commenced you have served your breeding stock on a regular basis and produced a very small number of offspring. With the current level of breeding stock producing an even smaller number of offspring you have not shown the minimum level of activity to maintain a commercial level of breeding. The main reason for not being able to devote more time to the activity is your outside employment. It is granted that activities such as this will take time to establish however, it is the low level of current and proposed activity which will prevent it from ever making a profit.

It is considered that the level of activities as a whole is not consistent with that of a commercially viable business.

5. Activities characteristic of the industry

An activity is more likely to be an enterprise if it is carried on in a similar manner to other participants in the same industry. Comparisons could be made to:

· volume of sales (taking into account the fact that, at the commencement of a business, sales would be relatively low)

· the types of customers for the activity

· the types of expenses incurred

· the level of capital investment

· previous experience

· the marketing of the livestock, including marketing methods

· comparison with similar activities carried out by a keen amateur.

Paragraph 11 of TR 93/26 provides industry-specific indicators which cover the characteristics inherent in a horse breeding business:

· whether the taxpayer regularly sells stock to the public, to generate cash flow

· whether the taxpayers mares are being serviced regularly

· whether the taxpayer is using any stallion rights it holds

· whether it keeps geldings, barren female horses or other horses inappropriate for breeding

· whether it sells colts.

Your volume of sales is very low. Low sales income is understandable in the early years when you are setting up your business, however you have not made any positive steps to increase your breeding stock since commencing the activity. You have stated what the maximum capacity of the activity will be. This maximum level of productivity is currently in place. The low level of activity is mainly due to the fact that you are not able to devote any more time because of your outside employment.

You have worked in the industry for a long period of time and are experienced in these types of livestock. Marketing of the livestock is done in a similar manner to the industry. Since the activity commenced you have produced a small number of offspring and have only sold a very small number, even though the unsold offspring are currently for sale. The current and intended level of activity is akin to that of keen amateurs.

6. Organisation in a business-like manner

Activities that are conducted in a systematic and organised manner are more likely to amount to a business than one which is conducted on an ad hoc basis. However, the lack of a proper system would not be sufficient on its own to conclude that there is no business being carried on. Further, the degree of record keeping required may vary depending on the type of activity being carried on.

Although you have not provided details of any specific research you have conducted into the breeding industry, your use of industry experts from other breeding and training farms indicates that the activity is not conducted on an ad hoc basis.

We consider that your activities are systematic and organised but these characteristics may also be present in someone vigorously pursuing a hobby.

However, the fact that you conducted these activities indicates you operate in a systematic and organised manner.

We consider that your activities show some organisation in a business-like manner.

7. Size and scale

In general, the larger the scale of the activity, the more likely it will be that a business is being carried on. However, you may still be carrying on a business even if the activities are on a small scale. For example, a taxpayer who undertakes proper research, invests significant capital, has a reasonable expectation of profit and conducts the activity on a regular basis may still be regarded as carrying on a business despite the scale of the activity.

However, the smaller the scale of the activity, the more important these other indicators become in determining whether you are carrying on a business.

Since first purchasing the mares you have conducted the activity in a business-like manner albeit on a very small scale. The scale of your operations has not increased since the breeding stock were purchased and you have indicated that their numbers will not increase from the current level.

It is considered that this activity is conducted on a very small scale.

8. Hobby or recreation

If the taxpayers activities are being conducted primarily for pleasure or because of an interest in the activity, the fact that the activities may be done on a substantial scale is not enough to decide that a business is being carried on see Ferguson at ATC 4265; ATR 877, where it was said that:

if what he was doing is more properly described as the pursuit of a hobby or recreation or an addiction to a sport, he will not be held to be carrying on a business, even though his operations are fairly substantial.

As detailed at paragraph 87 of TR 97/11, often it will be the case that a taxpayer's activities are done for pleasure or out of an interest when:

· it is evident that the taxpayer has no intention to profit from the activities

· losses are incurred because the activities are motivated by personal interest rather than to make a profit

· sales, if any, are isolated and irregular and generally not made to the public at large

· the activity is not carried on in the same manner as normal business activity

· there is no system directed at making a profit

· there is an intention by the taxpayer to carry on a hobby, recreation or sport rather than a business.

You state that you have held a personal interest for many years. Therefore the question of a dual purpose is raised, that is, whether you would conduct this activity anyway for other reasons (e.g. hobby, personal interest). 

There is no doubt that a direct and recognisable nexus exists between livestock and leisure activities. It is readily apparent that livestock could be kept and/or used for private purposes. It can therefore be difficult, at first glance, to determine whether a livestock-related activity has been undertaken for business or private purposes. The same cannot be said for many other primary production activities. Generally it will be reasonably apparent whether the activity is being undertaken for a business purpose rather than as a private pursuit (hobby).

The conclusions reached in your business plan clearly state that the enterprise appears not to be viable without the wages contribution. Without the wages injection into the activity it is not financially viable. The question then remains what is the reason for going ahead with the activity when the advice you received indicates the activity is not viable (without regular cash injections). It seems apparent that the only way for this activity to make a profit is to increase the size of the breeding stock however you have already stated that it will be very hard to find more time given your outside employment. Given the scale on which the current activity operates it is highly unlikely that a profit will ever be made.

Without any direct evidence it is assumed the activity operates for some reason other than profitability. Given your involvement in the industry over many years (and losses over the first three years of operation) it cannot be ruled out that the activity operates for other than commercial factors alone (i.e. personal reasons)

It is considered that your actions were more consistent with those that pursued breeding livestock as an interest or pastime rather than carrying on a business of breeding.

Conclusion

We have considered this case carefully and in detail on the facts provided, taking into account the relevant law.  We have analysed the information provided in your application and subsequent letter. We have conducted the analysis of your activities according to the indicators as set out in Taxation Ruling TR 97/11.

It does not appear that there is a genuine intention of profit-making as measures have not been put in place to ensure medium to long term profitability.

Your current and future maximum production is not consistent with that of a commercially viable business and more akin to that of keen amateurs.

There are some indicators however which show that the activity is conducted on a similar basis to those in business, i.e. activities are not conducted on an ad-hoc basis, and the activities appear to be systematic and organised.

The overall impression gained is that the activity is not operated on a similar basis to that of a commercial business as the very small scale of the activity and the lack of potential profitability appears to be present.

We consider that you were not carrying on a business of livestock breeding for the purposes of the ITAA 1997 during the years in question.

Trading Stock

Detailed Reasoning

Division 70 of the ITAA 1997 discussed trading stock. The meaning of trading stock is outlined under Section 70-10 of the ITAA 1997. It states trading stock includes:

a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

b) live stock.

In this case, as stated previously, the activity is not considered a business therefore the livestock is not trading stock as they are not produced in the ordinary course of a business.

Tax Losses

Detailed Reasoning

Section 36-10 of the ITAA 1997 outlines how to calculate a tax loss for an income year. In part it states you add up the amounts you can deduct for an income year and then subtract your total assessable income and any amount remaining is a tax loss.

In this case, as stated previously, this activity is not considered a business. You are therefore not entitled to claim any deductions and the income you receive from your breeding activities is not assessable income therefore no tax loss exists.

Agistment activities

Summary

Given the disproportion between the expenses and the income earned from agistment and that there may be other purposes, we consider it reasonable to limit the amount of the deductions in relation to the agistment to the amount of the assessable income actually received in the year.

Detailed Reasoning

The ordinary meaning of agistment is taking in and feeding or pasturing animals for a fee.

Generally the agistor (farm owner) provides a fenced paddock, water and seasonal grazing. The agistee (the owner of the livestock being agisted) is responsible to provide all the needs of his livestock other than fence and water. Usually, the agistee is allowed some measure of access, and may or may not be allowed to use the facilities available at the farm (i.e. yards, sheds etc).

Expenditure will be deductible under section 8-1 of the ITAA 1997 if it is incurred in gaining or producing assessable income unless it is of a capital, private or domestic nature.

It is necessary to consider the essential character of the expenditure incurred to determine whether there is a sufficient connection with the assessable income earned. The essential character of an expense is a question of fact to be determined by reference to all the circumstances.

Expenditure may have been incurred, in part, for a purpose other than the production of assessable income. If this is the case, the expenditure must be apportioned and a deduction allowed only to the extent that the expenditure was incurred for the income producing purpose. The appropriate method of apportionment will depend on the facts of each case and the method must be both 'fair and reasonable' in all the circumstances (Ronpibon Tin NL & Tongkah Compound NL v. FC of T (1949) 78 CLR 47; (1949) 8 ATC 431). For example, in Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 (Fletcher's case), the High Court suggested a 'commonsense' or 'practical' weighing of all the factors and in that case found that it was 'fair and reasonable' to limit the amount of the deduction to the amount of the assessable income actually received in that year.

In Fletcher's case the assessable income derived from the annuity in each of the tax years was less than one-eighth of the relevant amount of interest outgoings in that year. The High Court accepted the Commissioner's position that the deduction for interest outgoings should be allowed to the extent of the assessable income received from the annuity investment plan.

Although the decision in Fletcher's case was made in the context of an artificial tax avoidance scheme, we can see no basis for limiting it in this way. Therefore, the principles adopted in Fletcher apply generally to all cases involving the application of section 8-1 of the ITAA 1997.

Taxation Ruling TR 95/33 considers the implications of Fletcher's case and outlines the Commissioner's view on the importance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings. The ruling states that if an outgoing produces no assessable income, or the amount of assessable income is less than the amount of the outgoing, it may be necessary to examine all the circumstances surrounding the expenditure, including an examination of the taxpayer's subjective purpose, motive or intention in making the outgoing, to determine whether the outgoing is wholly deductible. If it is concluded that the disproportion between the outgoing and the relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective, then the outgoing must be apportioned between the pursuit of assessable income and the other objective.

The Court took the view that if, on consideration of all those factors, the whole of the interest could be characterised as 'genuinely and not colourably incurred in gaining or producing assessable income', the interest would be fully deductible. If only part of the outgoing could be so characterised, apportionment between the pursuit of assessable income and of other objectives was necessary.

AAT Case 38/97 97 ATC 397; (1997) 36 ATR 1154 specifically dealt with the treatment of interest expenses incurred in relation to agistment income. In that case it was held that the outgoings to pay the interest on the loan to purchase the property were more properly characterised as an outgoing to maintain the asset base than to produce assessable income and that the Commissioner was correct in allowing a deduction to the extent of the income received from agistment.

Generally, the income from leasing a property for agistment purposes is disproportionate to the level of expenses incurred, particularly in cases where borrowed funds were used to purchase the property. This is not seen as a commercial arrangement, as it would usually take many years of income to recoup the expenses for even one year.

You stated it was your intention when purchasing the property to establish a breeding activity. It has been concluded above that the activity is not a business. Given your long involvement in the industry over many years, your lack of profit-making intent in relation to the breeding activity and the fact that your residence is on the property, a purpose or purposes other than to make a profit cannot be discounted. You have used part of the property for agistment purposes and other parts for your residence and for the breeding activity which is conducted on such a small scale it is not considered a business, it is considered that expenditure may have been incurred, in part, for a purpose other than the production of assessable income therefore the expenditure must be apportioned and a deduction allowed only to the extent that the expenditure was incurred for the income producing purpose. It is considered fair and reasonable to limit the deductions in relation to the agistment to the level of agistment income.