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Ruling

Subject: Boat charter activity

Question 1

Will your boat charter activity amount to the carrying on of a business for the purposes of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Are you entitled to claim a deduction equal to the decline in value of your boat under section 40-25 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

The scheme commences on:

1 July 2012

Relevant facts and circumstances

· You have an Australian Business Number (ABN).

· You hold relevant certificates that are required to operate the vessel you intend to buy.

· You will purchase a boat and use it for commercial purposes.

· You intend to provide high-end service to customers.

· You will finance the boat by obtaining low interest loans from two sources and a small amount of capital contribution on your own.

· You have drawn up a business plan with expected profits in the second income year.

· You have clients pre-booked and you received prepayment from the client.

· You incurred necessary expenses such as international registration (once off Australian Government fee) and mooring fees (paid to the local Government) to secure the mooring site for the vessel.

· You will put the boat in survey once it is in Australia.

· You have clients interested in booking with you and you will receive income once you're handed the keys to the boat from the seller.

· You will market your boat with boat hire companies as well as on several websites.

· You will have appropriate insurances in place.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 8-1

Income Tax Assessment Act 1997 - Section 26-47

Income Tax Assessment Act 1997 - Division 35

Income Tax Assessment Act 1997 - Section 40-880

Income Tax Assessment Act 1997 - Section 995-1

Reasons for decision

Question 1

Section 995-1 of the ITAA 1997 provides that 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

The question of whether a business is being carried on is a question of fact and degree. Taxation Ruling TR 2003/4 provides the Commissioner's view on whether boat hire activities amount to the carrying on of a business. Paragraphs 16 to 23 set out the general indicators that are applicable to boat hire arrangements when determining whether a business exists:

· 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, business-like manner

· repetition and regularity

· the size and scale of the activity

While no single indicator is decisive and the determination is based on the 'large or general impression gained' (Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551), the prospect of profit is highly significant when assessing if an activity has the character of a business (see Stone v. FC of T [2002] FCA1492 at [68]).

Significant commercial purpose or character

The 'significant commercial purpose or character' indicator, is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is important to establish that the activity is carried on for commercial reasons and in a commercially viable manner.

Prospect of profit

The prospect of profit is critical in 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 activities are 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.

The activity does not have to be profit-generating in the first year of operation or in the short term to be characterised as a business. Bowen CJ and Franki J in Ferguson v. FC of T 79 ATC 4261 at 4262; ATR 876 stated that '…an immediate purpose of profit-making in a particular income year does not appear to be essential…'. Thus, where short term losses are expected it may be that a business is nevertheless carried on: see Tweddle v. FC of T (1942) 7 ATD 186; (1942) 2 AITR 360.

You have drawn up a business plan with expected profits in the second income year. You intend to provide high-end service to the general public and promote your business. In addition, you planned to have boat hire companies market your boat charter activity. This shows that you have researched and considered the markets to which you propose to sell and realistic estimates of quantity and volumes of sales.

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

The activities of a taxpayer are more likely to be a business when carried on in a manner similar to that in which other participants in the same industry carry on their activities.

In accordance with paragraph 19 of TR 2003/4, the following factors might be compared with the characteristics of others engaged in the same type of business:

· the boat is available for charter on an arms length basis;

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

o appropriate licences;

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

o appropriate experience;

o appropriate insurances;

o the owner and / or operator have appropriate indemnity cover; and

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

You will be providing service to the public at large which indicates the boat will be available for charter on an arms length basis.

You have previous experience in operating boat charter business.

You're a qualified commercial vessel operator and you have acquired both certificates that are required to operate the boat you are intending to buy.

In addition, you have obtained the mooring permit and you plan to have the appropriate insurance cover.

Based on the above, it is reasonable to conclude that your boat chartering activity is carried on in a manner that is characteristic of the industry.

Organised, systematic, 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 charter 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 of the boat hire activity the more likely it will be that the boat owner is carrying on a business. However this indicator is not determinative.

Where the scale of the activity is small, other indicators take on greater weight when deciding whether a business is being carried on by the boat owner.

After considering all of the above indicators, we conclude that your boat charter activity will amount to the carrying on of a business for the purposes of the ITAA 1997.

When has your business commenced?

Taxation Ruling TR 2001/14 discusses the application of the non-commercial loss provisions in Division 35 of the ITAA 1997. Paragraph 69A of TR 2001/14 states that a business has commenced when the taxpayer broadly satisfies the following three requirements:

· made a decision to commence the business activity

· acquired the minimum level of business assets to allow that business to be carried on, and

· actually commenced business operations.

You will not commence any business operations until you acquire the boat. The expenditure you necessarily incurred to commence your boat charter business prior to the commencement of business operations is considered preparatory expenses.

The mooring fees you paid to secure mooring site for the boat is a recurrent expenditure and of a revenue nature. It is incidental and relevant to the gaining or producing assessable income and therefore deductible notwithstanding that it was incurred prior to the derivation of expected assessable income.

The international registration fee however, will not be deductible under section 8-1 because of its capital nature. Section 40-880 of the ITAA 1997 provides that capital expenditure that is not otherwise deductible and that relates to a business that is, was or is proposed to be carried on is deductible over five years, provided the deduction is not denied by some other provision (such as the non-commercial loss provisions in Division 35 of the ITAA 1997).

Question 2

Section 8-1 of the ITAA 1997 allows deductions for expenses incurred in gaining or producing assessable income to the extent that the expenses are not of a capital, private or domestic nature.

Deductions in relation to boats are quarantined under subsection 26-47(2) of the ITAA for amounts relating to using or holding boats for which you could otherwise deduct. This includes losses or outgoings incurred in:

· acquiring and retaining ownership of or rights to use a boat;

· using, maintaining or repairing a boat; or

· relation to an obligation associated with ownership or rights to use the boat.

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

As your boat charter activity will have the character and elements of carrying on a business rather than the passive receipt of income or the lease of the boat for use in the business of a third party, you will be able to offset any losses or outgoings from your boat charter activity against other income sources.

Paragraph 116 of TR 2003/4 specifies that where the boat is held for both business and personal use, the expenses need to be apportioned to reflect the business use of the boat.

Broadly, the expenses in relation to a boat charter activity can be categorised into three different categories:

1. expenses which can be traced directly to either private or business use of the boat such as fuel or catering expenses

2. variable expenses which are directly related to using the boat but cannot be directly traced to either use (for example general maintenance); and

3. fixed expenses that are unrelated to the use of the boat (for example interest and depreciation).

As category 1 expenses can be directly traced to particular use of the boat, they do not need to be apportioned. However, the expenses under category 1 are only deductible to the extent that they are not of a private nature. Category 2 and 3 expenses will need to be apportioned based on the actual usage of the boat.

Depreciation

Section 40-25 of the ITAA 1997 allows a deduction of an amount equal to the decline in value for an income year of a depreciating asset they 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 (subsection 40-30(1) of the ITAA 1997).

Your boat will be a depreciable asset and you will be able to claim a deduction under section 40-25 of the ITAA 1997, apportioned to reflect any private use.

Subsection 40-65(1) of the ITAA 1997 states that you must choose to calculate the decline in value of a depreciating asset using either one of the following two methods:

· the prime cost method (PCM), and

· the diminishing value method (DVM).

Once you have made your choice for a particular depreciating asset you cannot choose the alternative method for that asset in a later income year. You can however choose either method for other depreciating assets they hold.

The Diminishing Value Method (DVM)

DVM allows you a larger deduction in each of the first few years and then a progressively smaller annual deduction, as the asset nears the end of its effective life.

DVM is suited to assets that are more productive early in their effective lives and less productive later - so larger initial deductions are matched with higher initial income generated by those assets.

The formula for calculating the decline in value for an income year for a depreciating asset which started to be held on or after 10 May 2006 using DVM is contained in subsection 40-72(1) of the ITAA 1997.

Base value x Days held x 200%

365 Asset's effect life

Where:

Base value is:

· for the income year in which the asset's start time occurs,

- its cost or,

· for a later year,

- the sum of its opening adjustable value (to be examined) and any amount included as a second element of cost for that year.

Base value is the amount that is yet to decline in value and is the starting point for further decline in value calculations.

Days held: is the number of days the taxpayer held the asset in the income year from its start time, ignoring any days in that year where the asset was not used, or installed ready for use, for any purpose.

Asset's effective life: is the period of time a depreciating asset can be used by any entity to produce assessable income.

The Prime Cost Method (PCM)

PCM is the alternative method taxpayers can choose to calculate the decline in value of their depreciating assets.

This method, unlike DVM, assumes that the decline in value is uniform over the effective life of an asset.

The formula for calculating the decline in value for a depreciating asset for an income year using PCM is contained in subsection 40-75(1) of the ITAA 1997.

Asset's cost x Days held x 100%

365 Asset's effective life

Where:

· Asset's cost: is broadly what the taxpayer has paid or is taken to have paid to hold (or improve) the depreciating asset. This figure will change if a second element of cost is incurred.

· Days held: is the number of days the taxpayer held the asset in the income year from its start time, ignoring any days in that year where the asset was not used, or installed ready for use, for any purpose.

· Asset's effective life: is the period of time a depreciating asset can be used by any entity to produce assessable income.