Edited version of your written advice

Authorisation Number: 1051192064866

Date of advice: 18 February 2017

Ruling

Subject: Am I in business - Vessel Charter

Question

Is the vessel hire activity considered to be carrying on a business for the purpose of section 26-47 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period(s)

Year ended 30 June 20YY.

Year ended 30 June 20ZZ.

The scheme commences on

1 April 20XX.

Relevant facts and circumstances

You (you and your partner) are in the process of acquiring a vessel for a specified price.

You have signed a purchase agreement and paid an initial deposit of X%.

You have financed the deposit using funds from an existing line of credit linked to your home mortgage account.

The acquisition is being funded through use of funds from the same home mortgage account.

The vessel is currently being relocated from overseas and is due to arrive in Australian in 20XX.

You will place the vessel into charter in 20XX.

This activity will be conducted under a partnership agreement.

You have been in discussions with an active charter operator and have engaged them as your agent in the day-to-day running of the operation.

You have provided a copy of the agreement and a signed copy of the execution clause.

You intend to have the vessel in charter for a total of 10 years.

The initial term of your agreement is 5 years, which made be extended to 10 years.

After the initial 5 year term, the performance of the operation and level of satisfaction with the charter operator will be evaluated; and if satisfactory, the agreement will be extended for an additional 5 years. If the performance of the charter operator is unsatisfactory, you intend to engage an alternative operator for another 5 years.

You expect to sell the vessel following 10 years of charter.

In your 10 year income projection you calculated the depreciation using a straight line method over the first five years and the remaining five years as per the estimate of the market value.

The charter operator will provide you with regular reports of income and expenditure as well as future booking status, forming the basis of your records for you to monitor the operation.

You will be periodically involved in maintenance that does not require specific skills such as cleaning, basic repairs and refinishing surfaces in conjunction with marketing activities.

You have conducted research into the market for charter vessels of similar type.

You have provided a 10 year income projection table.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 26-47

Income Tax Assessment Act 1997 Section 26-47(2)

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

Reasons for decision

Section 26-47 of the ITAA 1997 provides rules for deductions from non-business vessel activities. In most cases, costs of vessel charter activities can only be used to reduce assessable income received from vessel charter activities. They cannot reduce assessable income from other sources.

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

Taxation Ruling TR 2003/4 Income tax: boat hire arrangements discusses the Commissioner's view on vessel hire arrangements and the application of the above provision. Further guidance for determining if you are carrying on a business can be found in Taxation Ruling TR 97/11 Income tax: am I carrying on a business or primary production?

Using a vessel mainly for chartering it on hire in the ordinary course of a business that you are carrying on

TR 2003/4 states you may carry on a business of vessel charter and employ the services of a managing agent to aid this task. Where the vessel owner enters into a contract with a charter operator, two issues need to be considered:

● is the vessel being used in the owner's business, or does the agreement represent the lease of the vessel to the charter operator's business, and

● in chartering the vessel to customers, either by you directly, or through the charter operator, does the activity amount to more than the passive receipt of income from vessel rental?

The extent to which you participate in, and the effective control you have over, the operation of the charter activity, as well as the extent to which you share in the risks and rewards of it, will assist in determining the character of the arrangement.

The terms and conditions in the agreement or contract with the charter operator will present the facts that determine the answer.

In your case you will acquire the vessel and enter into a management agreement with the charter operator. Based on the agreement provided, the following facts indicate that the contract is a management agreement:

● the charter agreement affirms that charter operator are acting as your agent and their activities regarding your yacht will be undertaken on your behalf,

● you are entitled to all hiring fees earned in relation to the charter of your vessel,

● you are required to pay management fees in return for the services provided under the agreement,

● you are required to reimburse the charter operator for any costs incurred on your behalf of the vessel charter activities,

● you have access to the vessel given appropriate notice and no conflict with any commercial charter,

● The charter operator are required to consult with you prior to any expenditure for repairs, maintenance or equipment replacement over the value of $1,000,

● you are responsible for the payment of mooring costs, repairs and insurance, and

● the arrangement grants exclusive management of the yacht to the charter operator for the term of the agreement.

In light of the above facts the arrangement between the charter operator and yourself will have the characteristics of a management agreement as opposed to the characteristics of a rental or lease arrangement.

Carrying on a business or passive income

Where the arrangement between you and the charter operator does amount to a management agreement, the question still arises as to whether this activity amounts to the carrying on of a business, or instead involves only the passive receipt of income from chartering the vessel to the vessel hirer.

Paragraphs 55 and 56 of TR 2003/4 explains that whether the charter of a vessel is carrying on a business will depend on the level of additional services provided to complement the charter of the vessel. These services may be provided directly by you, or through the charter operator on your behalf. If this is the case, the extent of those services will be relevant in considering whether the activity amounts to carrying on a business or passive receipt of income.

TR 2003/4 provides examples of complementary services as:

● customer inquiry and booking services;

● issuing of accounts and processing of deposits and payments;

● reception area for charter guests;

● pre-charter briefing including training and assistance in the correct operation of the vessel and safety equipment;

● access to jetties with electric power, hot and cold water, waste disposal facilities and fuelling facilities; and

● support infrastructure for the hirer while the vessel is on charter, including a radio and rescue service.

As part of the activity, additional services will be provided to the hirers of your vessel. These services will be provided through your charter operator, as your agent, or yourself and include:

● inquiry and booking services,

● pre-charter training and assistance in the correct operation of the yacht and safety equipment,

● support infrastructure for the hirers while the yacht is on charter,

● waste disposal and fuelling facilities,

● cleaning of the vessel prior to charter, and

● arrangement of a qualified skipper and crew if required.

The extent of the services offered in addition to the hire of the vessel is indicative of carrying on a business rather than the passive receipt of income.

Additional indicators of carrying on a business

Throughout TR 2003/4 several indicators of carrying on a business are discussed, which are also found in TR 97/11 with regards to primary production. The principles discussed in TR 97/11 apply equally to determining whether other forms of activity amount to carrying on a business.

TR 97/11 lists the relevant indicators as:

● whether the activity has a significant commercial purpose or character;

● whether you have more than just an intention to engage in business;

● whether you have 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 on 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.

It is then necessary to apply the criteria as outlined in TR 97/11 to your circumstances to determine if your activities amount to a business being carried on.

Significant commercial purpose or character

This indicator generally covers aspects of all the other indicators and broadly requires that a taxpayer be able to show that the activity is carried on for commercial reasons and in a commercially viable manner. A taxpayer needs to be able to show that the interaction between the size and scale of the activity, the repetition and regularity and the intention and prospect of profit are sufficient to conclude that the activity has a significant commercial purpose.

In your case you:

● have undertaken preliminary research into charter operations in the Whitsunday region including evaluation of vessels, charter operators and trends in tourism over time;

● will engage a charter operator with considerable experience under a charter agreement for the day-to-day operation;

● sought advice from a number of sources within the industry and accounting experts;

● you will fund the vessel through a combination of available funds and borrowings; and

● from your projections, you expect to make a profit over the charter vessel management agreement period.

You satisfy this criterion and have demonstrated the commercial basis for entering into the vessel hire arrangement; a significant profit is expected to be made over the charter vessel management agreement period.

Intention to engage in business

Carrying on a business requires activities, not simply the idea, or desire to engage in a business. The extent of activity determines whether a business is being carried on.

In your case you have more than an intention to engage in business.

Prospect of profit

We consider this to be a very important indicator. It is important that you are able to show how the activity can make a profit. This indicator reflects three elements:

● a genuine belief that profit is attainable;

● the intention to produce profits from the yacht charter activities; and

● that the activities are capable of producing a profit.

It is not necessary for the activities to make a profit in every year of income to classify the activities as a business, and as such, you may be carrying on a business even though you are making a small profit or a loss in any given year of income.

However, where the objective evidence at the time of entering the vessel charter activities shows a significant profit (over the life of operations) is unlikely, this would strongly indicate that entering into the activities was not motivated by profit, and this indicator would not be satisfied (TR 2003/4 paragraph 75).

You have projected you will generate a profit in the third year of operation, in the year ended 30 June 2020 and in ever year thereafter. You project that you will make a significant overall profit after 10 years, the year 30 June 2027. This is considered to be at a commercial level.

Importantly your projected profit does take into account all of the expected income and expenses. This has included any decline in value of the vessel while used in the activity (TR2003/4 paragraphs 17 and 78).

In your case, you have shown that there is a reasonable expectation that you are undertaking this activity with the prospect of making a significant commercial or financial gain from it. Based on the projections you have provided the activity is profitable from the year ended 30 June 2020 and in every year thereafter, the activity makes a significant overall profit. This indicator is passed.

Activities of the kind carried on in a similar manner

A vessel hire activity is more likely to be a business where it is conducted using business methods and procedures similar to those ordinarily used in vessel hire activities said to be businesses.

TR 97/11 and TR 2003/4 state that the following factors may indicate that a vessel hire activity constitutes a business:

● the volume of sales;

● the types of customers - wholesalers, retailers, the public at large, or friends and relatives;

● the manner in which the marketing takes place;

● the sort of expenses incurred by you;

● the amount invested in capital items;

● you own the appropriate licences and permits required;

● you and/or the operator have the appropriate experience;

● you and/or the operator have appropriate indemnity cover; and

● use of the vessel is not primarily directed at private use.

In applying the facts of your case to the above factors:

● the volume of sales you project is comparable to those of other operators;

● your customers are the general public as opposed to mainly friends and family;

● you will market your vessel for charter through your agent, CCY as is common practice in the industry;

● you will have the appropriate licences and permits required;

● you will have appropriate insurance; and

● your private use of the vessel is for only two weeks per year.

These factors indicate a business activity is being carried on.

Organised, systematic and business-like manner

Paragraph 86 to 88 of TR 2003/4 clarifies that vessel hire activities are more likely to amount to carrying on of a business where they are carried out in a systematic and organised manner. Factors which indicate this include:

● operations are not haphazard and are carried on in a consistent manner;

● profitable activities are pursued and unprofitable activities are discontinued;

● vessel charter transactions and financial arrangements are managed separately and distinctly from personal finances;

● appropriate business records are kept; and

● personal use of the vessel does not take priority over use of the vessel for charter purposes.

These factors may be carried out by you or your manager on your behalf. A taxpayer may still carry on a business despite having poor organisational skills.

In your case:

● you have conducted research into the industry, area of operation, charter operators and financial implications of the activity;

● you will receive monthly reporting from your charter operator;

● you will hold regular meetings with your charter operator to review the activity and discuss future growth;

● you will keep records to assist with BAS and tax return preparation, and

● you will sign an agency agreement with your charter operator.

This represents a moderate level of organisation and a business-like approach.

Repetition, regularity, size and scale

Vessel hire activities are more likely to amount to carrying on a business where they are regular and ongoing. Additionally, the larger the scale the more business-like. However, it is possible for you to carry on a business on a small scale.

In your case, your vessel will be available for hire for the full year other than the private use days and when the vessel may be unavailable due to repairs. Your activities are considered to be carried on at a smaller scale. This indicator is not determinative by itself refer paragraph 23 of TR 2003/4.

Conclusion

When applying your facts to each of the business indicators it is considered that, as a whole, your vessel hire activity will meet the requirements and the overall impression would be that you are carrying on a business.

TR 2003/4 states that in order to demonstrate that a vessel charter activity amounts to the carrying on of a business, a taxpayer needs to show that it is carried on with the intention of making a significant commercial profit. The income and expense projections that you have supplied demonstrate that over the charter operation period, the vessel hire activity will make a significant overall commercial profit. Consequently, the activity does have significant commercial purpose and a prospect of profit.

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 your vessel activities.

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.

Note

This private ruling is binding on the facts provided. The main reason this activity as described is qualifying as a business is in regard to its overall profitability particularly when the vessel is sold. You should review the actual figures at the end of 30 June 20YY and 30 June 20ZZ. Should the vessel charter income and expenses vary significantly from the financial information that you provided with this private ruling application, this private ruling decision will have no application. If this is the situation you could apply for a new private ruling based on the different facts if you are unsure of how the ATO view would apply to your circumstances.

Limit to future years rulings

You had requested the Commissioner to provide you with a private ruling for a period from 1 July 20XX for an indefinite period . Due to the possibility of changes in your circumstances (the fact that your income projections and expenses, particularly the income may vary significantly), the possibility of change to the law, and the risk that a subsequently issued public ruling might override a private ruling the Commissioner has issued, the Commissioner has provided a private ruling from 20XX until 20ZZ only. You may request a further ruling after this time if you require further binding advice.