Edited version of your written advice

Authorisation Number: 1051283816736

Date of advice: 13 November 2017

Ruling

Subject: Am I carrying on a business or hobby?

Question 1

Are you conducting a hobby of horse racing and breeding that is independent of your commercial broodmare farm business?

Answer

Yes

Question 2

Is the sale of your interest in the foal from a mare in which you have a lien on relating to unpaid agistment/management fees, a K7 capital gains tax event?

Answer

No

This ruling applies for the following period(s)

Year ending 2017

The scheme commences on

1 July 2015

Relevant facts and circumstances

You and your spouse (you) operate a thoroughbred broodmare farm (farm business).

Activities undertaken as part of your farm business include:

You undertake a range of animal husbandry on your farm including:

● caring for client’s broodmare’s

● overseeing broodmares in foal

● transporting broodmares to be serviced with stallions

● caring for progeny

● arranging for yearlings to be prepared and transported to sales

● growing hay to feed the horses you are caring for

● arranging for veterinary intervention and the services of a farrier

When undertaking the preparation of client horses and yearlings for sale, you act as agent on behalf of the owners and deduct stud/agistment fees from the sale proceeds.

You house a couple of hundred mares each year and care for the mares for varying periods, including some mares up until they foal and other mares for longer periods of time.

You have placed a lien on the mare which is owned by a client who has a debt payable to you in respect to agistment/management fees. You have entered into an arrangement with the owner of this mare to service the mare with a commercial stallion as part of a foal sharing arrangement. You have obtained $X from the sale proceeds of this foal.

You have shown the proceeds from the sale of the foal from a mare that you have a lien over as returned income to your farm business. You believe it should be recorded as income from capital gain tax event K7. You believe K7 applies to your circumstances as the income derived from the sale of the foal is from a once off activity, not in the nature of your ordinary business activities.

Activities conducted by you independently from your farm business

You have a legal interest in X broodmares which reside on your farm business. You purchased a X0% interest in one of the broodmares at a cost of $X. The other X broodmares were originally gifted to you from another owner.

One of the mares that was gifted to you is in foal. The mare has been serviced by a non- commercial stallion.

One of the mares gifted to you has a poor foaling history and possibly remains unsuitable for breeding purposes.

You do not pay service fees to high end stallions and have not entered into any agreement in relation to stallion rights.

You have an interest in X race horses as part of a syndicate, your shares range from X% to X% interest.

You arranged for the race horses to be broken in and transported the horses to a trainer, but the horses are still not broken in and have never raced.

The horses are now X years of age and based on industry standards should have been racing some months ago.

Your intention is to race the race horses rather than breed from them.

You do not have a business plan or future strategies to increase profits through your activities undertaken independently from your farm.

Because of the low value of the mares you own, any foals will be sold and not used for breeding.

You have sold one foal that you owned, but have only sold other horses on behalf of owners as part of your commercial operations undertaken on your farm business.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1936 section 21A

Reasons for decision

Question 1

Summary

You are not in the business of breeding and racing horses in relation to the horses you independently own and use for your enjoyment, that are separate from the broodmares, foals and other horses operated through your farm business.

Detailed reasoning

In Taxation Ruling 2008/2 income tax: various income tax issues relating to the horse industry; including whether racing , training and breeding activities (carried out as stand-alone activities or in combination) amount to the carrying on of a business (TR 2008/2), the following specific industry indicators are characteristic of whether a business of horse breeding is being carried out:

● The quality and number of horses;

● Whether the taxpayer is selling stock for example at yearling sales, to generate a cash flow;

● Whether the mares are being serviced;

● Whether the taxpayer is using their stallion rights; and

● Whether the taxpayer maintains geldings, barren female horses or other horses which are inappropriate for breeding-excluding horses that are being raced.

TR 2008/2 relies on the indicators set out in Taxation Ruling 97/11 (Income tax: am I carrying on a business of primary production?) to determine whether a taxpayer's activities amount to the carrying on of a business. Factors that are considered important in determining whether a business is being carried out include:

● whether the activity has significant commercial purpose or character (this comprises aspects of some of the other indicators)

● whether the taxpayer has more than just an intention to engage in business;

● whether the taxpayer has a purpose of profit as well as a prospect of profit

● whether there is repetition and regularity of activity

● whether the activity is similar in kind and manner to those of the ordinary trade in that line of business

● whether the activity is planned, organised and carried on in a businesslike manner 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.

The commissioner considers that if a taxpayer conducts racing activities alone, it is not likely to amount to a commercial activity. This was considered in Case E22 73 ATC 168 at 172, where the Taxation Board of Review No. 2 said:

‘From observation and general knowledge, racing of horses is usually indulged in by owners as a hobby or pastime or for the sake of interest in spite of the fact that owners are anxious for their horses to win and want the money which the winning stakes provide. Again from general knowledge, the cost of racing in most cases exceeds what is won and this is particularly so if the owners do not bet. The likelihood that racing will result in losses rather than profits tends against a ready inference that it is conducted as a business’.

However, if horse racing is an integral part of a horse training or breeding business, then the horse racing activities would constitute activities in the carrying on of a business. To be considered an integral part of the other business, the racing activities must be inherently connected with it and be consistent with the furtherance of that business activity.

The pursuit of a hobby is not the carrying on of a business for taxation purposes. Money derived from the pursuit of a hobby is not regarded as income and is therefore not assessable. Expenses incurred in relation to a hobby are also not allowable deductions.

Application to your situation

In your circumstances, your activities conducted independently to your farm business involving the breeding of foals from X broodmares you own and a broodmare in which you have a X% interest in, does not appear to have a significant commercial purpose. This is reflected by the small scale of your operations, the small amount of broodmares you have that are capable of breeding from, the infrequent amount of foals bred and sold by you over a five year period and the fact that you have not entered into any agreement to obtain a right to access or use a commercial stallion for servicing your mares.

Similarly, the preparation of X race horses for racing is not considered a business, as racing is not considered a commercial activity. Only when the racing of horses is integrated with the training or breeding of horses, will the racing activities constitute the carrying on of a business. Your race horses are not engaged in any breeding activities and through the negligent activities of a trainer you engaged, have not been broken in and remain unfit to race and possibly due to their age and lack of racing experience may never reach the calibre to race commercially.

Overall, in light of your circumstances, the Commissioner’s view is that your activities of selling foals and yearlings from your X broodmares and X% share in another broodmares and preparing X horses for racing is better classified as a recreational pursuit or a hobby.

Any amounts you received from the breeding of your broodmares or the preparation of your horses for racing, undertaken independently of your farm business is not regarded as income and is therefore not assessable. Expenses incurred in relation to these activities are not considered allowable deductions.

Future years

You can change from conducting an activity as a hobby to that of being in business and vice-versa over time as your level of activity changes. Therefore you should evaluate your level of activity on a regular basis to see whether you are conducting a hobby or carrying on a business.

Question 2

Summary

CGT event K7 will not apply in your circumstances, as the sale of the foal from the mare that you have a lien on is used for the purposes of producing your assessable income for your farm business. CGT event K7 is only relevant for personal use assets.

Detailed reasoning

The interaction of the depreciation and CGT regime to horse related activities

A horse can be a CGT asset and also a depreciating asset.

Subsection 118-24(1) of the Income Tax Assessment Act (ITAA) 1997 disregards a capital gain or loss a taxpayer makes from a CGT event that is also a balancing adjustment event that happens to a depreciating asset whose decline in value was worked out under Division 40 of the ITAA 1997. However, under subsection 118-24(2), such a gain or loss is not disregarded if it is from CGT event K7. CGT event K7 happens if a balancing adjustment event occurs for a depreciating asset held by you, and at some time during which the asset was held, it was used or installed ready for use for a purpose other than a taxable purpose.

Where horse-related activities are not carried on as a business by a taxpayer or otherwise for the purpose of producing the taxpayer’s assessable income, the use of those horses is for a purpose other than a taxable purpose. Consequently, CGT event K7 happens if a balancing adjustment event occurs for the horse. Where CGT event K7 happens, a taxpayer makes a capital gain to the extent that the asset’s termination value is more than its cost.

Subsection 40-25(7) of the ITAA 1997 provides that a taxable purpose is:

(a) The purpose of producing assessable income; or

(b) The purpose of exploration or prospecting; or

(c) The purpose of mining site rehabilitation ; or

(d) Environmental protection activities.

The time of the K7 event is when the balancing adjustment event occurs in relation to the depreciating asset. For the purposes of subsection 40-295(1) of the ITAA 1997, a balancing adjustment event occurs for a depreciating asset if:

a. You stop holding the asset; or

b. You stop using it or having it installed ready for use, for any purpose and you expect never to use it, or have it installed ready for use, again; or

c. You have not used it and

(i) If you have had it installed ready for use-you stop having it so installed; and

(ii) You decide never to use it

Non cash business benefits

Under section 21A of the income Tax Assessment Act (IAA) 1936, the two essential prerequisites of a receipt being ordinary income are that it is:

● Cash or convertible to cash; and

● A real gain occurs to the taxpayer.

Benefits that are derived from carrying on a business and are convertible to cash are therefore considered to be ordinary income.

Section 21A(2) ITAA 1936 requires the benefit to be brought at its arm’s length value, less any amount that the taxpayer contributed to acquiring the benefit.

Application to your situation

At the time you believe a K7 event occurs (the disposal of the foal), you held the foal as a depreciating asset in your capacity as the operator of your broodmare/agistment farm business as you had acquired the foal as part of an agreement for allowing the mare of the foal to continue to reside at your farm business. You held a continuing lien over this mare as part of your business operations until the owner paid the mare’s agistment/management fees and then the mare would be released to the owner. The benefit you derived from the use of the mare as part of a foal sharing arrangement which produced a foal was a non cash benefit derived as part of your business operations. Consequently, the foal is not considered a personal use asset and K7 capital gain tax event does not apply