Edited version of your written advice

Authorisation Number: 1051382550813

Date of advice: 6 June 2018

Ruling

Subject: Taxation issues rising from horse breeding activities

Question 1

Do the horse breeding activities described in paragraphs 9 to 25 of the “relevant facts and circumstances”, conducted by Mr AX and Mrs BX (“the Taxpayers”), constitute the carrying on of a business such that revenue from those activities is assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (“ITAA 1997”)?

Answer:

Yes

Question 2

If the horse breeding activities described in paragraphs 9 to 25 of the “relevant facts and circumstances” constitute the carrying on of a business, will the horse racing activities described in paragraphs 26 to 28, conducted by the Taxpayers, constitute part of the horse breeding business such that that revenue from those racing activities is assessable as ordinary income under section 6-5 of the ITAA 1997?

Answer:

Yes

Question 3

To the extent that the horse breeding and racing activities do constitute the carrying on of a business, have the Taxpayers run the business as a partnership within the meaning section 995-1 of the ITAA 1997 since 1 July 20XL?

Answer:

Yes

Question 4

Are the Taxpayers eligible to access the small business restructure rollover relief concession under Subdivision 328-G of the ITAA 1997 in respect of the proposed restructure of the horse breeding activities?

Answer:

Yes

This ruling applies for the following periods:

Year ended 30 June 20XM

Year ended 30 June 20XN

Year ended 30 June 20XO

Year ended 30 June 20XP

Year ended 30 June 20XQ

The scheme commences on:

1 July 20XL

Relevant facts and circumstances

BACKGROUND

1. Mr AX and Mrs BX (“the Taxpayers”) are husband and wife.

2. The Taxpayers are Australian tax residents for income tax purposes.

3. The Taxpayers have an interest in a horse called Horse A. After its racing career was over, Horse A became a stallion. The Taxpayers and the other part owners of Horse A entered into a standing agreement with a Stud Farm Z which manages the day to day breeding activities of the horse.

4. Although most of the decisions in respect of the breeding activities of Horse A are made by Stud Farm Z, the Taxpayers still have active involvement as they need to be consulted on major decisions and have a right to clarify any financial issues.

5. The Taxpayers each applied for an Australian Business Number (“ABN”) as they were operating an enterprise of horse breeding due to the receipt of income from Horse A’s service activities. Each of the Taxpayers returned their share of income so generated from their respective shares of Horse A. The Taxpayers took the view that for the 20XL income year they were not carrying on the business of horse breeding.

6. To protect the future income generation of Horse A as a stallion for the horse breeding activities, the Taxpayers retain a Mortality Insurance Policy for their share in Horse A.

7. In the 20XM income year the Taxpayers reassessed their activities as to whether they were in fact carrying on the business of horse breeding and came to an affirmative conclusion based on the scale and regularity of conduct of the horse breeding activities at that time.

8. The Taxpayers have a Business Plan which outlines strategies for making the horse breeding activities profitable into the future and contains the following elements:

i. A description of the horse breeding activities is given in that it consists of income generated from stallion fees through the ownership interest in Horse A. It also outlines how the horse breeding activities will diversify its income stream by selling progeny from its band of high quality broodmares that have been recently acquired.

ii. It sets out the markets through which the Taxpayers propose to sell and realistic estimates of quantity and volume of sales. In respect of the ownership interest in Horse A the Taxpayers are in the market of providing a quality stallion for mare owners looking to produce quality foals. Income has already been generated as in the recent 20XM and 20XN breeding seasons, Horse A has served in access of XXX mares.

iii. In an attempt to diversify their income stream, the Taxpayers have acquired a high quality band of broodmares in order to cater for the market of horse purchasers looking for quality foals. The business plan sets out realistic expectations of quantity and volume of sales. It is the intention of the Taxpayers to sell all yearlings whenever it is possible and commercially sensible to do so. The first of these was in 20XO, with Y more yearlings planned for sale in the 20XP income year and then up to Z yearlings planned for sale in the 20XQ income year (based on mares already covered in 20XN) with similar or even larger numbers beyond that given the growth of the broodmare portfolio.

iv. The business plan also sets out a reasonable estimate of the income expected to be generated from the band of broodmares. Apart from serving the broodmares with Horse A, the Taxpayers also intend to have them served by some of Australia’s leading stallions.

v. Although the Taxpayers did not acquire their own breeding barn, they have acquired the use of Horse Farm Q to conduct the breeding activities of the broodmares owned. This Horse Farm is held in high regard within the Australasian Thoroughbred Industry, attracting international buyers and record high priced yearlings.

TAXPAYERS’ ACTIVITES

9. The Taxpayers devoted themselves fulltime to horse breeding activities from 1 July 20XL.

10. In the income years 20XM and 20XN, income was principally generated from stallions’ fees from Horse A.

11. In the 20XM and 20XN breeding seasons Horse A served in excess of XXX mares.

12. In addition to the stallion fees the Taxpayers have generated income from the sale of Horse A’s progeny. In the 20XM income year X Weanlings were sold. For the 20XN income year Y yearlings and Z Weanlings were sold.

13. To further develop their horse breeding activities, the Taxpayers entered into an agreement with Horse Farm Q. The Taxpayers pay agistment fees to Horse Farm Q to have a band of broodmares they had acquired cared for and sheltered at the Farm.

14. The Taxpayers acquired the broodmares with the intention that they will generate an additional income stream to that generated from Horse A. These broodmares have been sent to Horse Farm Q in preparation for them to be serviced.

15. All the horses that have been bought outright and are used in the horse breeding activities are jointly owned by the Taxpayers. Where the Taxpayers only have part ownership in a horse which is used in the horse breeding activities, that part ownership is shared equally between the Taxpayers.

16. The Taxpayers have produced progeny by paying the stallion service fees of Horse A to service their broodmares and keeping the resulting foals. During the 20XM income year (being the 20XL breeding season), X broodmares were serviced by Horse A and during the 20XN income year (being the 20XM breeding season), Y broodmares were serviced by Horse A. During the 20XO income year (being the 20XN breeding season) Z broodmares have been serviced by a varied array of Stallions. In the 20XP income year (being the 20XO breeding season) the Taxpayers have entered into contracts for all broodmares to be covered by a varied array of Stallions.

17. It is the intention of the Taxpayers to sell the new foals produced whenever possible.

18. In terms of the sale of the progeny of the broodmares, X yearlings were sold in 20XO, with Y more yearlings planned for sale in 20XP and then up to Z yearlings planned for sale in 20XQ (based on mares already covered in 20XN).

19. In 20XK, a Bloodstock Agency was initially appointed to assist the Taxpayers to provide ongoing advice and assist in the management of the Taxpayers’ share in Horse A.

20. During the 20XM income year the breeding activities expanded with X broodmares being acquired by the breeding operations to be served by Horse A. The reliance on the advisory services of the bloodstock agency expanded to include the wider breeding activities being undertaken by the Taxpayers’ band of broodmares and this arrangement continues to date.

21. Both Taxpayers are involved in making key decisions in the horse breeding activities such as which broodmares should be purchased to be bred with Horse A, the timing at which breeding should take place, decisions in relation to the care and treatment of the broodmares on hand as well as the determination of when, where and how the progeny should be sold. Any new acquisitions of broodmares for use within the breeding activities are jointly decided by the Taxpayers and typically involve the attendance of both of them at the sales auction house. The Taxpayers jointly undertake numerous visits throughout the year to assess the status and progress of the horses.

22. When filing their tax returns for the income years 20XL, 20XN and 20XM the Taxpayers each disclosed their 50% share of the income and expenses of the horse breeding activities.

23. The Taxpayers have a joint bank account into which income generated from the horse breeding activities is deposited and from which expenses and capital outlays are paid. However, the joint bank account is not a separate business account.

24. The Taxpayers maintain books of account in their joint names and minutes of meetings are kept but the Taxpayers have not registered a separate business name for the horse breeding activities.

25. The aggregated turnover for the Taxpayers for the 20XO income year in relation to their horse breeding activities was approximately $X,XXX,XXX.

26. Whilst it is the intention of the Taxpayers to sell the new foals sired by Horse A whenever possible, there will be times when it is deemed appropriate to retain and race a foal to ultimately breed from it in the future. The successful performance on the race track of the progeny builds Horse A’s future career as a stallion by enhancing demand for his services, thus supporting the service fee income stream.

27. The Taxpayers currently have X yearlings sired by Horse A of which Y yearlings are listed on the upcoming bloodstock sales. A yearling will be retained for racing.

28. Should a colt bred by Horse A from one of the Taxpayers’ broodmares be gelded for any reason but retained for racing, this will always be done with the intention of increasing the value of the horse for future sale.

PROPOSED RESTRUCTURE

29. The XX Trust is a family trust in which the Taxpayers and their children are the primary beneficiaries. Mr AX is the sole director and the Taxpayers are the sole shareholders of the trustee company– AA & Co Pty Ltd (AA & Co). The XX Trust generates income through passive investments (interest income, dividends, trust distributions and foreign income).

30. AA & Co engages in two activities being the trustee company of XX Trust and the holding company of BB Holdings Pty Ltd (BB Holdings). BB Holdings did not pay dividends in the 20XM, 20XN and 20XO income years and therefore AA & Co had nil income in these income years.

31. The Taxpayers have a controlling interest in BB Holdings through their ownership of AA & Co. Mr AX is the sole director of BB Holdings which generates income through passive investments.

32. The financial accounts for the 20XM and 20XN income years show that BB Holdings’ passive income receipts were interest income received from some bank accounts and distributions received from the XX Trust.

33. The 20XM financial statements for XX Trust show an amount of $FFF,FFF representing the unpaid present entitlement (UPE) owing to BB Holdings. The financial statements for the 20XM income year for BB Holdings shows that the UPE of $FFF,FFF was satisfied by it becoming a loan back to XX Trust. The financial statements for the 20XN income year for XX Trust show that this $FFF,FFF was repaid to BB Holdings. XX Trust paid back the $FFF,FFF to BB Holdings before the lodgement date of the XX Trust return. BB Holdings did not receive interest income from lending the $FFF,FFF to XX Trust in the 20XM income year.

34. The estimated annual turnover of BB Holdings for the 20XP income year is $HH,HHH.

35. The Taxpayers wish to restructure the horse breeding activities for asset protection purposes. The assets used in the horse breeding activities will be transferred into a new discretionary trust that will also have in place a Family Trust Election (FTE) under section 272-80 of Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936). Mr AX will be named as the primary individual. The Taxpayers will control the new discretionary trust as they will be the shareholders and directors of the corporate trustee. The beneficiaries of the new discretionary trust will be the Taxpayers and those individuals and entities eligible to be beneficiaries in accordance with a Family Trust Election where Mr AX is the primary individual.

Assumptions

● In accordance with subparagraph 328-110(1)(b)(ii) of the ITAA 1997 the new discretionary trust’s annual turnover, aggregated with the annual turnover of BB Holdings, will be less than $ZZ million for the 20XP income year.

● In accordance with subsection 272-80(1) of Schedule 2F of the ITAA 1936, in respect of the new discretionary trust, the Family Trust Election will be in writing and in the approved form

● In accordance with section 272-87 of Schedule 2F of the ITAA 1936 the family control test will be passed and this new discretionary trust will be a family trust.

● The period of ownership of the horses used in the Taxpayers’ breeding activities (being Horse A, the broodmares and the progeny of Horse A and the broodmares) beginning on the date on or after 1 July 20XL when they were first used in those breeding activities and ending on the date of their transfer to the new discretionary trust will satisfy the test in subsection 152-35(1) of the ITAA 1997 if they are active assets. That is, the period in question will total at least half of the period from the date of acquisition of the horses by the Taxpayers to the date of their transfer to the trust or at least 7.5 years where the horses have been owned for more than 15 years at the date of transfer.

● The Taxpayers and the newly created discretionary trust will each make a rollover election under paragraph 328-430(1)(f) of the ITAA 1997 in respect of the restructure of the horse breeding activities.

Relevant legislative provisions

Section 6(1) of the Income Tax Assessment Act 1936

Subsection 272-80(1) of Schedule 2F of the Income Tax Assessment Act 1936

Section 272-87 of Schedule 2F of the Income Tax Assessment Act 1936

Section 152-35 of the Income Tax Assessment Act 1997

Paragraph 8-1(b) of the Income Tax Assessment Act 1997

Section 6-5 of the Income Tax Assessment Act 1997

Section 995-1 of the Income Tax Assessment Act 1997

Subdivision 328-C of the Income Tax Assessment Act 1997

Subdivision 328-G of the Income Tax Assessment Act 1997

Reasons for decision

QUESTION 1

Summary

From the information the Taxpayers have provided the overall general impression after considering all the factors in Taxation Ruling TR 97/11: am I carrying on a primary production business? and TR 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 is that from 1 July 20XL the Taxpayers have been carrying on the business of horse breeding.

Detailed reasoning

Paragraph 8-1(1)(b) of the ITAA 1997 states that you can deduct from your assessable income any loss or outgoing to the extent that it is necessarily incurred in carrying on a business for the purposes of gaining or producing your assessable income.

If a taxpayer’s operations amount to the carrying on of a business, the gross proceeds derived from the activities will be assessable income under section 6-5 of the ITAA 1997 being ordinary income.

Section 995-1 of the ITAA 1997 defines the term business to include any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Section 995-1 of the ITAA 1997 defines the term primary production business to include maintaining animals for the purpose of selling them or their bodily produce (including natural increase).

The question of whether a particular activity constitutes a business is one of fact and degree. In the High Court in Spriggs vs Commissioner of Taxation (2009) ATC 20-109 (Spriggs) their honours stated:

The existence of a business is a matter of fact and degree. It will depend on the number of indicia, which must be considered in combination and as a whole. No one factor is necessarily determinative. Relevant factors include, but are not limited to, the existence of profit making purpose, the scale of activities, the commercial character of the transactions, and whether the activities are systematic and organised, often described as whether the activities are carried out in a business-like manner.

The Commissioner has published two public rulings to assist in determining whether a taxpayer’s activities constitute a business which are relevant in the current circumstances. Taxation Ruling TR 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) specifically refers to the horse racing industry whereas Taxation Ruling TR 97/11: am I carrying on a primary production business? (TR 97/11) considers primary production activities in general.

TR 97/11 lists the following indicia (which are based on legal precedent) to assist in determining whether a business exists:

● whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators;

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

● whether the taxpayer has a purpose of profit as well as 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 businesslike 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.

In addition, paragraph 18 of TR 97/11 states that the following three items are factors that support the main indicators:

● A business plan exists;

● Commercial sales of product; and

● Taxpayer has knowledge and skill

The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the ‘large or general impression gained’ (Martin v FC of T (1953) 90 CLR 470 (Martin) at 474; 5 AITR 548 at 551) from looking at all the indicators, and whether these factors provide the operations with a ‘commercial flavour’ (Ferguson v. FC of T (1979) 37 FLR 310 at 325 (Ferguson); 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884). However, the weighting to be given to each indicator may vary from case to case.¹

Where the activity being considered is that of horse breeding TR 2008/2 sets out further specific indicators which must also be addressed in determining whether the activity constitutes the carrying on of a horse breeding business, including:²

● Quality and number of horses;

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

● Whether the mares are being serviced;

● Whether the taxpayer is using their stallion rights;

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

The indicators outlined above are taken into consideration below in weighing-up whether all the indicators as a whole establish that the Taxpayers were carrying on a business of horse breeding.

Significant commercial purpose or character

A taxpayer needs to be able to provide evidence showing that the activity is carried out for commercial reasons and in a commercially viable manner. As stated in paragraph 29 of TR 97/11 this indicator cover aspects of all the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of the activity, the repetition and regularity of the activity and the profit indicators. Evidence of proper research into the activity so as to establish its commercial viability is also important, and might include:

● Drawing up a business plan;

● Seeking advice from experts in the industry in which you intend to operate;

● Obtaining any technical data relevant to the industry;

● Consideration of whether a market exists for the activity and the evidence of research into potential markets;

● Proper analysis of the capital required for the activity and how it will be obtained and used;

● Ensuring that research can properly conclude that profits can be expected taking into account the market and expected running costs;

● Ensuring that the size and scale of the activity is sufficient for a commercial enterprise.

The information the Taxpayers provided does demonstrate a significant commercial purpose for the following reasons:

a) Although the Taxpayers did not provide a business plan prior to when they believed the business commenced (on 1 July 20XL) they did provide a business plan which outlines strategies for making the horse breeding activities profitable into the future and contains the basic elements of what should be in a business plan as outlined in paragraph 111 of TR 97/11. In addition:

i. Information about expected expenses and capital outlays has been given. The expenses and capital outlays that have been incurred are set out in the financial accounts of the horse breeding activities that the Taxpayers provided for the 20XM to 20XO income years. To protect the future income generation of Horse A as a stallion for the horse breeding activities, the Taxpayers retain a Mortality Insurance Policy for their share in Horse A. In order to produce good quality progeny from the band of broodmares, the Taxpayers will have their broodmares served by Australia’s leading stallions.

ii. The Taxpayers have also incurred significant capital outlays in acquiring the band of broodmares.

iii. Apart from conducting their own analysis and research, the Taxpayers have sought the expertise of industry experts particularly to determine mare matings each season for the horse breeding activities.

iv. The business plan does not outline how the Taxpayers are paying for the expenses and capital outlays of their horse breeding activities. However, the financial accounts of the horse breeding activities for the 20XN to 20XO income years show that the Taxpayers are self- funding the horse breeding activities out of the Owner Contributed Equity and Retained Earnings.

b) Although the Taxpayers do not have a great deal of experience in horse breeding they have engaged the services of a blood stock agent. The bloodstock Agent was engaged on an annual retainer to provide ongoing advice and assist the Taxpayers with their shareholding in Horse A. The reliance on the advisory services of the blood stock agent increased when the horse breeding activities expanded to include the band of broodmares. In this additional role the blood stock agent has provided professional advice on the bloodline of each Broodmare and, by taking into account the conformation, pedigree and stud fees, advising on suitable stallions for the broodmares.

c) In relation to the Taxpayers’ ownership in horse A, there is already a thriving commercial market for the progeny of Horse A. In the 20XM income year X Weanlings were sold. For the 20XN income year Y yearlings and Z Weanlings were sold. Likewise, the service fees generated from the Taxpayers’ shareholding in Horse A have provided them with a healthy income stream.

d) The Taxpayers have provided some research that shows that the demand for quality thoroughbred foals from Broodmares with black type is high with record prices being achieved at the most recent major yearling sales.

e) The Taxpayers have already invested capital in acquiring the necessary stock to use in the horse breeding activities. This includes the acquisition of the band of broodmares as well as paying the service fees of other stallions apart from Horse A to breed with their band of broodmares. The financial accounts of the horse breeding activities for the 20XM to 20XO income years show that the Taxpayers are self- funding the horse breeding activities out of the Owner Contributed Equity and Retained Earnings.

f) There is information about the expenses. To protect the future income generation of Horse A as a stallion for the horse breeding activities, the Taxpayers retain a Mortality Insurance Policy for their share in Horse A. The Taxpayers have already incurred significant expenses in relation to their share in Horse A and the development of breeding activities in relation to the band of broodmares.

g) Unlike other breeding businesses that commence operation and generate considerable losses as they build up in the earlier years, the Taxpayers have generated significant income from the horse breeding activities through the service fees from their share in Horse A. Given that the horse breeding activities in relation to the band of broodmares are in their infancy, losses may be expected for the next few income years as the costs will increase for having the broodmares covered by external stallions and once a broodmare is covered there is typically a three year lag as the foal has to be conceived, carried by the mare, born and then reared before it can be sold.

h) Since the commencement of the horse breeding activities the Taxpayers have increased the size and scale of the activities. In order to diversity the income streams of the breeding activities and not just rely on the service fees generated from their share in Horse A as a stallion, the Taxpayers acquired additional broodmares and will acquire more into the future. The band of broodmares is expected to increase into the future. A yearling was already sold in 20XO, with Y more yearlings planned for sale in 20XP and then up to Z yearlings planned for sale in 20XQ (based on mares already bred in 20XN).

The intention of the Taxpayers

As stated in paragraph 39 of TR 97/11 the intention of the taxpayer in engaging in business activity is a relevant indicator: see Thomas v FCT (1972) 3 ATR 165; 72 ATC 4094; [1972-73] ALR 368 (Thomas). However, a mere intention to carry on a business is not enough. There must be an activity. Brennan J in Inglis vs FC of T 80 ATC 4001 at 4004-4005; (1979) 10 ATR 493 at 496-497 said that:

‘The carrying on of a business is not a matter merely of intention. It is a matter of activity….At the end of the day, the extent of activity determines whether the business is being carried on. That is a question of fact and degree.’

The Taxpayers have demonstrated a high level of commitment to the horse breeding activities of Horse A by retaining a Mortality Insurance Policy for their share in Horse A. Furthermore, the Taxpayers have incurred expenses in relation to Horse A The expenses incurred are in relation to activities that are already generating significant income. The Taxpayers have generated service fees from their share of Horse A. While the sale of Horse A’s foals also generated income for the Taxpayers.

The horse breeding activities in relation to the band of broodmares have only recently commenced so they are not generating significant income yet. However, the Taxpayers have put in place measures which will ensure income will be produced and demonstrates their intention to carry on a business. These include:

i. The Taxpayers have shown they have a serious intent as the breeding stock has gradually increased each year. At the commencement of the 20XL breeding season (the 20XM income year) X broodmares were sent to the Horse farm. By the 20XO income year the Taxpayers band of broodmares had increased to YY.

ii. The Taxpayers have shown serious intent as the number of broodmares serviced each year has increased. During the 20XM income year (being the 20XL breeding season), X broodmares were serviced by Horse A and during the 20XN income year (being the 20XM breeding season), Y broodmares were serviced by Horse A. During the 20XO income year (being the 20XN breeding season) Z broodmares have been serviced by a varied array of Stallions. In the 20XP income year (being the 20XO breeding season) the Taxpayers have entered into contracts for all broodmares to be covered by a varied array of Stallions.

iii. Engaging the services of a professional bloodstock agent. Through the assistance of the bloodstock agent they have been able to assemble a band of broodmares which have expanded in quantity and quality with the recent additions in the last few horse racing seasons. Likewise, through his knowledge of Horse pedigrees the bloodstock agent has been able to provide advice on which broodmares will be best served by Horse A. As the Taxpayers wish for a greater diversification in the bloodlines of the foals produced, the bloodstock agent has also been able to advise on which of Australia’s leading stallions would be suitable for their broodmares. A yearling was sold in 20XO, with Y more yearlings planned for sale in 20XP and then up to Z yearlings planned for sale in 20XQ (based on mares already bred in 20XN).

iv. The Taxpayers have been able to develop a large portfolio of contacts within the horse breeding industry. To date the Taxpayers have determined that utilising the established and well-known brand of Horse Farm Q to market their yearlings for sale as a more effective strategy for this stage of the activity.

Prospect of profit -

As stated in paragraph 48 of TR 97/11 it is important that the taxpayer is able to show how the activity can make a profit. Stronger evidence of an intention to make a profit occurs when the taxpayer has conducted research into his/her proposed activity, consulted experts or received advice on the running of the activity and the profitability of it before setting up the business. This was the situation in FC of T v. JR Walker 85 ATC 4179; (1985) 16 ATR 331 (“Jr Walker”). However, it is not necessary for the primary production activities to make a profit in every year of income in order to classify the activities as a business of primary production. Thus, a taxpayer may be carrying on a business of primary production even though he/she is making a small profit or a loss in any given year of income. Ultimately the taxpayer must demonstrate that the expectation of profit is reasonable.

When a taxpayer reasonably believes that a profit will eventually be made, but the objective evidence is that the activity will never make a profit, the taxpayer will need to be able to show that the other indicators of a business are sufficiently present to outweigh the lack of profitability of the activity. Otherwise, the absence of profit will most likely lead to a determination that the activities do not amount to a business.

Unlike other breeding businesses that commence operation and generate considerable losses as they build up in the earlier years, the Taxpayers have generated significant income from the horse breeding activities through the service fees from their share in Horse A.

Given that the horse breeding activities in relation to the band of broodmares is in its infancy, losses may be expected for the next few income years as the costs will increase for having the broodmares covered by external stallions and once a broodmare is covered there is typically a three year lag as the foal has to be conceived, carried by the mare, born and then reared before it can be sold. However, the Taxpayers have put in place measures which will ensure greater profitability for the breeding activities can be achieved.

A relevant industry report ‘Horse Farming in Australia’ of December 2016 identified the following key success factors for a business in the Horse Breeding Industry:

i. Access to high quality inputs – Industry operators, particularly thoroughbred horse farmers, that have access to high-quality bloodlines, mares and stallions tend to have a quality product.

The Taxpayers have a share in Horse A. Horse A is a well bred horse himself and had a successful racing career.

The Taxpayers have assembled a band of broodmares which have expanded in quantity and quality with the recent additions in the last few horse racing seasons. Some of the broodmares are stake performed including Group winning mares.

In order to have greater diversification of the bloodlines of future progeny the Taxpayers also intend to have the broodmares served by some of Australia’s leading stallions.

ii. Management of seasonal production – breeding is seasonal and industry operators that can manage the seasonality of their production effectively can benefit from the efficient production of horses.

Owners and occupiers of land (landowners) may allow horses or stock owned by another person to be kept on their land for a fee (agistment). The horse owner may also be liable for the costs of feed, exercising, training and caring for their horse.

The Taxpayers have hired a highly reputable Horse Farm to provide agistment for their broodmares.

iii. Market research and understanding – Market research related to a variety of industry operations including horse farming, breeding techniques and agistment service can boost players’ efficiencies in production.

The Taxpayers have demonstrated that they have undertaken research to underpin their analysis and strategies for the horse breeding activities. In particular they have shown that higher prices can be fetched for progeny who are produced from stallions and broodmares with strong pedigrees and have achieved some success on the racetrack. The Taxpayers have also cited statistics that show that the level of service fees of stallions, the value of broodmares and yearling stock at recent sales have all been trending upwards in recent years with new record gross, average and median sale results being achieved in numerous yearling and broodmare sales.

Their understanding of breeding techniques and agistment services has been enhanced by their association with the Bloodstock Agent and the Horse Farm.

iv. Appropriate climatic conditions – Farms that are located in areas with favourable climatic conditions are more able to successfully produce horses.

A relevant State or Territory has an abundance of flat areas with good natural rainfall or access to irrigation, which is crucial for horse farming. Many of the best breeding stocks, especially thoroughbred stallions, are in the XYZ region. The Taxpayers have contracted with a Horse farm to provide agistmist services for their band of broodmares. The Horse Farm is located on prime XYZ land.

v. Effective quality control – Industry operators that maintain high quality production can benefit from repeat purchases and word-of-mouth recommendations.

With the likelihood that the Taxpayers will be able to produce consistently high quality foals from Horse A and their band of broodmares, it is likely that they will benefit from repeat purchase and word of mouth recommendations. To date the Taxpayers are utilising the established and well-known brand of the Horse Farm to market their yearlings for sale.

The fact the Taxpayers have controlling ownership over most of their stock provides them with an ability to control how the horse will be used now or in the future in the most profitable manner.

Repetition and Regularity

As stated in paragraph 55 of TR 97/11 it is often a feature of a business that similar sorts of activities are repeated on a regular basis. The repetition of activities by the same people over a period of time on a regular basis helps to determine whether there is the ‘carrying on’ of a business. For example, in Hope v Bathurst City Council (1980)144 CLR 1; 12 ATR 231; 80 ATC 4386, the ‘transactions were entered into on a continuous and repetitive basis’, such that the taxpayer’s activities’ manifested the essential characteristics required of a business’. Similarly, in JR Walker the court held that there was repetition and regularity in the taxpayer’s activities directed to the breeding of high quality Angora goats and to keeping up with the latest information on Angora goats.

Regular breeding activities are taking place in respect of the Taxpayer’s share in Horse A. In the recent 20XM and 20XN breeding seasons Horse A has served in excess of XXX mares. In the 20XM income year X Weanlings were sold. For the 20XN income year Y yearlings and Z Weanlings were sold.

In respect of the breeding activities of the band of broodmares the activities are regular and will increase in repetition into the future. During the 20XM income year (being the 20XL breeding season), X broodmares were bred to Horse A and during the 20XN income year (being the 20XM breeding season), Y broodmares were bred to Horse A. During the 20XO income year (being the 20XN breeding season) Z broodmares have been bred to a varied array of Stallions. In the 20XP income year (being the 20XO breeding season) the broodmares have been covered by various stallions. The inclusion of external stallions during the 20XM, 20XN and 20XP breeding seasons is reflective of an expansion of the breeding activities and an increase to the regularity of the breeding activities. The Taxpayers have shown the level of their commitment to the horse breeding activities by engaging a leading thoroughbred breeding barn so that the band of broodmares can live there and be maintained for the sole purpose of breeding. Monthly expenses are incurred in relation to the care-taking and maintenance of the mares.

Furthermore the Taxpayers’ repetition and regularity in supporting Horse A’s breeding activities has been demonstrated by paying the service fees of Horse A to breed with their broodmares.

Is the activity of the same kind and carried on in a manner that is characteristic of the industry?

As stated in paragraph 63 of TR 97/11 an activity is more likely to be a business when it is carried out in a manner similar to that in which other participants in the same industry carry on their activities. Lord Clyde in IR Commissioners v. Livingston at 11 TC 542 said that:

‘…the test, which must be used to determine whether a venture..is, or is not, “in the nature of trade”, is whether the operations involved in it are of the same kind, and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made.’

The following factors indicate that the Taxpayers’ horse breeding activities share the characteristics of others engaged in the same type of business:

i. In respect of the Taxpayers’ share in Horse A, as with other popular commercial stallions in the industry, Horse A has had to cover a full book of mares. In the 20XM and 20XN breeding seasons Horse A served in excess of XXX mares.

ii. The horse breeding activities of the band of broodmares are in the early stages; however, in line with other successful participants in the industry the Taxpayers have put in measures that will ensure the volume of sales will increase significantly into the future by increasing its stock of broodmares, increasing the amount of broodmares that are covered and in foal and using other commercially recognised stallions apart from Horse A to cover their broodmares.

iii. Only one progeny from the band of broodmares has been sold, however the Taxpayers plan for future progeny to be sold at all the leading sales. The Taxpayers’ main marketing strategy has been to establish strong connections with the Horse Farm which has a strong reputation in the industry.

iv. The expenses incurred by the Taxpayers for their mares and foals such as transportation, general upkeep, veterinary care, agistment, maintenance, professional bloodstock advice, stallion fees and insurance are typical of the horse breeding industry. From the 20XO income year the Taxpayers have incurred large expenses in relation to stallion fees for their broodmares. Stallion service fees are expensive and service fees for the top sires can be over $100,000 per mare covered.

v. The Taxpayers’ level of capital investment is comparable to other participants in the industry. The Taxpayers have made significant investments in increasing their band of broodmares. The purchase of broodmares in particular can be expensive. Average broodmare prices have increased over the past five years and the industry’s best mares command a high price.

vi. Like other participants in the industry who have not had a great deal of experience in horse breeding the Taxpayers have sought advice from experts. In particular they have engaged the services of a blood stock agent who since the establishment of the band of broodmares has provided professional advice on the bloodline of each Broodmare and by taking into account the conformation, pedigree and stud fees advising on suitable stallions for the broodmares.

vii. The Taxpayers maintain books of account in their joint names and minutes of meetings are kept. They employ an accounting firm to review their record keeping and produce a BAS each quarter and a tax return each year. Having a recognised accounting system and practices in place give an indication that the activities are more than what is expected of someone who is merely a keen follower of horse racing.

viii. Quality is the main competitive factor in the industry, particularly for industry operators that farm thoroughbreds. Bloodlines of studs and broodmares that involve previous race winners attract much higher prices than other horses without proven ability. In addition, horse farms with a reputation for quality breeding and animal husbandry have an advantage in attracting and keeping clients.

In this regard the Taxpayers are following the blueprint of the most successful operators in the industry by focusing on the quality of their bloodstock. They have a share in Horse A who is well-bred and had a successful race career. The Taxpayers have engaged the services of a bloodstock agent who has been able to advise them on their acquisition of broodmares where many of them are black type winners. The bloodstock agent has also been able to advise on which of Australia’s leading stallions should cover their broodmares.

Organisation in a businesslike manner and the use of system

As stated in paragraph 68 of TR 97/11 in Newton vs Pyke (1908) 25 TLR 127, the court suggested that business should be conducted systematically. A business is characteristically carried out in a systematic and organised manner rather than on an ad hoc basis. An activity should generally conform with ordinary commercial principles to amount to the carrying on of a business.

The horse breeding activities of Horse A are being conducted in a businesslike manner.

Although the horse breeding activities of the band of broodmares is in its infancy, it is organised in a business-like manner such that there are reasonable prospects of the Taxpayers obtaining a return on the significant capital invested in the purchase of the band of broodmares. The fact the Taxpayers have directly engaged the a highly regarded bloodstock agent to provide professional advice on the selection of appropriate breeding partners for Horse A and the broodmares and have engaged a highly regarded Horse Farm as the thoroughbred breeding barn for their broodmares will enhance their chances of producing high quality foals for sale.

Likewise, the Taxpayers have conducted research into the activity and through this research have been able to assess that there are good prospects for the profitability of the horse breeding activities given that a number of their broodmares were Stake performed mares and that they are now also being served by some of Australia’s leading stallions. The Taxpayers have a Business Plan which outlines the business strategies which they will use to sustain the future profitability of the breeding activities. The horse breeding activities are also organised in a business-like manner as the Taxpayers maintain books of account in their own name and minutes of meetings are kept.

Size or scale of activity

As stated in paragraph 77 of TR 97/11 the larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business of primary production. However, this is not always the case. The size or scale of the activity is not a determinative test, and a person may carry on a business in a small way (Thomas at 72 ATC 4099; 3 ATR 171).

In relation to the Taxpayers’ share in Horse A, the horse breeding activities are already quite substantial. In the most recent 20XM & 20XN breeding seasons Horse A has served in excess of XXX mares. In the 20XM income year X Weanlings were sold. For the 20XN income year Y yearlings and Z Weanlings were sold.

In relation to the horse breeding activities of the band of broodmares the Taxpayers have started on a small scale; however the scale has increased and will continue to increase into the future. Additional broodmares are expected to gradually join the breeding activities in the near future. Compared to other participants in the industry this scale is relatively large. The Horse Farming industry is characterised by many small scale participants, with almost two thirds of all breeders having only one mare.

Likewise, the number of broodmares being serviced is increasing each year. During the 20XM income year (being the 20XL breeding season), X broodmares were serviced by Horse A and during the 20XN income year (being the 20XM breeding season), Y broodmares were serviced by Horse A. During the 20XO income year (being the 20XN breeding season) Z broodmares have been serviced by a varied array of Stallions. In the 20XP income year (being the 20XO) breeding season) the Taxpayers have entered into contracts for all broodmares to be covered by a varied array of Stallions.

Hobby or Recreation

As stated in paragraph 86 of TR 97/11 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 therefore is not assessable. As was stated in Ferguson at 79 ATC 4261 at 4266; 9 ATR 873 at 877:

‘…if what he is 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.’ (emphasis added)

Indicators that the activities are those of a keen follower of horse racing include:

● There may or may not be an intention to make a profit;

● The activity is motivated by personal pleasure;

● Sales, if any, are isolated and sporadic;

● The activity is not comparable with a normal business activity; and

● Lack of a system to allow profits to be made.

The Commissioner is satisfied that since 1 July 20XL the Taxpayers have been carrying on a business of horse breeding and not a hobby for the following reasons:

i. The Taxpayers are already making a profit and intend to make further profits from the horse breeding activities;

ii. The Taxpayers are incurring significant revenue and capital expenses but have a plan in place to show how further profits will be made;

iii. There is repetition and regularity of sales;

iv. The horse breeding activities are being carried on in the same manner as other similar businesses in the horse breeding industry;

v. There is a system in place to allow profit to be produced in the conduct of the activity;

vi. The horse breeding activities are being carried on, on a large scale in relation to Horse A. The horse breeding activities in relation to the band of broodmares started on a small scale but have expanded and will expand further into the future;

vii. All foals produced from the horse breeding activities are made available for sale at all the leading sales.

Specific industry indicators as per Taxation Ruling TR 2008/2

In addition to the above analysis, certain specific industry indicators as outlined in paragraph 37 of TR 2008/2 will be considered below in determining whether the Taxpayers’ horse breeding activities constitute the carrying of a business for income tax purposes:

i. Quality and number of horses – Horse A had a successful racing career and demand for his services as a stallion will only increase. In relation to the horse breeding activities of the band of broodmares the Taxpayers have started on a small scale; however the scale has increased and will continue to increase into the future. Additional broodmares are expected to gradually join the breeding activities in the near future. A number of the Taxpayers’ band of broodmares are stake winning mares. This bodes well for the future demand of the progeny produced from these broodmares.

ii. Whether taxpayer is selling stock – In respect of the progeny of the band of broodmares a yearling was already sold in 20XO, with Y more yearlings planned for sale in 20XP and then up to Z yearlings planned for sale in 20XQ (based on mares already bred in 20XN).

iii. Whether the mares are being served - During the 20XM income year (being the 20XL breeding season), X broodmares were bred to Horse A and during the 20XN income year (being the 20XM breeding season), Y broodmares were bred to Horse A. During the 20XO income year (being the 20XN breeding season) Z broodmares have been bred to a varied array of Stallions. In the 20XP income year (being the 20XO breeding season) the Taxpayers have entered into contracts for all broodmares to be covered by a varied array of Stallions.

iv. Whether the Taxpayers are using their stallion’s rights –In the most recent 20XM & 20XL breeding seasons Horse A has served in excess of XXX mares.

v. Whether the Taxpayer maintains geldings, barren female horses and other horses There are no geldings owned as part of the breeding activities, nor are there any barren mares in the breeding activities.

In conclusion, based on the business indicators outlined in TR 97/11 and the specific industry indicators outlined in TR 2008/2 the horse breeding activities of the Taxpayers do amount to the carrying on of a business. As such revenue from the breeding business will be assessable as ordinary income under section 6-5 of the ITAA 1997.

QUESTION 2

Summary

If any progeny derived from the breeding of Horse A with the broodmares are retained by the Taxpayers for the purpose of racing to improve breeding stock and are later used in the breeding business, the racing activities of these horses will be an integral part of the horse breeding business.

Detailed reasoning

Whether a taxpayer’s activities of racing horses may, of themselves amount to the carrying on of a business is a question of fact, having regard to all the relevant indicia set out in TR 97/11 and TR 2008/2.

As outlined in paragraph 28 of TR 2008/2 it is inherently more difficult to prove that the racing of horses as a stand-alone activity amounts to the carrying on of a business because it is considered that one or more of the following significant non-business features would be present:

i. The significant element of chance meaning that whether or not profit is made will depend very largely on considerations other than system and organisation of the taxpayer; and

ii. The activities are no more than the mere pursuit (albeit vigorous in many cases) of a hobby, recreational pursuit or pastime.

Although the Commissioner considers that only in a very rare case would the racing of horses amount to a business in its own right, if a taxpayer conducts racing activities as an integral part of a horse training or horse breeding business, then the horse racing activities would constitute activities in the carrying on of that business.

As outlined in paragraphs 32 and 33 of TR 2008/2 to be considered an integral part of the other business, the racing activities must be inherently connected with and be consistent with the furtherance of that business activity. Again, it will be a question of fact whether there is a business in the first place, and whether the racing activities are an integral part of it (as opposed to a separate activity).

In Case 54/96 96 ATC 521; (1996) 33 ATR 1243, the Tribunal found that the taxpayer was carrying on a business of horse racing and horse breeding. Evidence was given in that case that the taxpayers “took a risk and raced their horses to be able to prove them as good stock”.

In MR & SL Block v. Federal Commissioner of Taxation [2007] AATA 1897; 2007 ATC 2735; 67 ATR 452, the Tribunal stated that the taxpayers’ primary activity and purpose was the carrying on of a business of horse and sheep breeding and not the racing of horses. The Tribunal, in noting that the taxpayer “undertook some limited horse racing for the purpose of improving the value of the horses for sale, and to produce quality broodmares”, implicitly accepted that the racing activity was an integral part of the horse breeding business.

Initial intention – Horse bred initially from Horse A with any of the broodmares and held for racing activities but with an intention for later use in breeding business to improve value of breeding stock

The racing activities of any horse bred and initially held for racing activities, rather than for sale, will be part of the breeding business provided that the intention is to improve the value of the breeding stock for future sales and to use the horse in the breeding business.

The motivation behind racing these horses must be to win “black type races”. Black type races are the highest level of races in Australian Thoroughbred horse racing. Victory in these races marks a horse as being particularly talented, if not exceptional, and they are extremely important in determining stud values. Any horse that has won one of these races is printed in bold type in sale catalogues.

For both fillies and colts having a successful racing career will increase the value of the breeding stock from which it was derived as well as future progeny of the breeding stock. If the intention of the Taxpayers is to use a potential stallion in their horse breeding business after its racing career is over, the winning of black type races will increase its stud fees and increase the selling price of its progeny. Likewise, if the intention of the Taxpayers is to use a potential broodmare in their horse breeding business the winning of black type races will increase the selling price of its progeny. In both cases the racing of the potential stallion or potential broodmare will be an integral part of the horse breeding business as it will contribute to increasing the profitability of the horse breeding business.

The Taxpayers have the intention of selling the new foals produced from the breeding of Horse A with any of the broodmares whenever possible, however there may be times when they wish to retain a horse either to support the breeding activities of Horse A and the broodmares or to ultimately use that horse in the breeding business.

The Taxpayers currently have X yearlings of which Y are listed on the upcoming bloodstock sales. A yearling will be retained because of conformation flaws. The Taxpayers intend to race this yearling. This yearling is sired by Horse A and is out of the Taxpayers’ most valuable broodmare.

If the particular progeny retained is a colt and it wins several black type races, this will certainly help to increase the demand for the services of Horse A as a stallion and therefore his service fees. It will also increase the value of the particular broodmare it was bred from and any of the broodmare’s future progeny. However, for the racing activities of the colt to be an integral part of the horse breeding business the intention must be for the colt to become a stallion once its racing career is over.

Once the colt’s racing career is over the colt can either be used in the Taxpayers’ horse breeding business or it can be sold to another horse breeding stud. If the colt is used in the Taxpayers’ horse breeding business its racing activities are clearly integral to that business. In the event that the colt is sold to another breeding stud, although it will not be used in the Taxpayers’ horse breeding business, it is considered as trading stock of the horse breeding business. Thus the sale of the colt will be on revenue account rather than on capital account.

Likewise if the particular progeny retained is a filly, its racing activities will be an integral part of the horse breeding business if the intention of the Taxpayers is to use the filly in the breeding business once its racing career is over. Again if the filly is able to win several black type races this will help to increase the selling price of its progeny once it becomes a broodmare and raise the profile of Horse A as a stallion. It will increase the value of the broodmare it was derived from and the future progeny of this particular broodmare. In this respect it will be able to contribute to the profitability of the horse breeding business after its racing career is over. On the other hand if the filly wins black types and is later sold at a broodmare sale, although it will not be used in the Taxpayers’ horse breeding business, it is considered as trading stock of the horse breeding business. Thus the sale of the filly will be on revenue account rather than on capital account.

While the progeny of the breeding stock may have unsuccessful racing careers, they are part of the trading stock of the breeding business until a decision is made whether the horse goes on to have a breeding career. Likewise, even if a progeny of the breeding stock has an unsuccessful racing career, it may still retain some value as a breeding prospect if for example, it has a particular thoroughbred bloodline that the Taxpayers would like to preserve.

Question 3

Summary

From the information the Taxpayers have provided the Commissioner has concluded that after considering all the factors in Taxation Ruling TR 94/8 Income Tax: whether business is carried on in partnership (including ‘husband and wife’ partnerships) the Taxpayers’ business of horse breeding was carried on as a partnership from 1 July 20XL.

Detailed reasoning

The term ‘partnership’ is defined in section 995-1 of the ITAA 1997 as follows:

‘”partnership” means an association of persons (other than a company or a limited partnership) carrying on business as partners or in receipt of ordinary income or statutory income jointly.’

As stated in paragraph 9 of Taxation Ruling TR 94/8 Income Tax: whether business is carried on in partnership (including ‘husband and wife’ partnerships) (TR 94/8) whether a partnership exists is a question of fact and it is up to the person alleging partnership to prove that fact (Morden Rigg & Co and Eskrigge & Co v. Monks (1923) 8 TC 450).

The essential element for a partnership to exist is the genuine intention of all the parties to act as partners. This intention must be demonstrated by the conduct of the parties.

TR 94/8 outlines the following factors that are used in deciding whether persons are carrying on a business as partners in a given year of income:

Intention

● The mutual assent and intention of the parties

Conduct

● Joint ownership of business assets;

● Registration of business name;

● Joint business account and the power to operate it;

● Extent to which parties are involved in the conduct of the business;

● Extent of the capital contributions;

● Entitlement to a share of net profits;

● Business records; and

● Trading in joint names and public recognition of the partnership.

The weight to be given to these factors varies with the individual circumstances. The above list of factors is not exhaustive and no single factor is decisive, although the entitlement to a share of the net profits is essential. In domestic situations, for example involving a married couple, the conduct of each party must be examined to determine whether it is part of their ordinary domestic relationship or part of a business association.

The indicators outlined above are taken into consideration below in weighing-up whether all the indicators as a whole establish that the Taxpayers were carrying on the business through a partnership as of 1 July 20XL.

Intention

As stated in paragraph 12 of TR 94/8 mutual assent and intention to act as partners is the essential element in demonstrating the existence of a partnership between two or more persons.

Although advisable, a written partnership agreement is not essential as the conduct of the parties may itself evidence the existence of a partnership provided that there is mutual intention to act in partnership (Jolley v FCT (1989) 20 ATR 335 (the Jolley case) and AAT Case 1025 (1999) 44 ATR 1131). In the Jolley case, the AAT later decided that the existence of a joint bank account, the issue of receipts in joint names, the wife’s entitlement to half the profits and her agreement to the distribution of those profits to a family trust were sufficient evidence of a partnership despite the wife’s non-participation in the management of the business and the fact that her only investment in the business was an interest-free loan: AAT Case 5705 (1990) 21 ATR 3253.

The fact that a taxpayer may ostensibly conduct a business through a different structure does not necessarily negate that the true intention of the taxpayer was to conduct the business through a partnership. In (1956) 7 TBRD Case G76, it was held, despite the fact that income tax returns had for twelve years been submitted by the husband upon a sole trader basis, that there was a partnership in existence between husband and wife, the evidence disclosing that the business affairs of the parties had been conducted at all times upon a joint basis and their farming property was owned by them jointly.

Likewise in (1958) 8 TBRD Case H57 the fact that returns had been submitted on a “sole proprietor” basis by the husband was outweighed by the existence of a joint bank account between husband and wife for the moneys of the business and “the pooling of resources” and “joint devotion to the duties” of the business shown by the husband and the wife. It was held that the partnership had existed as from the date of the purchase of the business in 1946 and not merely from the date of the execution of the agreement of partnership in October 1950.

Although the Taxpayers do not have a written agreement, an agreement to act as partners may also be inferred from their conduct. This will be examined by the indicators outlined below. Likewise, the fact that the Taxpayers have been conducting the business ostensibly as sole traders does not mean a partnership did not exist if their conduct manifested that it was a partnership.

Joint ownership of business assets

As stated in paragraph 16 of TR 94/8 the joint ownership of business assets, together with a joint liability to business debt, is seen as indicative of a business partnership.

The Commissioner is satisfied that this indicator has been met. The Taxpayers have an equal share in Horse A. All the broodmares that are utilised in the business are jointly owned by the Taxpayers. The foals that were produced from the Taxpayers own broodmares being covered by Horse A are also jointly owned by the Taxpayers.

Likewise, the Taxpayers have joint liability for the business debts. The Taxpayers have provided some invoices from their major suppliers that have been addressed to both of them. Also in the individual income tax returns of both Taxpayers for the 20XM and 20XN income years they have both put the same figure in for the “Net primary production income or loss” label which suggests that they have joint liability for business debts.

Registration of business name

As stated in paragraph 17 of TR 94/8 the registration of a business name by the parties is viewed as a positive factor in determining the existence of a partnership.

This indicator cannot be satisfied as the Taxpayers ostensibly established and conducted the business as sole traders.

Joint business account and power to operate the account

As stated in paragraph 18 of TR 94/8 the existence of a joint bank account, specifically named as a business account, is viewed as a positive factor in establishing that the business is being carried on in partnership. This factor is given greater weight where the bank at which the account is held is aware that the parties are in partnership; and all the parties have power to operate the account. In the situation of husband and wife partnerships, the opening of a separate business bank account is viewed more favourably.

While the Commissioner will give consideration to the fact that the Taxpayers did operate a joint bank account, that the income from the breeding business is deposited into this bank account, that expenses and capital outlays from the breeding business are paid from this account and that both parties have access and power to operate the bank account, greater weight will not been given because the bank account wasn’t operated as a separate business account and no evidence was given that the bank was aware that the parties were in partnership.

Extent to which parties are involved in the conduct of the business

As stated in paragraph 20 of TR 94/8 while it is not essential that all partners actively participate in a partnership, such participation supports the existence of a partnership. In husband and wife situations, the conduct of each party will be examined to determine whether it is part of their ordinary domestic relationship or part of a business association.

The fact that both of the Taxpayers are actively involved in the business is viewed favourably by the Commissioner in supporting the existence of the partnership. Both Taxpayers are involved in making key decisions in the business such as which broodmares should be acquired by the breeding business to be bred with Horse A, the timing at which breeding should take place, decisions in relation to the care and treatment of the broodmares on hand as well as the determination of when, where and how the progeny should be sold. The Taxpayers provided evidence of an email where Mr AX advises their bloodstock agent that after consultation with his wife, they had made a decision about which broodmares would be bred and which stallions they would be served by for the 20XO racing season.

Any new acquisitions of broodmares for use within the breeding business are jointly decided by the Taxpayers and typically involve the attendance of both of them at the sales auction house. While all trading stock resides at Horse farms which manage the horses on a day to day basis, both taxpayers jointly undertake numerous visits throughout the year to assess the status and progress of the horses.

As such the active involvement of both Taxpayers in the business goes beyond their ordinary domestic relationship and is part of a business association.

Extent of capital contributions

As stated in in paragraph 24 of TR 94/8 the sharing by the parties of contributions to assets and capital weights in favour of the existence of a partnership.

The Commissioner is satisfied that this indicator has been met as any capital contributions that are required to be made are paid out of the Taxpayers’ joint bank account. These capital contributions include funding for the purchase of any additional trading stock, funding for costs of the upkeep of the bloodstock portfolio and other business running costs are paid through the joint funds of the Taxpayers.

Entitlement to a share of net profits

As stated in paragraph 25 of TR 94/8 partners must share between them the profits and losses of the partnership activity. A situation in which profits are shared in line with clearly stated rights and entitlements in the partnership agreement will be prima facie evidence of the existence of a partnership.

The Commissioner is satisfied that this indicator has been met. In the individual income tax returns of both Taxpayers for the 20XM and 20XN income years they have both put the same figure in for the “Net primary production income or loss” label which indicates that they have an equal share of the net profits and/or net losses of the business.

Business records

As stated in paragraph 26 of TR 94/8 the existence of a partnership is supported when business activities are entered in records that are separate and distinct from those kept for other business and private activities. The maintenance of business records in the name of the partnership, rather than in the name of one party only, is indicative of the existence of a partnership.

While the Commissioner will take into account that the Taxpayers have maintained books of account which are in both their names and minutes of meetings are kept, no other business records evidencing a partnership have been provided.

Trading in joint names and public recognition of the partnership

As stated in paragraph 28 of TR 94/8 the conclusion that a partnership exists is supported if the parties, by trading in joint names, make it clear to persons dealing with them that they are in partnership. Banks, suppliers and customers dealing with a partnership should be aware that they are trading with a partnership as opposed to dealing with an individual. It is important that creditors of a partnership are aware that they are dealing with a partnership, as partners are obliged, jointly and severally, to meet the partnership debts to the full extent of their own resources.

The Commissioner is satisfied that this indicator is met. All correspondence from advisors, lawyers, as well as suppliers and customers is addressed to the Taxpayers jointly as opposed to just one party. In relation to expenses of the business such as insurance and veterinary fees the Taxpayers have provided evidence of invoices from suppliers that have been addressed to both Mr AX and Mrs BX. The Taxpayers have provided evidence of invoices and adjustment notes from the Horse Farms and the Bloodstock Agency that have been addressed to both Mr AX and Mrs BX.

The Taxpayers began to use external stallions to cover their broodmares in the 20XN racing season. The Taxpayers have provided evidence of invoices of the Stallion Bookings.

In conclusion, despite the fact that the Taxpayers initially established the horse breeding business as sole traders, did not register a business name, did not have a separate joint bank account for the business and did not have separate business records in the name of the partnership, the Commissioner is satisfied that since 1 July 20XL the Taxpayers’ business of horse breeding was carried on as a partnership for the following reasons:

i. The Taxpayers have joint ownership of business assets and joint liability for the business debts;

ii. The Taxpayers are both actively involved in the conduct of the business;

iii. The Taxpayers have both shared in the contributions towards the capital and assets of the business;

iv. The Taxpayers have an equal share of the profits and losses of the business; and

v. External third parties deal with the Taxpayers’ business as if it were a partnership as opposed to an individual.

Question 4

Summary

The Taxpayers will be eligible to access the small business restructure rollover relief provided in Subdivision 328-G of the ITAA 1997 in regard to the planned restructure of their current business operation in which the assets of the Partnership will be transferred to a new discretionary trust.

Detailed reasoning

Subdivision 328-G of the ITAA 1997 provides an optional business restructure roll-over where a small business entity transfers an active asset of the business to another small business entity as part of a genuine business restructure without changing the ultimate economic ownership of the asset.

A rollover under Subsection 328-430(1) is available in relation to a transferred asset if the following criteria are satisfied:

i. The transfer of the asset is, or is part of, a genuine restructure of an ongoing business;

ii. Each party to the transfer is one of the entities listed in paragraph 328-430(1)(b);

iii. There is no material change in the ultimate economic ownership of the transferred asset;

iv. The asset being transferred is a CGT asset (other than a depreciating asset) that is an active asset;

v. Both the transferor and the transferee are residents of Australia, and

vi. Both the transferor and the transferee choose to apply the roll-over.

Law Companion Guideline LCG 2016/3 – Small Business Restructure Roll-over: genuine restructure of an ongoing business and related matters (LCG 2016/3) explains the Commissioner’s preliminary views on the consequences and adjustments that occur when a transferor and transferee choose to apply the small business restructure roll-over in Subdivision 328-G of ITAA 1997. The guideline applies to transfers occurring on or after 1 July 2016.

The transfer of the asset is, or is part of, a genuine restructure of an ongoing business

The Commissioner’s views on the meaning of “genuine restructure of an ongoing business” are set out in LCG 2016/3.

As stated in paragraph 6 of LCG 2016/3 a genuine restructure of an ongoing business is one that could be reasonably expected to deliver benefits to small business owners in respect of their efficient conduct of the business. It does not extend to a restructure by a small business owner in the course of winding down to transfer wealth between generations or realising their ownership interests.

As stated in paragraph 7 of LCG 2016/3, features indicating a genuine restructure of an ongoing business include:

● It is a bona fide commercial arrangement undertaken to facilitate growth, innovation and diversification, to adapt to changed conditions, or to reduce administrative burdens;

● It is authentically restructuring the way the business is conducted, as opposed to a divestment or a preliminary step to facilitate the economic realisation of assets;

● The economic ownership of the business and its restructured assets is maintained;

● The small business owners continue to operate the business through a different legal structure; and

● It results in a structure likely to have been adopted had the small business owners obtained appropriate professional advice when setting up the business.

As stated in paragraph 10 of LCG 2016/3 a restructure is likely to not be a genuine restructure of an ongoing business if:

● It effects an extraction of wealth from the assets of the business for personal investment or consumption;

● It creates artificial losses or brings forward their recognition; or

● It effects a permanent non-recognition of gain or creates artificial timing advantages.

In the Taxpayers’ case, the primary reason for the restructure is largely for asset protection purposes, as currently the assets of the business are owned in equal shares by the Taxpayers personally which leaves the Taxpayers liable to creditors beyond the value of the assets of the horse breeding business.

As shown in example one in LCG 2016/3 the restructure of a business for the purpose of asset protection does constitute a genuine restructure of a business. It has been acknowledged by the courts that the horse breeding industry is a high risk one and that availability of adequate capital is vital, not only to have the business operate on an economic scale but also to tide it over the non-revenue earning establishment stage³. The purchase of broodmares in particular can be expensive. Average broodmare prices have increased over the past five years and the industry’s best mares command a high price. Also, in an attempt to diversify its breeding stock the Taxpayers have started to have their broodmares serviced by external stallions. Stallion service fees are expensive and service fees for the top sires can be over $100,000 per mare covered.

Given that the horse breeding activities in relation to the band of broodmares is in its infancy, industry experience indicates that losses may be expected for the next few income years as the costs will increase for having the broodmares covered by external stallions and once a broodmare is covered there is typically a three year lag as the foal has to be conceived, carried by the mare, born and then reared before it can be sold.

The Taxpayers are transferring the assets from the Partnership to quarantine their business from their personal assets. This is a benefit to the Taxpayers in terms of their ability to grow the riskier operations and enhance profits. The horse breeding activities in respect of the band of broodmares is inherently riskier than the activities arising from Horse A. The Taxpayers have provided evidence of their commitment to expand the side of the business relating to the band of broodmares. Moving the assets of the business to a corporate trustee will allow the Taxpayers to take more risks in order to expand the quality of their broodmares and generate more profits.

For a restructure to be genuine the ultimate ownership test also needs to be met. This will be examined in the analysis detailed below.

Each party to the transfer is one of the entities listed in paragraph 328-430(1)(b)

Under paragraph 328-430(1)(b) of the ITAA 1997 the roll-over is only available if each party to the transfer of the assets is one or more of the following:

i. It is a “small business entity” for the income year during which the transfer occurs;

ii. It has an “affiliate” that is a small business entity for that income year;

iii. It is “connected with” an entity that is a small business entity for that income year, or

iv. It is a partner in a partnership that is a small business entity for that income year.

As discussed in Question 1 and Question 3 the Commissioner has decided that the Taxpayers’ horse breeding activities are being conducted as a business and are being carried on in a partnership.

Small business entity has the meaning given by section 328-110 of the ITAA 1997 which, broadly, requires that the entity is carrying on a business in the current income year and either its ‘aggregated turnover’ in the previous income year was less than $10 million and/or it is anticipated that the entity’s aggregated turnover for the current income year will be less than $10 million.

An entity’s aggregated turnover is defined in section 328-115 of the ITAA 1997 to include the “sum of the relevant annual turnovers” of the entity as well as the annual turnovers of any ‘affiliate’ of the entity as well as any ‘connected entity’ (subject to certain amounts which are excluded for inter entity dealings as provided for in subsection (3)). ‘Annual turnover’ is defined in section 328-120 of the ITAA 1997 to be “the total ordinary income the entity derives in the income year in the ordinary course of carrying on a business.”

Section 328-125 of the ITAA 1997 outlines when an entity is connected with another entity and section 328-130 of the ITAA 1997 outlines when an entity is an affiliate of another entity. Before applying these tests it must be determined that the connected entity or the affiliate is carrying on business as under section 328-120, the annual turnover of an entity only includes income generated from the carrying on of a business.

Under subsection 328-125(1) of the ITAA 1997 an entity is connected with another entity if one of the entities controls the other entity, or if the 2 entities are controlled by the same third entity. The provision contains separate control tests for different entities.

Subsection 328-125(2) of the ITAA 1997 outlines the general control test, which applies to all entities other than a discretionary trust and is based on a control percentage of at least 40%.

Under paragraph 328-125(2)(a) an entity controls another entity (other than a discretionary trust) where the first entity, its affiliates or the first entity together with its affiliates own or have the right to acquire ownership of interests in the other entity that between them give the right to receive at least 40% of any distribution of income or capital by the other entity or (in the case of a partnership) the net income of the partnership.

The Partnership carrying on the breeding business

The draft financial statement of the Horse Breeding business for the 20XO income year shows that the Taxpayers were in receipt of total income from the horse breeding business of $X,XXX,XXX. Whether the Partnership through which the Taxpayers have been effectively running the breeding business is a small business entity will depend on whether its annual turnover, aggregated with the annual turnover of any affiliates or connected entities, was less than $ZZ million for the 20XO income year.

The New Discretionary Trust that will be carrying on the breeding business

Paragraph 328-430(1)(b) also requires that the new discretionary trust to which the assets of the breeding business will be transferred, needs to be a small business entity. In order to comply with subparagraph 328-430(1)(b)(i) the new discretionary trust’s annual turnover, aggregated with the annual turnover of any affiliates or connected entities, for the 20XP income year will need to be less than $ZZ million. As outlined in paragraph 328-110(2)(b) the aggregated turnover of the new discretionary trust will be calculated from the date it starts to carry on a business. Also, since the new discretionary trust will not have carried on a business for the whole of this current income year, under subsection 328-120(5) a reasonable estimate must be made of what the annual turnover for the income year would be if it had carried on a business for the whole of the income year.

Is BB Holdings Pty Ltd carrying on business?

TR 2017/D7 indicates that a company that is established and maintained to make profits for its shareholders will generally be carrying on a business even if the company’s activities primarily consist of passively receiving rent or returns on its investments and distributing them to its shareholders.

The financial accounts for the 20XM and 20XN income years show that BB Holdings’ passive income activities consist of receiving interest income from some bank accounts and receiving distributions from XX Trust. Example 5 in TR 2017/D7 shows that a corporate beneficiary which reinvests its Unpaid Present Entitlement (UPE) or trust distribution in a profitable manner will be carrying on business. Looking at the 20XM financial statements for XX Trust, an amount of $FFF,FFF represents the UPE of BB Holdings Pty Ltd. The financial statements for the 20XM income year for BB Holdings showed that the UPE of $FFF,FFF was satisfied by its conversion to a loan back to XX Trust. The financial statements for the 20XN income year for XX Trust show that this $FFF,FFF was repaid to BB Holdings. XX Trust repaid the $FFF,FFF to BB Holdings before the lodgement date of the XX Trust return. As BB Holdings did not receive interest income from lending the $FFF,FFF to XX Trust in the 20XM income year, it is not carrying a business as it has not reinvested its UPE in a profitable manner.

While BB Holdings is not carrying on a business in respect of the trust distribution it may still be carrying on a business in respect of the interest income. The financial statements for the 20XN income year show that the company had total savings of $J,JJJ,JJJ in two bank accounts which generated interest income of $KK,KKK. Example 1 in TR 2017/D7 provides that a dormant company with retained profits in a bank account is not carrying on a business because its interest income is low, its expenses are greater than its interest income and there is no objective purpose or prospect of profit. BB Holdings’ circumstances can be distinguished from Example 1 in that its interest is substantial and objectively it has the purpose and prospect of profit as its expenses are low. Therefore, BB Holdings is carrying on a business.

BB Holdings is a connected entity with the Partnership under paragraph 328-125(2)(b) of the ITAA 1997, as the partners have at least 40% of the voting power in the Company. This is because the sole shareholder of BB Holdings is AA & Co and the Taxpayers (the partners) are the only shareholders of AA & Co. Therefore when calculating the aggregated turnover of the Partnership for the 20XO income year, the annual turnover of BB Holdings will need to be included.

Is XX Trust carrying on a business?

The annual turnover of XX Trust should not be included in the aggregated turnover of the Partnership for the 20XO income year. XX Trust is not carrying on a business as it is only in receipt of income through passive investments (interest income, dividends, trust distributions and foreign income). Companies are typically formed for the purpose of carrying on a business and it follows that, as stated in paragraphs 15 and 16 of TR 2017/D7, the profit-making activities of a company will normally have a fundamentally different character to those of an individual and a trust. As such the same profit-making activities undertaken by a trustee are much less likely to give rise to the presumption that a business is being carried on, than if they were carried on by a company.

As XX Trust is not carrying on a business it is not necessary to consider whether it is an affiliate or a connected entity of the Partnership carrying on the horse breeding business.

Is AA & Co Pty Ltd carrying on a business?

AA & Co engages in two activities: being the trustee company of XX Trust and the holding company of BB Holdings. As stated in paragraph 3 of TR 2017/D7 the draft ruling does not apply to companies in their capacity as trustee of a trust. Thus it only needs to be determined whether AA & Co’s activities as a holding company amount to the carrying on of a business. As shown in example 7 of TR 2017/D7 where a holding company only holds shares in a subsidiary, it is possible for it to carry on a business. AA & Co’s circumstances can be distinguished from this example in that AA & Co is not holding shares in a company that has a trading business. Likewise, BB Holdings did not pay dividends in the 20XM, 20XN and 20XO income years and therefore AA & Co had nil income in these years. As such AA & Co is not carrying a business as there is no objective purpose or prospect of profit.

As AA & Co is not carrying on a business it is not necessary to consider whether it is an affiliate or a connected entity of the Partnership carrying on the horse breeding business.

Is the Partnership carrying on the breeding business as a small business entity?

As outlined above the only entity that is carrying on business and is either connected with or is an affiliate of the Partnership carrying on the breeding business is BB Holdings. When BB Holdings’ estimated annual turnover of $HH,HHH is added to the annual turnover of the Partnership carrying on the breeding business ($,X,XXX,XXX) for the 20XO income year, the aggregated turnover for the 20XO income year will be less than $ZZ million. In accordance with section 328-110 of ITAA 1997 the Partnership carrying on the breeding business is a small business entity. Therefore for the purposes of being eligible for the small business restructure rollover the requirement of subparagraph 328-430(1)(b)(iv) is satisfied, the Taxpayers are partners in a partnership that is a small business entity.

Will the new discretionary trust carrying on the breeding business be a small business entity?

Similarly the only entity that is carrying on business and is either connected with or is an affiliate of the new discretionary trust that will be carrying on the breeding business is BB Holdings. BB Holdings would be a connected entity of the new discretionary trust under paragraph 328-125(1)(b) of the ITAA 1997, as both entities will be controlled by the Taxpayers.

The Taxpayers will be the sole shareholders and directors of the new trustee company and will therefore control it by virtue of subsection 328-125(2). Under subsection 328-125(3) the Taxpayers control the new discretionary trust because they control its trustee, the new trustee company, which can reasonably be expected to act in accordance with their directions and wishes.

The sole shareholder of BB Holdings is AA & Co and the Taxpayers are the only shareholders of AA & Co. Therefore the Taxpayers control BB Holdings under subsection 328-125(2).

As AA & Co is not carrying on a business it is not necessary to consider whether it is an affiliate or a connected entity of the new discretionary trust carrying on the horse breeding business.

Similarly as the XX Trust is not carrying on a business it is not necessary to consider whether it is an affiliate or a connected entity of the new discretionary trust carrying on the horse breeding business.

In summary BB Holdings will be the only entity connected with the new discretionary trust and the trust will have no affiliates. It is an assumption for the purpose of this Private Ruling that the new discretionary trust’s annual turnover, aggregated with the annual turnover of BB Holdings, will be less than $ZZ million for the 20XP income year. Therefore the new discretionary trust will be a small business entity under section 328-110 and the requirement of subparagraph 328-430(1)(b)(i) will be satisfied.

There is no material change in the ultimate economic ownership of the transferred asset

The transaction for the transfer of the assets must not have the effect of materially changing the ultimate economic ownership of the assets. As stated in paragraph 328-430(1)(c) of the ITAA 1997 it must not materially change:

i. Which individual has, or which individuals have, the ultimate economic ownership, and

ii. If there is more than one such individual, each of those individual’s share of the ultimate economic ownership.

Determining if this criterion has been satisfied is generally straight forward, and involves identifying those individuals who will benefit economically from the assets of a company, partnership or fixed trust. The ultimate economic ownership of an asset will be a question of fact to be ascertained from the circumstances of the particular case.

The nature of a non-fixed trust may mean that it is not possible to determine the ultimate economic ownership of its assets after they have been transferred and thereby to show that the ultimate economic ownership has not been materially changed.

An alternative ultimate economic ownership test may be applied where a transaction for the transfer of assets involves a non-fixed trust that is a family trust.

Section 328-440 of the ITAA 1997 provides for an alternative ultimate ownership test intended to facilitate the roll-over for non-fixed discretionary trusts. It allows small family businesses carried on through non-fixed trusts to satisfy the test in paragraph 328-430(1)(c) as long as the ultimate economic ownership of the transferred assets remains within the family.

The alternative test in section 328-440 is satisfied if:

a. Either or both:

i. just before the transaction transferring the assets took effect, the asset was included in the property of a “non-fixed trust” that was a “family trust”

ii. just after the transaction takes effect, the asset is included in the property of a non-fixed trust that is a family trust, and

b. just before the transfer took effect, every individual who had the ultimate economic ownership of the asset was a member of the family group (within the meaning of Schedule 2F to the ITAA 1936) relating to the trust or trusts referred to in para (a), and

c. just after the transfer takes effect, every individual who has ultimate economic ownership of the asset is a member of that family group.

The Taxpayers intend to restructure the business by dissolving the Partnership and transferring the assets of the Partnership into a new non-fixed discretionary trust that will also have in place a Family Trust Election (FTE) under section 272-80 of Schedule 2F of the ITAA 1936. Mr AX will be named as the primary individual. The Taxpayers will control the new discretionary trust as they will be the shareholders and directors of the corporate trustee.

Provided that the FTE is in writing and in the approved form (subsection 272-80(1) of Schedule 2F of the ITAA 1936) and the family control test is passed (section 272-87 of Schedule 2F of the ITAA 1936) this new non-fixed discretionary trust will be a family trust. For the purposes of this ruling it has been assumed that:

● In accordance with subsection 272-80(1) of Schedule 2F of the ITAA 1936, in respect of the new discretionary trust, the Family Trust Election will be in writing and in the approved form

● In accordance with section 272-87 of Schedule 2F of the ITAA 1936 the family control test will be passed and this new discretionary trust will be a family trust.

The proposed restructure would not meet the normal ultimate economic ownership test in paragraph 328-430(1)(c) as the Taxpayers, being the partners in the Partnership, currently have the sole ultimate economic ownership in the business assets but after the restructure this would not be the case, ultimate economic ownership would rest with all the beneficiaries of the family trust. That is, the ultimate economic ownership of the assets will not be maintained.

Therefore the proposed restructure would have to meet the alternative ultimate economic ownership test provided by section 328-440 of the ITAA 1997 in order for the restructure rollover to be available.

The operation of the alternative test is illustrated in Examples 12 and 13 in LCG 2016/3. The alternative test is only available when the assets are included in the property of a non-fixed trust that is a family trust, that is, a non-fixed trust for which there is a family trust election in force.

Under paragraph 328-440(a) the assets must be included in the property of the new discretionary trust either just before the transaction or just after it. This requirement is met as after the transfer of the assets from the Partnership to the new discretionary trust takes place, these assets will be included in the property of the new discretionary trust.

Furthermore as required in paragraphs 328-440(b) and 328-440(c), every individual who had economic ownership of the transferred assets before the transfer, and every individual who has economic ownership of the transferred assets after the transfer, must be members of the family group relating to the family trust.

The Explanatory Memorandum to Tax Laws Amendment (Small Business Restructure Rollover) Bill 2016 at paragraph 1.35 states that the purpose of the alternative ultimate economic ownership test is to provide additional flexibility to small family businesses carried on through non-fixed trusts by allowing them to meet the requirement to maintain proportionate ultimate economic ownership of the assets if the ultimate economic ownership of those assets remains within the family.

This requirement is met as Mr AX and Mrs BX have ultimate economic ownership of the assets just before the transfer. They are also members of the family group relating to the family trust which has ultimate economic ownership of the assets after the transfer.

The asset being transferred is a CGT asset that is an active asset;

Paragraph 328-430(1)(d) of the ITAA 1936 requires that the asset being transferred must be a “CGT asset” as defined in section 108-5 (other than a depreciating asset) that is at the time of the transfer:

i. if a party to the transfer is itself a small business entity – an “active asset” as defined in section 152-40, broadly an asset used in the business;

ii. if a party to the transaction is not a small business entity but is either an entity that has an affiliate that is a small business entity or an entity that is connected with a small business entity – an active asset that satisfies subsection 152-10(1A) which, among other things, requires that the relevant small business entity carries on business in relation to the asset; and

iii. if a party to the transaction is not a small business entity but is a partner in a partnership that is a small business entity – an active asset and an interest in an asset of the partnership.

Subsection 108-5(1) of the ITAA 1997 states that a CGT asset is:

a) any kind of property; or

b) a legal or equitable right that is not property.

To avoid any doubt, subsection 108-5(2) states that these are CGT assets:

a) part of, or an interest in, an asset referred to in subsection (1);

b) goodwill or an interest in it;

c) an interest in an asset of a partnership;

d) an interest in a partnership that is not covered by paragraph (c).

Paragraph 15 of TR 2008/2 states that a horse (or an interest in a horse) is a CGT asset regardless of whether or not it is also a depreciating asset or trading stock.

The definition of ‘trading stock’ in section 70-10 of the ITAA 1997 includes:

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

b) livestock.

Paragraphs 123 to 126 of TR 2008/2 state that the definition of ‘livestock’ includes all animals used in a business of primary production. Consequently, as horses used in a breeding business are used in a business of primary production, they are livestock. As horses in a breeding business are live stock, they are trading stock. Being trading stock they are not depreciating assets (paragraph 40-30(1)(b) of the ITAA 1997).

Subsection 152-40(1) states that a CGT asset is an active asset at a time if, at that time:

a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone of in a partnership) by:

i. you; or

ii. your affiliate; or

iii. another entity that is connected with you;

The assets of the Partnership comprise of the share in Horse A, the band of broodmares and the progeny derived from the breeding of the broodmares with Horse A. These are GCT assets as they are property. Furthermore a CGT asset can be an interest in the asset(s) of a partnership and it can be a part ownership of an asset. The Taxpayers each have an equal share in Horse A and a 50% interest in all the broodmares and a 50% interest in the progeny derived from the breeding of the broodmares with Horse A.

The Explanatory Memorandum to Subdivision 328-G (the EM) at paragraph 1.18 states that the restructure rollover relief applies not only in respect of CGT assets, but also in respect of the transfer of depreciating assets, trading stock and revenue assets between entities as part of a genuine restructure of an outgoing business. As explained at paragraph 1.45 of the EM, the rollover not only provides relief from any CGT consequences of the transfer of assets but also provides relief from any income tax consequences by virtue of section 328-450 of the ITAA 1997. Thus the rollover will apply to a transfer of trading stock. That is, provided that all the conditions in section 328-430 are met and thus the subdivision 328-G rollover is available to the asset(s) in question, the transfer of the asset(s) will have no consequences under income tax law.

As the Commissioner has determined that the Taxpayers are carrying on a business of horse breeding and thus carrying on a business of primary production, the assets of the business (Horse A, the broodmares and the progeny derived from the breeding of the broodmares with Horse A) are livestock and as a consequence are also trading stock. The Commissioner is satisfied that these are active assets within the meaning of subsection 152-40(1) of the ITAA 1997. In addition to being active assets the period that the horses have been used in the business as a proportion of the total period of their ownership must satisfy the test in section 152-35 of the ITAA 1997. It is an assumption for the purposes of this ruling that the test in section 152-35 will be satisfied.

As the active asset tests in sections 152-35 and 152-40 of the ITAA 1997 are met the requirement under subparagraph 328-430(1)(d)(iii) will be satisfied.

Both the transferor and the transferee are residents of Australia

Both the transferor and each transferee must, according to the type of entity they are, meet the appropriate residency test as set out in section 328-445 of the ITAA 1997.

Section 328-445 states that for the purposes of paragraph 328-430(1)(e), the residency requirement for an entity is that:

a) if the entity is an individual or a company – the entity is an Australian resident; or

b) if the entity is a trust – it is a resident trust for CGT purposes; or

c) if the entity is a partnership (other than a corporate limited partnership) – at least one of the partners is an Australian resident; or

d) if the entity is a corporate limited partnership – it is, under section 94T of the ITAA 1936, a resident for the purposes of the income tax law.

Section 995-1 of the ITAA 1936 contains the definition of a resident trust for CGT purposes. If the trust is not a unit trust, it will be a resident trust for CGT purposes if at any time during the income year, the trustee is an Australian resident or the central management and control of the trust is in Australia.

The transferor entity is the Partnership carrying on the breeding business in which the Taxpayers are the partners. For the Partnership to be resident in Australia for the purposes of paragraph 328-430(1)(e) one of partners must be an Australian Resident. Both Taxpayers are residents of Australia and therefore the Partnership is also a resident.

The transferee entity will be the newly created discretionary trust. The trustee will be a company incorporated in Australia and the Taxpayers will be the directors and shareholders of this company. The new discretionary trust will therefore be an Australian resident trust for CGT purposes.

Both the transferor and the transferee choose to apply the roll-over

Under paragraph 328-430(1)(f) of the ITAA 1997, as the rollover is optional, both the transferor and the transferee must choose to apply the roll-over in relation to the assets transferred, and the choice affects the tax consequences for both the transferor and each transferee.

It is an assumption for the purposes of this ruling that this election will be made.

Conclusion

All of the requirements for the small business restructure rollover under section 328-430 of the ITAA 1997 will be satisfied and therefore the restructure rollover will be available with respect to the proposed restructure. Once the requirements under section 328-430 of the ITAA 1997 have been met, the restructure rollover will also provide relief from any income tax consequences from the transfer of the trading stock from the Partnership to the new discretionary trust by virtue of section 328-450 of the ITAA 1997.