Edited version of private advice

Authorisation Number: 1051785476010

Date of advice: 01 December 2020

Ruling

Subject: Capital gains tax - personal use assets - cost

Question 1:

Are your ownership interests in the horses you have bred viewed as being personal use assets for capital gains tax purposes?

Answer:

Yes.

Question 2:

Will the amount of the stallion fee be included in the first element of the cost of each horse you have bred in the calculation of any capital gain or loss under CGT event K7?

Answer:

No.

Question 3:

Can the holding costs incurred in relation to each horse you have bred be included in their individual costs in the calculation of any capital gain or loss under CGT event K7?

Answer:

No.

This ruling applies for the following period

Income year ending 30 June 2020.

The scheme commences on

1 July 2019.

You have owned horses since 201X, commencing your breeding activities after several years.

You purchased a small ownership interest in the stallion (Horse A) in 201X for $33,000, who you selected based on the cost of their service fees.

Your ownership interest in Horse A entitles you to a specified number of service fees to use during a specified number of years, and then one service for each year the stallion is standing at stud.

You currently own one mare foaled, Horse X, which you purchased in 20XX for more than $10,000 and have a share in another mare.

You bred Horse X with Horse A in 20XX and sold the resulting progeny during the period covered by this ruling for $XXX,XXX gross before costs. You incurred costs to get this horse to sale, excluding stallion service fee of $XX,XXX.

You bred Horse X with Horse A during the following breeding season and anticipate the foal resulting from that mating in in 202X and anticipate that it could be sold for $XXX,XXX-$XXX,XXX.

You are not involved in the day-to-day management of the horses which is managed by a horse stud where they are on agistment.

You visit the horses on average several times per year.

You have incurred costs in relation to the foals you have bred, such as agistment, mortality insurance, veterinarian costs, farrier expenses, stud book registration, foaling fees, weanling handling costs and costs to prepare the foal for sale.

You have been employed full-time while undertaking these activities and will continue to do so into the future.

You do not have any intention in pursuing these activities on a full-time basis and have a vision impairment that precludes you from engaging in this activity as a business pursuit.

You consider that:

•         your activities are a hobby, with your aim being to break-even; and

•         your involvement in the racing industry is at the lower portion of the market which will make your ability to make a profit significantly limited.

Your aim is to sell one foal annually subject to the foal being a saleable commodity.

Your activities are not planned, with the few decisions having to be made being made on a more ad-hoc basis than being planned.

You are considering purchasing another broodmare in upcoming sales for less than $30,000 which has just finished racing, or a broodmare in foal which may result in you potentially having other foals to sell.

Assumption:

For the purposes of this ruling, any veterinary fees incurred in relation to the birthing of each foal to get a live foal on the ground were less than $10,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 40-180

Income Tax Assessment Act 1997 Section 40-190

Income Tax Assessment Act 1997 Section 104-235

Income Tax Assessment Act 1997 Section 104-240

Income Tax Assessment Act 1997 Section 108-20

Income Tax Assessment Act 1997 Section 108-30

Income Tax Assessment Act 1997 Section 118-10

Income Tax Assessment Act 1997 Section 118-24

Income Tax Assessment Act 1997 Division 40-C

Reasons for decision

Summary

Based on the information provided:

•         CGT event K7 will happen when each horse is sold because they are depreciating assets

•         CGT event K7 uses the Division 40 concepts of cost and termination value to calculate capital gains and loss (not cost base and capital proceeds)

•         The cost for each horse you bred will only be the amount of any veterinary fees to the extent that they were incurred in relation to the birthing of each of the foals.

•         The cost of the stallion fee will not be included in the cost of either of the foals you have bred.

•         Holding costs that you have incurred in relation to the foals you have bred, such as agistment and veterinary costs, will not be included in the cost of either foal.

•         The foals you have bred are viewed as PUAs.

•         The proceeds from the sale of the foals (horses) will not be assessable; and

•         You can disregard any capital gain/capital loss made on the disposal of the horses that you have bred.

Detailed reasons

Personal use assets

A capital gain that a taxpayer makes from a personal use asset, or part of the asset, is disregarded if the taxpayer acquired the asset for $10,000 or less under subsection 118-10(3) of the Income Tax Assessment Act 1997 (ITAA 1997). Accordingly, a capital gain can only be made if the acquisition cost of a PUA exceeds $10,000.

Additionally, capital losses made from personal use assets are also disregarded under subsection 108-20(1) of the ITAA 1997.

'Personal use asset' is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by section 108-20 of the ITA 1997.

Section 108-20 of the ITAA 1997 states that personal use assets (PUAs) are capital gains tax (CGT) assets, other than collectables, that are used or kept mainly for the personal use or enjoyment of you or your associates.

Subsection 108-20(2)(b) of the ITAA 1997 states that a PUA can include an option or right to purchase a CGT asset of that kind -meaning a right to purchase a PUA.

There are three categories of PUAs as defined in subsection 108-20(2) of the ITAA 1997 as follows:

1.    CGT assets used or kept mainly for personal use or enjoyment

2.    certain options and rights, and

3.    certain debts.

Whether an asset is a PUA depends on how the asset is used or kept by the taxpayer or associate of the taxpayer. This means that a CGT asset of a particular kind which may be a PUA in the hands of one taxpayer may not be a PUA in the hands of another.

For an asset to be a PUA, it must be used or kept " mainly " for the personal use or enjoyment of the taxpayer or associate of the taxpayer.

Taxation Ruling IT 2585 outlines that a horse that is acquired by a taxpayer who races horses as a hobby, and is not in the business of racing horses, is a PUA. While this ruling has been withdrawn as it contains references to repealed provisions, it still has effect.

The words " personal use " in the definition of PUA are used in contradistinction to use for business or profit-making purposes (Favaro v FC of T 96 ATC 4975). In Favaro's case, Italian currency, which was converted to Australian currency and invested, was held not to be a PUA (under ITAA 1936 s 160B(1)). This issue was not considered when the appeal in this case was decided by the Full Federal Court (Favaro v FC of T 97 ATC 4442).

The word " contradistinction " means distinction by contrast or opposition (Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne). Therefore, an asset that is not used for business or profit-making purposes is, by default, used or kept mainly for personal use and enjoyment. The two categories are mutually exclusive.

Paragraph 6 of Taxation Ruling TR 93/26 outlines what must be demonstrated for activities to be viewed as the carrying on a business. The relevant factors that would be considered to determine whether a business is being carried on in relation to horse breeding activities are being conducted as a business rather than a business.

Additionally, Taxation Ruling TR 97/11 outlines the factors that are taken into consideration when determining when a business is being carried on with the alternative being that a hobby is being undertaken. While this ruling relates to primary productions, the factors outlined in that ruling can be used in general when determining whether a business is being carried on.

There is no benchmark that determines whether a business on horse breeding is being carried on and that decision will be determined based of the facts of each situation.

Paragraph 73 of TR 2008/2 states that a horse that is not used in a business or not otherwise used for the purpose of producing the taxpayer's assessable income, is used or kept mainly for personal use or enjoyment. Consequently, it will be a PUA as outlined in paragraph 108-20(2)(a) of the ITAA 1997.

Paragraph 12 of TR 2008/2 states that if a taxpayer's horse-related activities do not amount to the carrying on of a business, then:

•         the gross proceeds derived from the activities will not be assessable income under section 6-5 of the ITAA 1997

•         the non-capital outlays and other expenses will not be deductible under section 8-1 of the ITAA 1997

•         the horses will not be trading stock

•         the horses, or interests in them, are depreciating assets, but no deductions for decline in value under Division 40 of the ITAA 1997 will usually be available; and

•         CGT event K7 may need to be considered if a balancing adjustment event occurs for the horse, such as a disposal, and the horse has been used for a purpose other than a taxable purpose.

CGT event K7

As a horse is also a depreciating asset, CGT event K7 will occur in relation to the ownership interest in the horse such as when it, or an interest in it, is disposed of under section 104-235 of the ITAA 1997. Any capital gain made from CGT event K7 happening to a horse will be disregarded if the first element of the cost of that horse is $10,000 or less.

Where there is a balancing adjustment event that occurs for the horse, or an interest in it, the CGT provisions will not apply unless the horse, or an interest in it, is used for a purpose other than a taxable purpose in accordance with section 118-24 of the ITAA 1997.

Where this occurs, CGT event K7 applies. Any capital gain or loss worked out under CGT event K7 is calculated using the concepts of cost and termination value under Division 40 of the ITAA 1997, and not those found in the CGT provisions, that is cost base and capital proceeds, under section 104-240 of the ITAA 1997.

The cost of a depreciating asset consists of two elements and is worked out under sections 40-180 of the ITAA 1997, the first element of cost, and 40-190 of the ITAA 1997, the second element of cost.

Any capital gain made from a CGT event happening to a PUA is disregarded if it is also a depreciating asset with its first element of cost is $10,000 or less.

Application to your situation

In your situation you have used the stallion services you obtained in relation to your stallion rights to cover Horse X, resulting in the foals being born in subsequent years. You have sold one of the foals you bred during the period covered by this ruling and anticipate selling the other in the future.

You own a share in another mare however you do not intend pursuing your horse related activities on a full-time basis, undertaking activities in the lower portion of the market on a small scale, with the aim to sell one foal annually for the purpose of breaking even.

Your interest in the foals you have bred are CGT assets under section 108-5 of the ITAA 1997 and the foals are also depreciating assets under section 40-30 of the ITAA 1997.

When the horse is a foal that you have bred, Division 40 of the ITAA 1997 would

apply in the following way:

•         you commence holding the foal as a depreciating asset when it is born in accordance with section 40-40 of the ITAA 1997

•         a balancing adjustment event will occur when you stop holding your ownership in the foal, such as when you sell it, under section 40-295 of the ITAA 1997

•         section 40-290 of the ITAA 1997 provides that where the foal has been used for a purpose that is other than a taxable purpose, such as being used privately, the amount of deduction or assessable income otherwise calculated under section 40-285 of the ITAA 1997 is reduced; and

•         the first and second element of a cost of a depreciating asset are contained in sections 40-180 and 40-190 of the ITAA 1997 respectively.

Based on the facts provided, there are no ancillary amounts included in either section 40-180 or 40-190 of the ITAA 1997 that meet the requirements of your situation in relation to the foals that you have bred.

Therefore, the first element of the cost of each of the foals that you have bred will only be the amount of any veterinary costs that were incurred in relation to the birthing of either of the foals to get that foal on the ground under subsection 40-180(3) of the ITAA 1997.

While you have incurred costs in relation to stallion fees and agistment, those costs cannot be included in the cost of the foals under either section 40-180 or 40-190 of the ITAA 1997.

Based on the information provided, it is not viewed that your horse related activities meet the factors as outlined in TR 93/26 and/or TR 97/11 to be considered as being undertaken in the course of carrying on a business. It also cannot be viewed that your activities are being undertaken as part of a profit-making undertaking.

Therefore, as your activities are being undertaken as a hobby, your ownership interest in the horses you have bred will meet the conditions for those horses to be viewed as being PUAs. Accordingly, any amount derived from your hobby activities in relation to the sale of the horses you have bred will not be viewed as income and is not assessable. Additionally, expenses incurred in relation to those activities are not deductible.

As the first element of the cost of each of the foals you have bred are less than $10,000, they are viewed as PUAs and any capital gain made on their disposal can be disregarded.

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

As outlined above, TR 93/26 provides the factors that should be considered when determining whether a business is being carried on in relation to horse related activities in addition to the factors as provided in TR 97/11.