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New Tax Case Is A Coup For Breeders - Feb 2008

New horse industry tax rulings, ATO audits, and now a recently decided tax case to warm the hearts of many breeders - the horse tax world is still abuzz with unprecedented activity.

It has become increasingly obvious during the current ATO audit that the ATO's position on the "business" status of small-scale breeders was, on too many occasions, in conflict with the established case law in the area.

The best way to convince the ATO that their administrative position is wrong is for the courts and tribunals, who are the final arbitrators on these matters, to continue to provide decisions that make it obvious to the ATO they should think hard as to whether their decisions are not only fair and just, but reflect the judiciary of the time.

This is what makes the recent WA AATA Case 1897 so significant.

This case, decided in late October 2007, decided in favour of partners conducting a "business-like" horse breeding activity, even where limited sales where evident due to perfectly legitimate reasons, in this instance extraordinary bad luck.

This case was also a victory for breeders who retain fillies and colts for racing, not only for future breeding purposes, but in instances where it is more commercially appropriate to do so.

This decision again makes it clear that such a practice does not automatically mean a tax business is not being conducted and that, as always, all of the "business" factors need to be taken into account.

The facts - AATA Case 1897

THIS case involved the breeding and sheep activities of a WA-based husband and wife partnership, Malcolm and Sally Block, and whether such activities constituted a "business" for tax purposes.

For our purposes, I will only focus on the horse breeding activities, though the sheep activities were also accepted by the ATO.

The partnership started by acquiring a 30 hectare farming property in Gidgegannup in WA for $185,000, which included a house and improvements. In the following year it acquired a neighbouring 30 hectare farming property for $200,000 to increase the size of the land and facilities available to enable it to conduct horse and sheep breeding activities. Together, the two properties were called Cheverell Park.

Malcolm and Sally had extensive financial, managerial and business experience, including relevant experience breeding thoroughbred horses.

In relation to horse breeding, their intention was to breed thoroughbred horses and sell the progeny for profit. However, they incurred significant losses because of the capital costs in setting up the business, subsequent restructuring, and unforeseeable setbacks such as accidental injuries and deaths to the horses in the relevant period.

The ATO considered that the partnership was not carrying on a business of horse breeding for the period December 31, 2000 to September 30, 2005. Accordingly, GST registration was cancelled and income tax losses disallowed, resulting in the partnership owing the ATO approximately $400,000.

The partnership had commenced breeding in 1991 and by the year 2000 had some 10 active mares and many foals available for sale.

What went wrong?

THE breeding activities went awry in the years 2000 to 2004 due to an incredible amount of bad luck and factors very much outside of the control of the partnership.

Consider the following:

  • foals presented for sale were not sold as they failed to reach an acceptable price;
  • a buyer reneged on a sale due to a horse being injured while being scoped;
  • six of the mares died;
  • two stallions for which shares were held died; and
  • five sale yearlings could not be sold due to leg faults or paddock accidents sustained.

New direction - breed own mares and additional racing to "prove" them

FROM 2005 onwards, the partnership made a decision to invest in the infrastructure of the business while producing its own young mares to replace mares that had died or aged.

The restructure of the horse breeding business resulted initially in the business declining in size and scale, and contributed to the losses made by the business in the years ended June 30, 2003 to 2005.

As part of the restructure, the partnership reviewed the quality of its stock and sold, culled, or otherwise disposed of horses (including mares), which it regarded of little value.

It was decided not to purchase broodmares as part of the restructure because of concerns about quality, and because the purchasing of broodmares had already been tried with limited success.

The partnership also decided to continue to undertake some limited horse racing for the purpose of improving the value of the horses for sale, and to produce quality brood mares.

The additional racing was very much forced upon the partnership and was always intended to be a temporary strategy until a new breeding herd was established.

Remarkably, even in the face of all of this evidence, the ATO disagreed and concluded that the partnership's horse activity had deliberately changed its primary purpose to that of horse "racing", not horse "breeding".

As has been noted many times in my recent articles, the ATO very rarely views a "racing" activity as being a tax business.

It should be noted that neither of the partners have any interest in racing and only attended race meetings when their horses were racing and then usually only for that race. Wagering was rare and usually confined to a $10 "each way" bet.

Arguments of the ATO

THE major arguments put up by the ATO in support of their "hobby" view were:

  • the partnership consistently made losses;
  • no formal business plan;
  • little prospect of profit;
  • too many "home-breds" were raced. The ATO was trying to argue a "racing" hobby activity;
  • mares serviced every second year;
  • expert advice re matings not followed;
  • lack of sales proceeds and volume; and
  • lack of quality of mares, especially in terms of "black type".

Conclusion

ON the balance of facts, the AATA decided Malcolm and Sally Block were running a breeding business during the relevant period, and that all GST claims and tax losses were available to them.

The factors that won the case for the partnership can be summarised as:

  • the lack of sales were due to a run of bad luck with mares and the foals bred for sale;
  • future profit prospects beyond 2004. A strong overall profit intention was in place;
  • the "business-like" and "commercial manner" in which the business was conducted;
  • the seeking of expert advice, supported by sophisticated breeding programs, such as the "Pedigree Dynamics" system;
  • excellent record keeping;
  • a selling mentality;
  • a flexible business plan, especially in terms of regular review and upgrading of mares;
  • the previous and subsequent commercial practices of the partnership, outside of the period where the bad luck set in, e.g. buying mares with “black type” in their pedigrees;
  • acquired interests in stallions for the purpose of serving mares;
  • they utilised the commercial market for the sale of horses in the Magic Millions, Yearling and Ready to Run sales, as well as making private sales;
  • the time and money spent on property and pasture improvements;
  • their extensive financial, managerial and business experience;
  • their extensive experience with thoroughbred horses, including the undertaking of courses in horse management, in the United Kingdom; and
  • membership of the WA Bloodhorse Breeders Association since 1996.


The judgment comments of the AATA Senior Member who heard the case, A. Sweidan, very much reflect what is noted above:

" The husband and wife had built up the horse breeding business by investing a significant amount of their capital, time and effort in the conduct of the business, more than a person undertaking a recreational pursuit or hobby - with a view to making a profit.

The partnership incurred significant losses in respect of the business because of the capital costs of setting up the business, the subsequent restructuring of the business and unforeseeable setbacks. With infrastructure and improvements for the business now in place, and steps having been taken to upgrade its stock, the partnership would have saleable progeny to secure future income and profit from the horse breeding activities. "

Comments

A common sense decision that also reflects the new "integration" principle incorporated into the new horse industry tax ruling, i.e. the ATO will relax their "hard line" racing position is where the racing of horses is an "integral" part of a horse training or breeding activity. This makes it all the more puzzling as to why the ATO thought they could win this case.

This case is amongst a series of favourable decisions that have been bought to my attention from all over Australia recently, so maybe all of my ranting over the years as to what "business" factors should be in a breeding business is starting to bear some fruit!

You are welcome to contact me if you wish me to clarify or expand upon any of the matters raised in this article.

 

Prepared by:
PAUL CARRAZZO CPA
CARRAZZO CONSULTING CPAs
22 BLACKWOOD ST,
NORTH MELBOURNE VIC 3051
TEL: (03) 9329 7044
FAX: (03) 9329 8355
MOB: 0417 549 347
E-mail: This e-mail address is being protected from spambots. You need JavaScript enabled to view it
Web Site: www.carrazzo.com.au

 

DISCLAIMER - Any reader intending to apply the information in this article to practical circumstances should independently verify their interpretation and the information's applicability to their particular circumstances with an accountant specialising in this area.

Reproduced with permission from the Australian Bloodhorse Review © Copyright 2008

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