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TAX CASE a blow for the industry - Sept 2008

HOW things can change in the world of horse tax! To the many breeders out there who believe they are in business where they hold less than 50% of the mare(s), I report on a recent landmark decision that may impact on their income tax/GST status.

Yes, it is that serious!

Back in October 2007, the tax community was rejoicing at the common sense decision reached by the WA Administrative Appeals Tribunal (AAT) in the landmark "Block's" case - a case where a family partnership was held to be in business in a period where significant losses were present.

Now, some 11 months or so later, we are in despair about the findings of a "business v hobby" case recently decided at the NSW AAT.

This case involved a small breeder, Greg D'Arcy, appealing against a previous ATO decision that disallowed his GST claims for the period October 1, 2002 to September 30, 2006.

These GST claims were disallowed on the basis that Mr D'Arcy was not conducting a horse breeding "enterprise" in this period. Furthermore, Mr D'Arcy's income tax returns were amended to disallow his horse breeding losses for the 2003, 2004 and 2005 income tax years.

The AAT decided in favour of the ATO, primarily on the basis that Mr D'Arcy did not have sufficient "control" of his business stock, notwithstanding that his activities demonstrated many strong business elements, especially in terms of quality of stock and the expertise and profit purpose of the taxpayer.

I write about this case with a heavy heart, as I was drafted at the last moment by Mr D'Arcy's tax advisers to help fight this case. Like Greg and the rest of the tax team, we were bitterly disappointed with the decision, and as I write we are seriously contemplating an appeal to the Federal Court.

Of even greater concern are the implications this case could have to many small breeders who invest in multiple quality and costly mares, but due to the high cost of so doing and the desire for proper investment diversification, choose to own a partial interest in each mare. For example, 10%, 25%, 33 1/3% etc of the quality mare acquired.

Breeding costs are equally high. Broodmares cost on average $40,000, and at the top end, more than $200,000. For top end stallions to service a mare, it can cost tens of thousands of dollars. The stud fee for Redoute's Choice is $275,000 - $25,000 of which is GST. The stallion's progeny have to date earned more than $24m.

I will now discuss this case in more detail and I can only hope that, in the event that the decision is not subsequently overturned on appeal, the ATO use common sense when applying this decision as every case has its own peculiar facts and these "business v hobby" cases should always decided on this basis.

The facts - AATA Case 709
THE basic background to the case could not be better described than by referring to Mr D'Arcy's statement to the tribunal, excerpts of which I copy below:

"My decision to commence horse breeding in 2002 stems from a long-standing general interest in primary production and horses.

"I decided to commence a business with a view to eventually establishing my own stud farm. My basic strategy is to learn more about horse breeding, bloodlines and the marketplace before purchasing a property.

"I have an association with [my uncle, who] . . . has a wealth of knowledge, many contacts within the industry and acts as a good mentor from whom I am learning.

"Our collective aim is to gather a group of top quality mares through various means and produce foals for sale utilising marketable and fashionable stallions.

"We make informed decisions after seeking and obtaining advice from industry experts including bloodstock agents [names deleted], top trainers [names deleted] and the specialised staff from commercial studs [names deleted] on a regular basis.

"We have regular discussion about the mares, foals and fillies on all aspects of horse life. Decisions on stallions, matings, welfare issues, vets decisions, sales location decisions and many more are discussed and agreed to.

"I am a member of the NSW Thoroughbred Owner and Breeders' Association and receive regular updates from [names deleted] regarding upcoming sales and related industry events.

"My main interest is breeding rather than racing."

Other facts worth noting are:

  • on average, six-eight current or potential broodmares were held at any one time. Fourteen mare interests were held in total over the period. Total investment on mares was approximately $230,000;
  • on average, Mr D'Arcy owned approximately 23% of each mare and one mare was owned 100% outright. This latter mare was his most costly;
  • Mr D'Arcy was a regular seller and little racing was present;
  • no formal business plan was prepared;
  • between Mr D'Arcy and his uncle, they owned greater than 50% of each mare;
  • there was never a dispute where a dispute resolution mechanism would have been needed. There was no formal written agreement between the owners;
  • books of account and records could not be produced to the tribunal, though the taxpayer kept computer spreadsheets of all financial transactions and they were tabled with the ATO as part of a previous GST review;
  • losses were made in each of the tax years; and
  • though strongly argued to the contrary, the AAT resolved that a profit was not likely "within any reasonable time frame".

Comments

AFTER a considered review of the finding and taking account of the overwhelming line of argument of the ATO's counsel, I have concluded that the AAT has placed great weight in the ATO assertion that Mr D'Arcy was not making his own decisions in relation to this venture and the best he could do was provide "input" to the decision-making process.

Other "non-business" elements were raised by the AAT in its decision, such as lack of a formal business plan and prospect of profit, however the former has never held much weight in these AAT decisions and it could be very reasonably argued that Mr D'Arcy's activities had at least had as much "prospect of profit" as the activities within "Block's" and other well known horse breeding AAT cases that have been held for the taxpayer. I found this latter AAT conclusion particularly disappointing.

Due to my personal interest in this case, readers can expect to updated immediately on any developments within the next few months.

This "control" principle in deciding "business v hobby" cases has wider application than just the racing industry, which is the most interesting (and troubling) aspect of this decision.

Readers are welcome to contact me if you wish 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
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Web Site: www.carrazzo.com.au

 

Report: Paul Carrazzo
© Copyright 2008 - Reproduced with permission from Australian Bloodhorse Review.

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.

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