News and Media

03 January 2012

It’s a relief to bring in the festive season with some positive news in the world of horse tax, especially where it concerns wrenching our GST refunds out of the clutches of the ATO!
 

This involves a case where a company had its GST refunds (almost $1 million) unfairly withheld during the course of a BAS audit, money the company wanted to access to avoid cash-flow problems, but also as a matter of principle and fairness. The company had to withstand an ATO High Court appeal to reinforce the findings of lower courts were they held that GST refunds should be issued immediately upon lodgment “as a matter of administration”, regardless of any audit being on foot.
 

This is a significant case for our industry, as due to its nature many players claim large GST refunds, especially in the start-up period, and frequently people are being audited, primarily for the reason of proving their GST “enterprise” status, sometimes delaying the issue of a refund for many months. Our industry is a major beneficiary of this case finding, no doubt.

This XMAS update also comments on some major developments in the area of the new “Non-Commercial Loss” rules, including discussions on a recent tax case with implications for our industry, one of the first cases to have gone to the judiciary dealing with the operations of the new “Non-Commercial Loss” (NCL) rules for high income earners. This cattle farmer failed in his private ruling submission and our industry needs to learn lessons from the findings of this case – both of the NCL updates are compulsory reading.

1.    “Multiflex” case – The issue of GST refunds cannot be held up due to audits

As some background, the ATO conducts numerous BAS audits within the horse industry, as it tends to do for many “high risk” activities and their activities within our industry shows no signs of abating. Over many years it has been withholding BAS refunds whilst at the same time placing enormous workloads on accounting and administrative functions of a business, making them comply with a whole range of additional disclosure requirements during the course of an audit. In the meantime, the BAS refund claimed remains in trust with the ATO until the audit is finalized.

Well Multiflex had had enough of this policy and successfully issued proceeding against the ATO for immediate release of its refund and duly was successful at the Federal Court. Not only did the court reject the ATO assertion that the refund was issued within a “reasonable time”, but also reminded the ATO that there are should also be a “reasonable time” for how long it takes to investigate a taxpayer’s affairs.

This case is a triumph for supporting the working capital needs of horse businesses as these businesses rely on the regular payment of GST refunds to support working capital and cash flow. 

2.    New Loss Rules update 1 – Farmer does not convince ATO that lead time for his business is 20 years!

Under the new Non-Commercial Loss (NCL) rules, a high income earner cannot claim immediate losses from a business activity unless a successful private ruling application is received.

Our industry should always be on the lookout for NCL cases that go to the courts as so many breeders are, and will, apply to the ATO via a private ruling so that losses can be immediately deductible.

In this case, decided in November 2011, the taxpayer, a member of a profession was also engaged in a loss-making business of beef cattle breeding, which he began in 1988.

The ATO rejected the taxpayer's ruling request to exercise his discretion for his farm losses to be applied against the taxpayer's assessable income. The ATO subsequently rejected the taxpayers objection.

The AAT agreed with the Commissioner that the NCL rules were not satisfied as the:

• nature of beef cattle breeding did not require 2 decades to produce assessable income; and

• commercially viable period of cattle breeding was 6 years, which had long expired.

Facts

The taxpayer, who is a senior member of a learned profession, commenced a business of cattle grazing in 1988.
 

The taxpayer expanded his operations to operate a beef cattle breeding and fattening business. The taxpayer acquired three separate properties spanning approximately 2,000 hectares with 1,200 head of cattle on this land. The taxpayer incurred substantial debt, which led to increased interest costs.

As a result of the drought, the taxpayer incurred further losses.

The taxpayer's income for non-commercial losses purposes (i.e. Adjusted Taxable Income) in the income year prior to lodging the private ruling request was greater than $250,000.

The taxpayer requested a private ruling from the ATO as to whether he would exercise the discretion in the NCL rules to permit the taxpayer to include losses from his primary production business in determining his taxable income. The ATO’s decision was to not exercise the discretion, to which the taxpayer objected. The ATO disallowed the objection and the taxpayer sought a review of the ATO’s decision by the AAT.

Decision

The AAT affirmed the Commissioner's decision to not exercise the discretion in the NCL rules.

The AAT found that the taxpayer did not satisfy the NCL rules as it was not the nature of the business activity, being the beef cattle breeding and fattening, to not produce income greater than associated deductions. In particular, the AAT found that the business of beef cattle breeding does not take two decades to produce income greater than deductions.

The AAT found that the commercially viable period for cattle breeding was six years, which had long expired.

Comment

The “income tax business” status of this business was never in question, in spite of average losses of $680,801 in the 9 years to 30 June 2009.

What told against this farmer was that he made, in the words of the members hearing the case “idiosyncratic managerial choices” as to how he went about this business activity. It was also noted in the judgment:

“Although the taxpayer was perfectly entitled to make such choices, not every managerial reaction to events encountered in the course of a business activity or measure designed to achieve economies of scale was to be regarded as having occurred because of the nature of that activity”.

These unorthodox business choices, including the use of all heifers in the breeding herd regardless of their standard, were not considered by the ATO to be within the “nature of the activity”. Hence the farmer could not convince the AAT that a 20 year “lead time” to attain “commercial viability” was acceptable.

This case also highlighted the fact the “lead time” is taken from when the business originally started (1988), not from the time the ruling is applied for, this being questioned by the farmer.

3.    New Loss Rules update 2: Shock ATO interpretation - the “business activity” doesn’t just relate to when YOU started the business

Only recently I have become aware of a worrying development in the way the ATO processes the NCL private ruling applications.
 

It has always been thought by the tax community that, for the purposes of assessing the “lead time” of a business activity, that such time commences when you, the individual, start the activity. This is a crucial issue as the activity needs to become “commercially viable” within a “lead time” acceptable for that industry for the ATO to rule in your favour and allow the immediate deduction of the loss.

Be warned – the ATO are taking a liberal interpretation of WHEN the business activity starts, as per their interpretation the “business activity” lead time is taken from the time the “business activity” started, regardless of whether you, the taxpayer, were the owner and running it!

Example

Fred the horse breeder owns a property in the Hunter Valley where a breeding business has been operated by himself since 1 July 2002.

Fred died on 30 June 2008 and the business was passed to his wife, Dorothy. For a number of reasons, the breeding business has never made a profit for the entire period 1 July 2002 to 30 June 2011, some 9 tax years.

Dorothy is a high income earner and is forced to apply for a private ruling to be able to deduct her horse breeding losses for the tax years 2011 to 2014 inclusive.

In her application, Dorothy’s projections note that a profit will first be made in the FY 2015. This profit has been supported be expert reports that indicate that the lead time for her to make a profit is “8 years”. As Dorothy commenced the business in her own right on 1 July 2008, a profit by FY 2015 is within this 8 year “lead time” period.

Though the ATO accepted the “reasonableness” of her projections, they said she was outside the lead time of 8 years as the business activity had actually started with Fred back on 1 July 2002! Using this older start date, the “lead time” for generating a profit is now increased to 13 years (based on a FY 2015 profit) and this now puts the business well outside the accepted 8 year lead time and Dorothy’s application to claim the losses was unsuccessful.

This interpretation has been bought to the attention of a leading tax body and we are hopeful that the ATO will give a clearer indication into the future as to when the “lead time” period actually starts – to date, there has been no mention of this approach within its tax rulings, examples and fact sheets. I will let you know all developments in this area, be assured. 

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

END OF RELEASE

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: paul.carrazzo@carrazzo.com.au

Web Site: www.carrazzo.com.au