VCK and Federal Commissioner of Taxation
Document type: Decision Impact Statement
Venue: Administrative Appeals Tribunal (VT2005/554-556)
Judgment date: 12 December 2006
Date published: 16 March 2007

Summary of decision:
Outlines the Tax Office's response to this case which concerned whether the taxpayer was entitled to income tax deductions in a business of boat charter, or whether his activities were no more than a passive investment.

Overview of facts:
The Commissioner disallowed deductions claimed by VCK in respect of a boat on the basis that he did not use or hold the boat mainly for letting it on hire in the ordinary course of a business that he carried on, as required by section 26-50. | Pursuant to two separate Management Agreements, (one with QC from 4 October 2001 until it was terminated in October 2003 and one with HCC from 20 October 2003), VCK appointed charter operators to hire out his boat. | VCK's evidence was that he entered the arrangements in reliance on a one page "Analysis of Charter Boat Ownership Benefits" which contained projections of annual income and expenses for a comparable boat. The Analysis projected a cash return of $23,804; however it did not take into account depreciation of the boat and any interest payable on the loan used to acquire the boat. | VCK's accountant reviewed the Analysis and concluded that, taking into account all expenses (including depreciation and interest), profits would be generated after three years, with progressive increases each year thereafter. | Income did not meet expectations and maintenance costs were much higher than anticipated. VCK made losses of approximately $50,000 in each of the relevant years (compared to the projected loss of $32,571 referred to in the Accountant's advice). VCK became increasingly concerned and in October 2003 he removed the boat from the QC arrangement and placed it in charter with another charter operator (HCC). | The Commissioner had argued that the agreement between VCK and QC contained certain features that characterised it as a lease agreement rather than an agency agreement. The Tribunal found that the agreement was correctly characterised as an agreement under which QC was the agent for VCK. The Commissioner did not question this characterisation of the agreement between VCK and HCC. | VCK did not use the boat for private use notwithstanding that the respective Management Agreements allowed up to four weeks of personal use. | Issues decided by the court or tribunal | • Was VCK carrying on a business of chartering his boat? • Were his activities no more than a passive investment? • Whether section 26-50 of the ITAA97 operates to deny deductions claimed in relation to a boat. | • Was VCK carrying on a business of chartering his boat? • Were his activities no more than a passive investment? • Whether section 26-50 of the ITAA97 operates to deny deductions claimed in relation to a boat. | The Tribunal found that VCK's activities in chartering the boat through HCC constituted a business. The Tribunal accepted that VCK, relying on the projections provided by QC, had an expectation of profit. This was notwithstanding that he may have been "naïve in accepting the projections from [QC] who might be seen as having an interest in persuading [him] to become involved in chartering" and "naïve in not factoring in the interest costs on borrowings and depreciation of the boat". Nevertheless, the Tribunal accepted evidence from VCK's accountant that not only would 'there... be a positive cash flow before interest and depreciation', but also that 'a profit should emerge in later years'. That is, the accountant considered that the activity would be profitable, taking into account interest and depreciation as elements of calculating the profitability of the activity. | The Tribunal therefore found that 'on balance and on the particular facts of this case ... [VCK] was carrying on a business of chartering his boat'. As noted above, the Tribunal had also found that the arrangement between VCK and QC was correctly characterised as an agency agreement, rather than the provision of a boat to QC under the terms of a lease. | Section 26-50 therefore did not operate to deny the deductions claimed; the taxpayer was carrying on a business of chartering his boat and as such the outgoings and depreciation were deductible.

Issues decided:
• Was VCK carrying on a business of chartering his boat? • Were his activities no more than a passive investment? • Whether section 26-50 of the ITAA97 operates to deny deductions claimed in relation to a boat. • Was VCK carrying on a business of chartering his boat? • Were his activities no more than a passive investment? • Whether section 26-50 of the ITAA97 operates to deny deductions claimed in relation to a boat. The Tribunal found that VCK's activities in chartering the boat through HCC constituted a business. The Tribunal accepted that VCK, relying on the projections provided by QC, had an expectation of profit. This was notwithstanding that he may have been "naïve in accepting the projections from [QC] who might be seen as having an interest in persuading [him] to become involved in chartering" and "naïve in not factoring in the interest costs on borrowings and depreciation of the boat". Nevertheless, the Tribunal accepted evidence from VCK's accountant that not only would 'there... be a positive cash flow before interest and depreciation', but also that 'a profit should emerge in later years'. That is, the accountant considered that the activity would be profitable, taking into account interest and depreciation as elements of calculating the profitability of the activity. The Tribunal therefore found that 'on balance and on the particular facts of this case ... [VCK] was carrying on a business of chartering his boat'. As noted above, the Tribunal had also found that the arrangement between VCK and QC was correctly characterised as an agency agreement, rather than the provision of a boat to QC under the terms of a lease. Section 26-50 therefore did not operate to deny the deductions claimed; the taxpayer was carrying on a business of chartering his boat and as such the outgoings and depreciation were deductible.

ATO view of decision:
An appeal from a decision of the Administrative Appeal Tribunal lies only for errors of law, not of fact. A conclusion of fact may, however, constitute an error of law if the conclusion is not reasonably open to it on the evidence. The Tribunal's conclusions of fact were open to it on the evidence. Conclusions as to whether a business is being carried on are usually only involve questions of fact. | In relation to whether the taxpayer was engaged in more than the mere passive receipt of income (i.e., a business), the Tribunal had regard to both the character of the contract, as a contract of an agency not a lease, and also to the additional activities undertaken by the taxpayer and his partner, to show that an active business was being carried on by the taxpayer. It accepted, as a fact, the taxpayer's evidence of his profit-making intentions. The Commissioner considers that the decision was, as noted by the Tribunal, one that turned on its own particular facts. It raises no implications for the views expressed in Taxation Ruling TR 2003/4.

Administrative treatment:
Implications on current Public Rulings & Determinations | In light of the findings of the Tribunal in this case, particular attention will be paid in current and future cases to: • The actual activities of the taxpayer in addition to the form of contract, to determine whether the activity is correctly characterised as the carrying on of a business rather than the receipt of passive income; and • Consistent with evidence produced to the Tribunal in this matter, whether there is evidence available that the taxpayer, and (where available) their professional advisers have considered the profitability of the boat chartering activity, including interest and depreciation. | • The actual activities of the taxpayer in addition to the form of contract, to determine whether the activity is correctly characterised as the carrying on of a business rather than the receipt of passive income; and • Consistent with evidence produced to the Tribunal in this matter, whether there is evidence available that the taxpayer, and (where available) their professional advisers have considered the profitability of the boat chartering activity, including interest and depreciation.

Legislative references: Income Tax Assessment Act 1997 8-1 26-50 40-25 Taxation Administration Act 1953 14ZZE
Case references: Ell & Anor v Federal Commissioner of Taxation 2006 ATC 4098 [2006] FCA 71 Ferguson v Federal Commissioner of Taxation (1979) 37 FLR 310 (1979) 9 ATR 873 (1979) 79 ATC 4261 Re Peerless Marine and the Federal Commissioner of Taxation [2006] AATA 765 2006 ATC 2419 (2006) 63 ATR 1303
Subject references: Income Tax carrying on a business of boat chartering is loss or outgoing deductible passive income or business prospect of profit