Private ruling: Non-business boating activities- Division 7A deemed dividend
Date of advice: 28 September 2016
Published: January 2017
Ruling period: 1 July 20XX to 30 June 20YY
Date scheme commenced: 17 April 20XX.

Ruling: Q1: Will Company A's new business activity satisfy the exceptions under paragraph 26-47(3)(d) or subsection 26-47(4) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will subsection 109ZB(3) of the Income Tax Assessment Act 1936 (ITAA 1936) operate to apply the Fringe Benefits Tax Assessment Act 1986 (FBTAA) in preference to Division 7A of the ITAA 1936? | A2: No. | Q3: If the answer to question 2 is yes, how is the taxable value determined for the purpose of the FBTAA 1986? | A3: As the answer to question 2 is no, a ruling will not be given for this question. | Q4: If the answer to question 2 is no, and the private use is subject to Division 7A of the ITAA 1936, will the value of the payment be determined under subsection 109CA(10) of the ITAA 1936? | A4: Yes.

Relevant facts and circumstances: Company A Company A (You) is an Australian company. Individual A is your director and controlling shareholder. Your business activity is the leasing of a commercial property. This activity is facilitated by the Group Manager who is remunerated as an employee by Company X. Managerial oversight is provided by Individual A. You do not remunerate Individual A in the capacity as your employee or director. Company B Company B is an Australian company in the business of designing and manufacturing luxury vessels. You have acquired an interest in Company B's group. Individual A and another individual are directors and shareholders of Company B. Individual A is not remunerated by Company B in the capacity as an employee or director of Company B. The Agreement You are considering entering into a Sub-dealer's Agreement (Agreement) with Company B, where you are appointed non-exclusively to promote for sale certain vessels manufactured by Company B. Under the Agreement, Company B will remunerate you by way of commission income for each vessel of the same type sold by Company B. This new activity pursuant to the Agreement is not related to your existing commercial leasing activity. You will maintain detailed records that will clearly distinguish between this new activity and your existing commercial leasing activity. There is no formal business plan for either of these activities. Your commission income will be sporadic due to the niche market and the high base price of each vessel. It is anticipated that Company B will sell x number of vessels in the first term of the Agreement which equates to a gross commission income of $x amount. It is also anticipated that sales volume will gradually increase as the brand is established and demand increases. Proposed vessel purchase You are considering purchasing a vessel manufactured by Company B for use as a demonstrator for your promotional activities pursuant to the Agreement. Individual A is actively involved in securing future vessel sales under the terms of the Agreement. You anticipate a significant element of private use by Individual A (or their associates) from your intended acquisition. While the vessel is being used at boat shows as a demonstrator and sea trials for customers post boat shows, it will be unavailable for private use. The vessel will not be used for any of the activities described in paragraphs 26-47(3)(a) to (c) of the ITAA 1997, inclusive. The activity of acquiring the vessel is unlikely to directly make a profit due to depreciation and operating costs of the vessel, and its future sale as a used vessel. A new agreement with Company B on similar terms will be entered into upon the expiry of the existing Agreement. The vessel will be retained for use as a demonstrator until it is replaced with an updated model or when the Agreement terminates.

Relevant legislative provisions: Fringe Benefits Tax Assessment Act 1986 Section 45 | Subsection 136(1) | Section 137 | Subsection 148(1) | Income Tax Assessment Act 1936 Subsection 109C(1) | Subsection 109C(2) | Subsection 109C(3) | subsection 109CA | Subsection 109ZB | Subsection 109ZD | Section 318 | Subsection 318(1) | Subsection 960-100(1) | Income Tax Assessment Act 1997 Section 8-1 | Subsection 8-5(1) | Section 12-5 | Section 26-47 | Subsection 26-47(2) | Subsection 26-47(3) | Subsection 26-47(4) | Section 995-1

Reasons for decision: Summary: No. | Detailed Reasoning - Detailed reasoning: Section 8-1 provides a deduction for losses or outgoings to the extent to which they are necessarily incurred in carrying on a business, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. A deduction is also available outside this Division if it is allowed under any other provision of this Act (subsection 8-5(1)). Included in the list of specific deductions under section 12-5 are those provisions dealing with deduction in relation to boats under section 26-47. | Detailed Reasoning - Non-business boating activities: Section 26-47 is about non-business boating activities. The object of this section is to improve the integrity of the taxation system by preventing deductions from boating activities that are not carried on as a business, being offset against other assessable income. The quarantining rule in subsection 26-47(2) applies to you as if so much of the amounts relating to 'using or holding boats' that you could otherwise deduct for an income year as exceeds your assessable income from 'using or holding boats' for that year. Subsection 26-47(3) states that the rule in subsection (2) does not apply to amounts that are attributable to one or more of the following boating activities: a) holding a boat as your trading stock; b) using a boat (or holding it) mainly for letting it on hire in the ordinary course of a business that you carry on; c) using a boat (or holding it) mainly for transporting the public or goods for payment in the ordinary course of a business that you carry on; d) using a boat for a purpose that is essential to the efficient conduct of a business that you carry on. To satisfy one of the exceptions in subsection 26-47(3), it is necessary that the activity amounts to the carrying on of a business. In addition, subsection 26-47(4) provides that the quarantining rule in subsection 26-47(2) does not apply to amounts that are incurred in providing a fringe benefit. There is no intention to hold the acquired vessel as trading stock, or use or hold it for hire or transport purposes in the ordinary course of a business that you carry on. In these circumstances, we only need to consider the exceptions under paragraph 26-47(3)(d) and subsection 26-47(4). | Detailed Reasoning - (1) Exception under paragraph 26-47(3)(d): To satisfy the exception in paragraph 26-47(3)(d), you must demonstrate that the use of your acquired vessel as a demonstrator is essential to the efficient conduct of a business that you carry on. In your ruling application, you contend that the circumstances of your arrangement are similar to those considered by the Court in Peerless Marine Pty Ltd v. FC of T [2006] ATAA 765 ( Peerless Marine ) and different from the facts in Drysdale v. FC of T [2008] AATA 393 ( Drysdale ). | Detailed Reasoning - Essential to the efficient conduct of a business: Whether a boat is essential to the efficient conduct of a business is discussed in Taxation Ruling TR 2003/4 Income tax: boat hire arrangements (TR 2003/4), which is about boat hire arrangements. In explaining the expression 'essential to the efficient conduct of a business', paragraph 106 of TR 2003/4 states that the taxpayer must be able to satisfy the requirement that the boat is more than an aid or advantage to the conduct of the business. In Re Sinclair and FC of T [2000] AATA 1168; 2001 ATC 2092; (2000) 47 ATR 1001 ( Sinclair ), the taxpayer used his boat to demonstrate navigational aids. After examining the evidence provided, Mr KL Beddoe (Senior Member) concluded that the boat was an aid and provided advantages but it was not considered essential to the efficient conduct of the business of selling computer programs. It was considered that the business could have been carried out with equal efficiency based in another location rather than on a boat. In Case 6/2001 AATA 965; 2001 ATC 142 at 148; (2001) 48 ATR 1176 at 1185 ( Case 6/2001 ), the taxpayer owned a catamaran and leased part of the boat as an office to her husband who carried on an accounting business. The taxpayer provided secretarial services from the boat. In disallowing deductions claimed for expenses associated with the maintenance of the boat, and interest and loan expenses, Mr KL Beddoe (Senior Member) said 'convenience and economy may suggest efficiency but they do not suggest essentiality.' In Case R63 84 ATC 457; (1984) 27 CTBR (NS) Case 117 934 ( Case R63 ), the taxpayer carried on a business of an advertising agency and claimed a deduction for costs of a motor cruiser which was used for entertaining clients and potential buyers. Mr P M Roach (Member) upheld the Commissioner's decision to disallow the deduction and indicated that the boat was not essential to the efficient conduct of the business if the business could be conducted efficiently without the use of such a boat. The opposite conclusion was reached in Peerless Marine . In this case, the construction of a boat was held to be essential to the efficient conduct of the taxpayer's boat building business. The evidence established that the sale of luxury vessels was largely dependent on customers being able to see a fully functioning prototype. Mr Hack (Deputy President) stated that the use of the boat to demonstrate the capability of the taxpayer and the nature of the finished product was a use that was essential and not merely desirable, to the efficient conduct of the taxpayer's business of constructing and marketing luxury catamarans [at para 121]. The decisions in the above mentioned cases suggest that the benchmark of what is considered to be 'essential to the efficient conduct of a business' is high. The requirement will not be satisfied if the use of the boat is merely convenient, an aid or economical. The boat must be essential to the efficient conduct of the business (paragraph 110 of TR 2003/4). | Detailed Reasoning - Carrying on a business?: In order to satisfy the exception in paragraph 26-47(3)(d), it is necessary that your new business activity amounts to the carrying on of a business. 'Business' is defined in section 995-1 as including any profession, trade, employment, vocation or calling but does not include occupation as an employee. The meaning of 'business' is comprehensively considered in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11). Although TR 97/11 deals with carrying on a primary production business, the principles discussed in that Ruling apply to any business. Paragraph 26 of TR 97/11 states that the relevant indicators of a business are: ● Does the activity have a significant commercial purpose or character? ● Does the taxpayer have more than a mere intention to engage in the activity ● Is there an intention to make a profit from the activity or a genuine belief that a profit will be made? Will the activity be profitable? ● Is there repetition and regularity in the activity? ● Is the activity of the same kind and carried on in a similar way to that of the ordinary trade? ● Is the activity organised in a businesslike manner? ● What is the size or scale of the activity? ● Is the activity better described as a hobby, recreation or sporting activity? No single indicator is determinative and the determination is based on the large or general impression gained ( Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551). However, where an overall profit motive appears absent and the activity does not look like it will ever produce a profit; it is unlikely that the activity will ever amount to a business. | Detailed Reasoning - Application to your circumstances: Applying the above indicators to your circumstances, the large and general impression gained is that your activity of promoting the sale of vessels pursuant to the terms of the Agreement does not amount to the carrying on of a business. In summary, it is considered that your activity is not carried out in such a scale and in such a way as to show that it will be operated in a commercially viable manner and with an intention of producing a significant commercial gain. Paragraph 48 of TR 97/11 states that it is important that a taxpayer is able to show how the activity can make a profit. Stronger evidence of an intention to make a profit occurs when a taxpayer has conducted research into his/her proposed activity, consulted experts or received advice on the running of the activity and the profitability of it before setting up the business. This was the situation in FC of T v. JR Walker 85 ATC 4179; (1985) 16 ATR 331. However, it is not necessary for the activities to make a profit in every year of income in order to classify the activities as a business. The circumstances of your arrangement are not dissimilar to Drysdale , a case which concerned whether the taxpayer carried on an enterprise for the purposes of section 9-20 of the A New Tax System (GST) Act 1999 . Like you, the taxpayer in Drysdale entered into a sub-dealer's agreement with the vendor whereby the taxpayer would receive commission income for each vessel of the same type sold by the vendor. Like the taxpayer in Drysdale , your new business activity is not the direct sale of Company B's vessels but rather to promote it for sale in accordance with the terms of the Agreement. In Drysdale , the Tribunal found that the taxpayer was not entitled to input tax credits for the acquisition of a vessel and associated acquisitions. This was on the basis that the acquisitions were not made in carrying on an enterprise. The Tribunal was satisfied that the vessel was used either for private recreational purposes or as a hobby and/or was purchased without any reasonable expectation of profit or gain. In making this finding, the Court distinguished the facts with the indicia of a business as evidenced in Hostess Marine Pty Ltd v Commissioner of Taxation [2006] FCA 1651 and Peerless Marine : …The level of investment, involvement, planning, commitment, time, effort, promotion, marketing and enthusiasm all point to Peerless Marine and Hostess Marine undertaking a business. Few of those features, if any, exist in the case of the applicant [at para 26]. The circumstances of your arrangement are distinguished from the facts in Peerless Marine . In that case, the taxpayer constructed a boat over a period of three years, with the intention of it being a demonstrator, so as to secure other orders. The taxpayer had developed a business plan which was subsequently updated and revised, the boat was displayed in an unfinished state at the Sanctuary Cove Boat Show, details of the boat were published on a web site to generate a sale and brokers were appointed to sell a boat based on the prototype. Although the taxpayer's expenses were disproportionate to assessable income, the Court found that the taxpayer did have a reasonable expectation of profit. The Court held that the taxpayer was carrying on the business of a boat builder, even though the taxpayer had built one boat (at a cost of $2.5m) which it sold at the end of the period for $1.25 million. Mr Hack (Deputy President) stated that the taxpayer was carrying on a business from the outset: … Peerless Marine started in business with the intention of constructing White Spirit as a demonstrator, that is keeping her for that purpose once constructed…As costs increased and the time for construction blew out Peerless Marine determined to sell the vessel if possible. But until sold, White Spirit was to be available as a demonstrator. Ultimately the notion of building other boats was abandoned and the efforts of the taxpayer were devoted to the sale of White Spirit in order to recoup some of the investments' [para 100]. It is considered that your intended acquisition and use of the vessel as a demonstrator may be convenient and economical in carrying on a business of promoting the sale of Company B's vessels pursuant to the Agreement, but these attributes are not to be confused with 'essentiality' as indicated by Mr KL Beddoe in Case 6/2001 . The circumstances of your case are similar to Sinclair and Case R63 on the basis that your promotion business would still be carried out efficiently without ownership of a demonstrator vessel. On this basis, the exception in paragraph 26-47(3)(d) does not apply to your circumstances. | Detailed Reasoning - (2) Exception under section 26-47(4): Expenses in respect to the private use of your acquired vessel are not deductible under section 8-1. However, in certain circumstances this private use may have Fringe Benefits Tax (FBT) implications. FBT is separate from income tax and is based on the taxable value of the various fringe benefits you provide, which is calculated under the Fringe Benefits Tax Assessment Act 1986 (FBTAA). To be subject to FBT, a benefit must be a 'fringe benefit' as defined in subsection 136(1) of the FBTAA. Broadly, that definition requires that a benefit is provided to an employee (or associate) by their employer in respect of the employment of the employee. 'Benefit' is defined in the same subsection to be any right, privilege, service or facility. Paragraph 8 of Miscellaneous Taxation Ruling MT 2016 Fringe benefits tax: benefits not taxable unless provided in respect of employment states: To be subject to fringe benefits tax two essential requirements must be satisfied. First, the benefit must be provided to an employee (or associate) and, second, the benefit must be provided in respect of the employment of the employee. | Detailed Reasoning - An 'employee': An 'employee' is defined in subsection 136(1) of the FBTAA to be a 'current employee', a 'future employee' or a 'former employee', with the term 'current employee' defined as a person who receives, or is entitled to receive, salary or wages. 'Salary or wages' is further defined to mean one of the listed payments for which an amount must be withheld (even if an amount is not withheld) under one of the listed provisions of Schedule 1 to the Taxation Administration Act 1953 (TAA). The listed payments include a payment made to either an employee, or a company director. Section 137 of the FBTAA further extends the definition of 'employee' to include persons who receive non-cash remuneration in circumstance where the person would have been treated as an employee if the non-cash remuneration had been received by way of a cash payment. In Miscellaneous Taxation Ruling MT 2019 Fringe benefits tax: shareholder employees of family private companies and directors of corporate trustees (MT 2019), the Commissioner clarified the application of FBT to benefits provided by a private company to shareholders who are also employees. Paragraph 4 of MT 2019 provides the following example: … a director of a company who does not receive any cash remuneration but who does receive non-cash benefits by way of remuneration is treated as an employee for FBT purposes. Conversely, if a non-cash benefit is received by a director solely by reason of his or her shareholding rather than by way of remuneration, the receipt of that benefit would not result in the director being treated as an employee for FBT purposes. | Detailed Reasoning - In respect of employment of employee: In considering whether a benefit is provided to an employee 'in respect of' their employment, subsection 136(1) of the FBTAA defines the phrase 'in respect of' to include by reason of, by virtue of, for or in relation directly or indirectly to, that employment.' 'Employment' is broadly defined subsection 136(1) of the FBTAA to include the holding of an office which would include holding the office of director of a company. In J and G Knowles and Associates Pty Ltd v. FC of T (2000) 96 FCR 402; 2000 ATC 4151; (2000) 44 ATR 22, the full Federal Court considered the expression 'in respect of' in relation to FBT and noted that: Whatever question is to be asked, it must be remembered that what must be established is whether there is a sufficient or material, rather than a, causal connection or relationship between the benefit and the employment. There is, in any event, a danger in placing too much emphasis on causation... [para 26]. The Court also stated that: While the width of the definition of 'fringe benefit'' was designed to capture benefits that, in truth, were other than remuneration, the stated purpose suggests that asking whether the benefit is a product or incident of the employment will be helpful [para 28]. In addition, paragraph 148(1)(a) of the FBTAA states that where a benefit is provided to a person by reason of both his/her employment activity and by virtue of any other matter or thing (eg shareholding), the benefit will be taken to be provided in respect of the person's employment. Despite this provision, paragraph 6 of MT 2019 recognises the situation that such a benefit might still have been provided solely in respect of a shareholding and in which case, the benefit would not be subject to FBT. However, questions as to the application of Division 7A of the ITAA 1936 may apply in circumstances where payments for the benefit of a shareholder of a private company could be deemed to be dividends paid to the shareholder (refer to question 2 of this ruling). Paragraphs 8 to 19 of MT 2019 provide guidance specifically on whether benefits provided are in connection with one's capacity as a shareholder or an employee. There is a general rule in paragraph 19 of MT 2019 which states: … as a general rule, where there are no facts or circumstances which positively indicate that a loan (benefit) to a shareholder/employee is associated with that person's employment and the loan (benefit) is consistent with his or her status as a shareholder, it would ordinarily be inferred that the loan (benefit) was made (provided) by virtue of that shareholding. Although referring to a loan and shareholding, paragraph 19 of MT 2019 can be applied to any benefits that could be provided to a person with multiple roles. On that basis, where the provision of a benefit is not expressly linked to the employment of the recipient, it is necessary to examine all the facts and circumstances of the case to determine the reason why the benefit was provided. Paragraph 9 of MT 2019 lists a number of factors that may be relevant in concluding whether a non-cash benefit was provided as remuneration for services or in the capacity of the shareholder. Those factors include: ● nature of the benefit; ● any cash remuneration paid; ● the nature and extent of any trading activities of the company; ● the extent of any services rendered by the shareholder director; and ● the extent of his or her shareholding. | Detailed Reasoning - Application to your circumstances: Applying the principles in Knowles and our views in MT 2019, we are not satisfied that the provision of the vessel for Individual A's private use is sufficiently or materially connected to Individual A's employment as your director. As there are no facts or circumstances to positively indicate otherwise, the provision of the vessel for Individual A's private use will be treated as being a benefit provided to him by virtue of his shareholding. On this basis, the exception in section 26-47(4) does not apply to your circumstances. | Summary: No. | Detailed Reasoning - Detailed reasoning: Subdivision B of Division 7A of the ITAA 1936 treats certain payments, loans and debt forgiveness made by a private company to a shareholder (or their associate) as a dividend paid by the company. Subsection 109C(1) of the ITAA 1936 states that a private company is taken to pay a dividend to an entity at the end of the private company's year of income if the private company pays an amount to the entity during the year and either: (a) the payment is made when the entity is a shareholder in the private company or an associate of such a shareholder; or (b) a reasonable person would conclude (having regard to all the circumstances) that the payment is made because the entity has been such a shareholder or associate at some time Subdivision D of Division 7A of the ITAA 1936 sets out payments and loans that are not treated as dividends under subsection 109C(1) of the ITAA 1936, none of which apply to your circumstances. 'Entity' is defined in subsection 109ZD of the ITAA 1936 and has the meaning given by subsection 960-100(1). An entity includes an individual. 'Associate' is defined in subsection 109ZD of the ITAA 1936 and has the meaning given by section 318 of the ITAA 1936. An 'associate' of a natural person (other than in the capacity of trustee) includes a relative of the natural person under paragraph 318(1)(a) of the ITAA 1936. Subsection 109C(2) of the ITAA 1936 provides that the amount of the dividend is the amount paid, subject to the private company's distributable surplus calculated under section 109Y of the ITAA 1936 A 'payment' to an entity is defined in subsection 109C(3) of the ITAA 1936 and includes a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity. However, Division 7A of the ITAA 1936 does not apply to a payment made to a shareholder or their associate, in their capacity as an employee (subsection 109ZB(3) of the ITAA 1936). The concept of a payment to an entity for the purposes of Division 7A of the ITAA 1936 was extended with effect from 1 July 2009 to include the provision of an asset for use by the entity under subsection 109CA(1) of the ITAA 1936. Specific exclusions in respect of the provision of assets for use to an entity are listed in subsections 109CA(4) to (9) of the ITAA 1936, none of which apply to your circumstances. | Detailed Reasoning - Application to your circumstances: The provision of the vessel for private use by Individual A (or their associates) is considered to be a payment as defined in subsection 109CA(1) of the ITAA 1936 and will result in a deemed dividend under section 109C of the ITAA 1936. For the reasons discussed in question 1, the provision of the vessel for private use is not a fringe benefit provided in respect of employment for the purpose of the FBTAA. As such, subsection 109ZB(3) of the ITAA 1936 does not operate to apply the FBTAA in preference to Division 7A of the ITAA 1936. The private use of the vessel is subject to Division 7A (refer to question 4 of this ruling). | Summary: Not applicable. | Detailed Reasoning - Detailed reasoning: As the answer to question 2 is no, a ruling will not be given for this question. However, we offer this general advice. The provision of the use of a vessel for recreational purposes by an employer to an employee is a residual benefit as it does not come within one of the specific benefit categories contained within the FBTAA (section 45 of the FBTAA). For valuation purposes, there are two types of residual fringe benefits. These are in-house residual fringe benefits and external residual fringe benefits. Each type of residual fringe benefits has specific valuation rules. The taxable value of a residual fringe benefit is the GST-inclusive value of the residual benefit (determined according to the appropriate valuation rule), less any employee contribution. Our publication, titled ' Fringe benefits tax: a guide for employers ' (NAT 1054) at Chapter 18 explains residual fringe benefit and the calculation of the taxable value of a residual benefit in accordance with the valuation rules. | Summary: The taxable value of the 'payment' is determined under section 109CA(10) of the ITAA 1936. | Detailed Reasoning - Detailed reasoning: Where a payment being the provision of an asset is made after 1 July 2009, the payment is taken to be made when the entity first uses the asset with the permission of the private company (paragraph 109CA(2)(a) of the ITAA 1936) or first has a right to use the asset to the exclusion of the private company (paragraph 109CA(2)(b) of the ITAA 1936). Where the entity's use or right to use continues into a second income year, the provision of the asset for use in the subsequent year is treated as a separate payment made at the start of that income year (Subsection 109CA(3) of the ITAA 1936). The amount of the payment is the arm's length consideration for the provision of the asset less any consideration actually paid (subject to the company's distributable surplus). If the consideration paid equals or exceeds the arm's length amount, the amount of the payment is nil (subsections 109CA(10) and (11) of the ITAA 1936). | Detailed Reasoning - Application to your circumstances: In accordance with paragraph 109CA(2)(a) of the ITAA 1936, the payment occurs when the vessel is first used by Individual A (or their associates) with your permission. In the absence of actual use, the availability of the vessel for Individual A's (or their associates) use is still subject to Division 7A because the vessel is not readily available for your use (paragraph 109CA(2)(b) of the ITAA 1936). The value of the deemed dividend is calculated under subsection 109CA(10) of the ITAA 1936. Subsection 109CA(11) of the ITAA 1936 will not operate to make the value of the payment nil. We are not in a position to provide advice on how to determine an arm's length value. Our publication, titled ' Market valuation for tax purposes' (QC 21245) may provide you with some assistance.