Private ruling: Am I in business - vessel charter
Date of advice: 28 June 2016
Published: August 2016
Ruling period: Year ended 30 June 20AA. | Year ending 30 June 20BB.
Date scheme commenced: 1 July 20CC.

Ruling: Q1: Is the vessel charter activity considered to be carrying on a business for the purpose of section 26-47 of the Income Tax Assessment Act 1997 ? | A1: No.

Relevant facts and circumstances: You will purchase a second hand vessel which is currently chartered through a charter operator. You will not make the suggested upgrades to the vessel made by the charter operator. You will sign a charter management agreement for X years with a further X year option. You will fund the purchase of the vessel by initially utilising and existing loan, then refinancing part of the loan in later years to assist with cash flow. You have used the straight line method to calculate the depreciation for your Z year income projection; however you will claim depreciation at 13.33% using the diminishing value method in your income tax return. You will sell the vessel at the end of the charter operation as it will be at the end of its charter life. You will include any assessable balancing adjustment for the disposal of the vessel at the end of the charter agreement in your income tax return. You estimate the vessel will be valued at over $200,000 after the vessel is sold and you will use these funds to pay out the remaining loans. You have provided a copy of the standard management agreement template. The charter agreement states that the charter operator is responsible for the day to day running of the charter activity while acting as your agent. The charter agreement also shows that all the income belongs to you and that you pay a management fee to the charter operator in return for the services provided under the agreement. This fee is a fixed percent of the charter income. You will reimburse the charter operator for any expenses incurred on your behalf. You are responsible for all insurance, repairs and mooring costs. You will be involved with the charter operation on a regular basis, this will include regular discussions with the charter operator to monitor performance and future plans. The charter operator will provide you with monthly reports which itemise all income and expenditure as well as the details of the days that the vessel was chartered. You will maintain a cashbook to record your personal expenses and will use the monthly reports received from the charter operator to support the preparation and lodgement of Business Activity Statements (BAS). You have provided the charter history of the vessel and you have used this information to evaluate the viability of the activity and to undertake financial projections over a ten year commercial time frame. You projected the activity would generate a profit in Year X. It is noted that the projected profit in year X is less than $2000 and it is not until year Y that there is a projected overall cumulative profit made from the activity.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 26-47 | Income Tax Assessment Act 1997 Section 26-47(2) | Income Tax Assessment Act 1997 Section 26-47(3)

Reasons for decision: Detailed Reasoning - Detailed reasoning: Section 26-47 of the Income Tax Assessment Act 1997 (ITAA 1997) provides rules for deductions from non-business boating activities. In most cases, costs of vessel charter activities can only be used to reduce assessable income received from vessel charter activities. They cannot reduce assessable income from other sources. The exception to this is when you use or hold a vessel mainly for chartering it on hire in the ordinary course of a business you carry on. Taxation Ruling TR 2003/4 discusses the Commissioner's view on vessel hire arrangements and the application of the above provision. Further guidance for determining if you are carrying on a business can be found in Taxation Ruling TR 97/11. Using a vessel mainly for chartering it on hire in the ordinary course of a business that you are carrying on TR 2003/4 states you may carry on a business of vessel charter and employ the services of a managing agent to aid this task. Where the vessel owner enters into a contract with a charter operator, two issues need to be considered: • is the vessel being used in the owner's business, or does the agreement represent the lease of the vessel to the charter operator's business, and • in chartering the vessel to customers, either by you directly, or through the charter operator, does the activity amount to more than the passive receipt of income from vessel rental? The extent to which you participate in, and the effective control you have over, the operation of the charter activity, as well as the extent to which you share in the risks and rewards of it, will assist in determining the character of the arrangement. The terms and conditions in the agreement or contract with the charter operator will present the facts that determine the answer. In your case you will purchase the vessel and enter into a management agreement. Based on the standard template provided, the following facts indicate that the contract is a management agreement: • the charter operator is acting as your agent and their activities regarding your vessel will be undertaken on your behalf, • you are entitled to all hiring fees earned in relation to the charter of your vessel, • you are required to pay management fees in return for the services provided under the agreement, • you are required to reimburse any costs incurred on your behalf of the vessel charter activities, • you have access to the vessel given appropriate notice and no conflict with any commercial charter, • are required to consult with you prior to any expenditure for repairs, maintenance or equipment replacement over a certain value, • you are responsible for the payment of mooring costs, repairs and insurance, and • the arrangement grants exclusive management of the vessel to for the term of the agreement. In light of the above facts the arrangement will have the characteristics of a management agreement as opposed to the characteristics of a rental or lease arrangement. Carrying on a business or passive income Where the arrangement between you and the charter operator does amount to a management agreement, the question still arises as to whether this activity amounts to the carrying on of a business, or instead involves only the passive receipt of income from chartering the vessel to the vessel hirer. Paragraphs 55 and 56 of TR 2003/4 explains that whether the charter of a vessel is carrying on a business will depend on the level of additional services provided to complement the charter of the vessel. These services may be provided directly by you, or through the charter operator on your behalf. If this is the case, the extent of those services will be relevant in considering whether the activity amounts to carrying on a business or passive receipt of income. TR 2003/4 provides examples of complementary services as: • customer inquiry and booking services, • issuing of accounts and processing of deposits and payments, • reception area for charter guests, • pre-charter briefing including training and assistance in the correct operation of the vessel and safety equipment, • access to jetties with electric power, hot and cold water, waste disposal facilities and fuelling facilities, and • support infrastructure for the hirer while the vessel is on charter, including a radio and rescue service. As part of the activity, additional services will be provided to the hirers of your vessel. These services will be provided through the charter operator, as your agent, or yourself and include: • inquiry and booking services, • pre-charter training and assistance in the correct operation of the vessel and safety equipment, • support infrastructure for the hirers while the vessel is on charter, • waste disposal and fuelling facilities, • cleaning of the vessel prior to charter, and • arrangement of a qualified skipper and crew if required. The extent of the services offered in addition to the hire of the vessel is indicative of carrying on a business rather than the passive receipt of income. Additional indicators of carrying on a business Throughout TR 2003/4 several indicators of carrying on a business are discussed, which are also found in TR 97/11 with regards to primary production. The principles discussed in TR 97/11 apply equally to determining whether other forms of activity amount to carrying on a business. TR 97/11 lists the relevant indicators as: • whether the activity has a significant commercial purpose or character, • whether you have more than just an intention to engage in business, • whether you have a purpose of profit as well as a prospect of profit from the activity, • whether there is repetition and regularity of the activity, • whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business, • whether the activity is planned, organised and carried on in a business like manner such that it is directed at making a profit, • the size, scale and permanency of the activity, and • whether the activity is better described as a hobby, a form of recreation or a sporting activity. It is then necessary to apply the criteria as outlined in TR 97/11 to your circumstances to determine if your activities amount to a business being carried on. | Detailed Reasoning - Significant commercial purpose or character: This indicator generally covers aspects of all the other indicators and broadly requires that a taxpayer be able to show that the activity is carried on for commercial reasons and in a commercially viable manner. A taxpayer needs to be able to show that the interaction between the size and scale of the activity, the repetition and regularity and the intention and prospect of profit are sufficient to conclude that the activity has a significant commercial purpose. In your case you: • have undertaken preliminary research into charter operations in the region including evaluation of vessels, charter operators and trends in tourism over time, • will engage a charter operator with considerable experience under a charter agreement for the day to day operation, • sought advice from a number of sources within the industry and accounting experts, and • researched various financing options that will help maintain a healthy cash flow throughout the life of the operation. Whilst you are able to meet some of the indicators, the updated income projections of the activity show that in regard to profit, it is borderline as to whether you demonstrate the commercial basis for entering into the vessel hire arrangement when a significant profit is not expected to be made over the period. | Detailed Reasoning - Intention to engage in business: Carrying on a business requires activities, not simply the idea, or desire to engage in a business. The extent of activity determines whether a business is being carried on. In your case you have more than an intention to engage in business. | Detailed Reasoning - Prospect of profit: We consider this to be a very important indicator. It is important that you are able to show how the activity can make a profit. This indicator reflects three elements: • a genuine belief that profit is attainable, • the intention to produce profits from the vessel charter activities, and • that the activities are capable of producing a profit. It is not necessary for the activities to make a profit in every year of income to classify the activities as a business, and as such, you may be carrying on a business even though you are making a small profit or a loss in any given year of income. However, where the objective evidence at the time of entering the vessel charter activities shows a significant profit (over the life of operations) is unlikely, this would strongly indicate that entering into the activities was not motivated by profit, and this indicator would not be satisfied (TR 2003/4 paragraph 75). You have provided a financial projection and your agreement will be for X years with a further X year option. You have projected you would generate a profit in Year X, however a profit amount of less than $2,000 is very low and not at a commercial level. While it is not necessary that a profit be made every year, the expectation of making a commercially realistic profit should be achieved. To establish whether a bona fide intention to make a profit, it is necessary to take into account all of the expected income and expenses. This will include any interest incurred and any decline in value of the vessel while used in the activity (TR2003/4 paragraphs 17 and 78). In your case, you have not shown there is a reasonable expectation that you are undertaking this activity with the prospect of making a significant commercial of financial gain from it. In regard to the profit you have said that the vessel will be sold after Z years so this activity does not have an indefinite period for it to become profitable (TR2003/4 paragraph 79). TR2003/4 paragraph 82 states that when there is a genuine belief that the total income of the vessel hire activity will significantly exceed the total expenses over the anticipated life of the activity that losses in the early years are tolerated. Based on your projections the projected total income does not significantly exceed the total expenses. In your case, based on the projections it does not begin to achieve an overall profit until year Y, this indicator is failed. | Detailed Reasoning - Activities of the kind carried on in a similar manner: A vessel hire activity is more likely to be a business where it is conducted using business methods and procedures similar to those ordinarily used in vessel hire activities said to be businesses. TR 97/11 and TR 2003/4 state that the following factors may indicate that a vessel hire activity constitutes a business: • the volume of sales, • the types of customers - wholesalers, retailers, the public at large, or friends and relatives, • the manner in which the marketing takes place, • the sort of expenses incurred by you, • the amount invested in capital items, • you own the appropriate licences and permits required, • you and/or the operator have the appropriate experience, • you and/or the operator have appropriate indemnity cover, and • use of the vessel is not primarily directed at private use. In applying the facts of your case to the above factors: • the volume of sales you project is comparable to those of other operators, • your customers are the general public as opposed to mainly friends and family, • you will market your vessel for charter through your agent as is common practice in the industry, • you will have the appropriate licences and permits required, • you will have appropriate insurance, and • your private use of the vessel is only 14 days per year. These factors indicate a business activity is being carried on. | Detailed Reasoning - Organised, systematic and business-like manner: Paragraph 86 to 88 of TR 2003/4 clarifies that vessel hire activities are more likely to amount to carrying on of a business where they are carried out in a systematic and organised manner. Factors which indicate this include: • operations are not haphazard and are carried on in a consistent manner, • profitable activities are pursued and unprofitable activities are discontinued, • vessel charter transactions and financial arrangements are managed separately and distinctly from personal finances, • appropriate business records are kept, and • personal use of the vessel does not take priority over use of the vessel for charter purposes. These factors may be carried out by you or your manager on your behalf. A taxpayer may still carry on a business despite having poor organisational skills. In your case: • you have conducted research into the industry, area of operation, charter operators and financial implications of the activity, • you will receive monthly reporting from the charter operator, • you will hold quarterly meetings to review the activity and discuss future growth, • you will keep records to assist with BAS and tax return preparation, and • an agency agreement will be signed with the charter operator. This represents a moderate level of organisation and a business-like approach. | Detailed Reasoning - Repetition, regularity, size and scale: Vessel hire activities are more likely to amount to carrying on a business where they are regular and ongoing. Additionally, the larger the scale the more business-like. However, it is possible for you to carry on a business on a small scale. In your case, your vessel will be available for hire for the full year other than the private use days and when the vessel is unavailable due to repairs. Your activities are considered to be carried on at a smaller scale. This indicator is not determinative on whether or not a business is being carried on (refer paragraph 23 TR 2003/4). Conclusion When applying your facts to each of the other factors it is considered that, as a whole, your vessel hire activity will not meet the requirements and the overall impression would be that you are not carrying on a business. TR 2003/4 states that in order to demonstrate that a vessel charter activity amounts to the carrying on of a business, a taxpayer needs to show that it is carried on with the intention of making a significant commercial profit. The income and expense projections that you have supplied demonstrate that over Z years of operation, the vessel hire activity will only begin to make an overall profit by year Y and the overall profit by year Z is not considered a significant commercial profit. Consequently, the activity does not have significant commercial purpose or a prospect of profit. As such, the vessel charter activities will not constitute a business for the purposes of section 26-47 of the ITAA 1997. This means the income received will be assessable income but deductions in excess of the boating income are quarantined and carried forward to be deducted against assessable income from boating activities in later years. Note This private ruling is binding on the facts provided. The main reason this activity, as described, is failing as a business is the lack of profitability and overall return on the amount invested. You should review the actual figures at the end of 30 June 20AA and at that time if the income and expenses projections have varied significantly you could apply for a new private ruling on the different facts if you are unsure of how the ATO view would apply to your circumstances. Limit to future years rulings You had requested the Commissioner to provide you with a private ruling for a period of Z years into the future. Due to the possibility of changes in your circumstances (the fact that your income projections and expenses, particularly the income may vary significantly), the possibility of change to the law, and the risk that a subsequently issued public ruling might override a private ruling the Commissioner has issued, the Commissioner has provided a private ruling until the 30 June 20BB only. You may request a further ruling after this time if you require further binding advice.