Private ruling: Am I in business - vessel charter
Date of advice: 30 June 2016
Published: August 2016
Ruling period: Year ended 30 June 2017. | Year ended 30 June 2018.
Date scheme commenced: 1 July 2016.

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 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: You have purchased a vessel for a price (Inc. GST). They will be chartered through a charter operator somewhere in Australia commenced recently. You have entered into a charter agreement with a charter operator commencing recently and finishing in several years. You have financed the purchase of the vessel privately and no borrowings were required. In your original 10 year income projection you calculated the depreciation using the straight line method over the first five years and the remaining five years as per the estimate of the market value provided by the manufacturer. The depreciation amount has been reduced to allow for a small amount of private use. It is noted that even though you have provided a 10 year income projection that you are selling the vessel at the end of the charter agreement which is during year 7. You will claim depreciation at 13.33% using the diminishing value method in your income tax return. The amount will be reduced to allow for private use. You will sell the vessel after the charter agreement finishes in several years. 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 have provided a signed copy of the 'vessel management agreement' between you and the charter operator. 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 fixed at a certain 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 use the monthly reports received from the charter operator to support the preparation and lodgement of your Business Activity Statements (BAS). You have used a 10 year income projection to evaluate the viability of the activity. Based on the financial information (the 10 year income projection), the vessel charter activity is profitable from year 1 and will make a significant overall cumulative profit.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | 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: Summary: Section 26-47 of the ITAA 1997 provides rules for deductions from non-business 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 Income tax: boat hire arrangements (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 Income tax: am I carrying on a business or primary production? (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 boat 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 have purchased the vessel and entered into a management agreement with the charter operator. The management agreement confirms the following: • the charter agreement affirms that the charter operator are 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 the charter operator for any costs incurred on your behalf for the vessel charter activities; • you have access to the vessel given appropriate notice and no conflict with any commercial charter; • the charter operator is required to consult with you prior to any expenditure for repairs, maintenance or equipment replacement over the value of a certain amount; • you are responsible for the payment of mooring costs, repairs and insurance; and • the arrangement grants exclusive management of the vessel to the charter operator for the term of the agreement. In light of the above facts the arrangement between the charter operator and yourself 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 boat is carrying on a business will depend on the level of additional services provided to complement the charter of the boat. 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 boat 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 vessel charter 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 • by funding the vessel acquisition using existing funds and thereby not requiring financing, you expect the venture will be both profitable and cash flow positive. You satisfy this criterion and have demonstrated the commercial basis for entering into the vessel hire arrangement; a significant profit is expected to be made over the charter vessel management agreement 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 ten year financial projection and stated your agreement with the charter operator will be for several years. You have projected you would generate a profit from year 1 and this profit increases in every year. You will make a significant profit that is considered to be at a commercial level. Importantly your projected profit does take into account all of the expected income and expenses. This has included any decline in value of the vessel while used in the activity (TR2003/4 paragraphs 17 and 78). In your case interest deductions will not apply because you have bought the vessel outright without the need for any finance, there is no interest expense. In your case, you have shown that there is a reasonable expectation that you are undertaking this activity with the prospect of making a significant commercial or financial gain from it. Based on the projections you have provided the activity is profitable from year 1 and in every year thereafter, the activity makes a significant overall profit. This indicator is passed. | 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 minimal 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 regular meetings with the charter operator to review the activity and discuss future growth; • you will keep records to assist with BAS and tax return preparation, and • you have signed an agency agreement 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 refer paragraph 23 TR 2003/4. Conclusion When applying your facts to each of the business indicators it is considered that, as a whole, your vessel hire activity will meet the requirements and the overall impression would be that you are 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 the charter operation period, the vessel hire activity will make a significant overall commercial profit. Consequently, the activity does have significant commercial purpose and a prospect of profit. Because you are considered to be carrying on a business, sub-section 26-47(3) of the ITAA 1997 will apply so that sub-section 26-47(2) of the ITAA 1997 does not stop you from deducting a loss or outgoing for your activity. The expenses associated with conducting the activity will be deductible under section 8-1 of the ITAA 1997 provided they are not of a capital or private nature. Note This private ruling is binding on the facts provided. The main reason this activity as described is qualifying as a business is in regard to its profitability. You should review the actual figures at the end of 30 June 2017, should the vessel charter activity make a loss as opposed to the projected profit in year 1 you should at that time review all of the income and expense projections. If the figures have varied significantly from the financial information that you provided with this private ruling application, this private ruling will have no application. If this is the situation you could apply for a new private ruling based 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 10 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 2018 only. You may request a further ruling after this time if you require further binding advice.