Private ruling: Charter boat - application of section 26-47 of the ITAA 1997
Published: September 2013
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015
Date scheme commenced: 1 July 2010

Ruling: Q1: Does section 26-47 of the Income Tax Assessment Act 1997 (ITAA 1997) deny you a deduction for outgoings in relation to your charter boat operation? | A1: No.


Relevant legislative provisions: Income Tax Assessment Act 1997 Section 26-47

Reasons for decision: Summary: You are considered to be carrying on a business as a charter operator using the vessel. The limitations placed on the allowable deductions for a year in subsection 26-47(2) of the ITAA 1997 will not apply when you are considered to be carrying on a business. The exception in subsection 26-47(3) of the ITAA 1997 will apply. | Detailed Reasoning - Detailed reasoning: Is the company carrying on a business as a charter operator and therefore will not be limited in claiming deductions by section 26-47 of the ITAA 1997? Section 26-47 Non-business boating activities - limits the amount of deductions that can be claimed in relation to an entity that uses or holds a boat in an income year. The excess deductions are quarantined. There are exceptions to this rule and these are set out in subsection 26-47(3). This is where the boat is used for business use. One of the business use categories is where the boat is for mainly letting it on hire in the ordinary course of a business that you carry on. We have to apply the normal business indicators to the company to determine if it is carrying on a business as a charter operator. The activity is one of offering one vessel for charter and offering the services associated with the operation of the vessel including a crew. Taxation Ruling TR 97/11 sets out a number of indicators that the courts have held to be relevant in determining if a business is being carried on: · whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators · whether the taxpayer has more than just an intention to engage in business · whether the taxpayer has 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 businesslike manner such that it is directed at making a profit · the size, scale and permanency of the activity · whether the activity is better described as a hobby, a form of recreation or a sporting activity. From the information provided and the list of expenses in the financial statements, it can be seen that you are carrying out all the activities that would be expected in this type of business. The key issue in this case is whether you have a purpose of profit and whether there is a prospect of profit from this activity. You have made substantial losses in the 20XX and 20YY financial years. You have claimed that this is due to the downturn in the industry after the global financial crisis. You have provided information that the industry standard would be to expect to hire the vessel out for X days per financial year. Applying this number of days to your expected daily rate for hire gives an amount that you believe could potentially produce a profit. Below is an extract from TR 97/11 that covers the Commissioner's view on this indicator 'prospect of profit'. We need to consider this in detail and apply it to your facts. | Detailed Reasoning - Prospect of profit: 47. We consider this to be a very important indicator. In Hope at CLR 8-9; ATC 4390; ATR 236, Mason J indicated that the carrying on of a business is usually such that the activities are: '... engaged in for the purpose of profit on a continuous and repetitive basis.' In Smith v. Anderson (1880) 15 Ch D 247 at 258, Jessell MR said that: '... anything which occupies the time and attention and labour of a man for the purpose of profit is business.' In Case H11 76 ATC 59 at 61; 20 CTBR (NS) Case 65 at 603, the Chairman of Board of Review No 1 said: 'In determining whether a business is being carried on it is, in my view, proper to consider, as one of the elements, whether the activities under consideration could ever result in a profit ...' 48. We believe it is important that the taxpayer is able to show how the activity can make a profit. Stronger evidence of an intention to make a profit occurs when the 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 primary production activities to make a profit in every year of income in order to classify the activities as a business of primary production. Thus, a taxpayer may be carrying on a business of primary production even though he/she is making a small profit or a loss in any given year of income. 49. The situation may arise where a taxpayer is carrying on a business and has an intention to make a profit but the objective evidence is such that a profit is unlikely to be made in the short term. Bowen CJ and Franki J in Ferguson at ATC 4264; ATR 876 stated that '... an immediate purpose of profit-making in a particular income year does not appear to be essential ...'. Thus, where short term losses are expected it may be that a business is nevertheless being carried on: see Tweddle v. FC of T (1942) 7 ATD 186; (1942) 2 AITR 360. 50. Where an activity is carried on and the objective evidence is that it is unlikely a profit will ever be made, this fact in itself does not necessarily mean that a business is not being carried on, if the taxpayer believes that the activity will become profitable. As Walsh J said in Thomas at ATC 4100; ATR 171: 'It is not in doubt that he made mistakes. But many persons carry on a business for the competent conduct of which they have not previously acquired much knowledge or experience.' See also Tweddle's case at ATD 190; AITR 364. Taxpayers need to show that the other indicators of business are present in sufficient strength to outweigh any objective view that the activity may be inherently unprofitable. A number of Board of Review and Administrative Appeals Tribunal decisions show that a taxpayer in this situation bears a heavy onus: see Case M50 80 ATC 349; 24 CTBR (NS) Case 24 ; Case K9 78 ATC 98; 22 CTBR (NS) Case 29 ; Case L16 79 ATC 84; 23 CTBR (NS) Case 20 and Case L22 79 ATC 106; 23 CTBR (NS) Case 25 . Even though you have suffered losses in the early years, you have provided figures that show a potential to make a profit, where what you call a commercial lease rate is charged and the vessel is hired out for the full X days. You have stated that the activity has had a number of set backs that have affected your viability. You appear to meet all of the other business indicators convincingly and have persisted with the belief you can make a profit. You have stated that there is no private use of the vessel. In Tweedle v F.C. of T (1942) ATD 186, the Court remarked: It is not suggested that it is the function of income tax Acts or of those who administer them to dictate to taxpayers in what business they shall engage or how to run their business profitably or economically. The Act must operate upon the result of a taxpayer's activities as it finds them. If a taxpayer is in fact engaged in two businesses, one profitable and the other showing a loss, the Commissioner is not entitled to say he must close down the unprofitable business and cut his losses even if it might be better in his own interests and although it certainly would be better in the interests of the Commissioner if he did so: Toohey's Ltd v C of T (NSW) (1992) 22 SR (NSW) 432 at pp 440,441. If the appellant succeeds and makes a profit it will plainly be taxable, and it is difficult to see how his activities could at the moment of time be transmogrified from an indulgence in a somewhat unusual form of recreation into the carrying on of a business. I am satisfied that the appellant is seeking to establish himself … as a recognised breeder of high class stud stock, and that while he is prepared to make losses to achieve this ambition he has a genuine belief that he will be able eventually to make the business pay. The overall impression is that you entered into the activity with the intention of making a profit. You have persisted with the activity, even though there have been setbacks, in the belief that you can eventually make a profit. Even though you have been unable to make a profit, you could still be considered to meet this indicator in terms of the discussions above, believing that there is the potential to make a profit. The unprofitability to date does not appear to be enough to make a determination that you were not carrying on a business. Note: The status of whether you are carrying on a business is something that should be reviewed on a yearly basis. The making of heavy losses over a prolonged period may objectively cast doubt on whether a business is being carried on. It may also suggest that the activity is carried on for some other purpose and that the deductions allowed should be limited to the income derived each year. You should review your status each year before lodging your income tax return.

Relevant facts: You operate a charter activity. | The company acquired the rights to exclusively charter the vessel. | The launch of the vessel occurred after the commencement of the Global Financial Crises, an obviously very different economic environment to that in which the owner had spent a considerable sum in readying the vessel for operation. | The owner did consider selling the vessel due to the onset of the global financial crises, the likely selling value of the yacht would have been less than half of what had been expended. | With the onset of the global financial crises, the charter boat market for luxury vessels has declined significantly and competition between existing players has increased. The high Australian dollar has also resulted in reducing the interest from the international clientele market which was one of the key segments for the private charter industry. | The business has done all it can to minimise costs in the meantime whilst maintaining exposure. | Investigations have also been made into whether repositioning the vessel would provide a better return (which was also deemed unviable). | There has been no private use of the vessel. An associated company has used the vessel to entertain their clients, but has paid a fee for this use | The sole purpose of the company since inception has been to derive income from the charter boat market and significant effort has been made to enable this to occur. | It was expected that X charter days out of each year was a realistic objective and is in line with industry standards. Based on the figures that you have developed and updated with time and use of the vessel, you had the expectation that a profit could be made with full use. | You have provided a copy of the lease agreement and stated that the vessel is leased at a commercial rate. | You have provided copies of financial statements for past years of operation.