Private ruling: Vessel expenses
Date of advice: 21 April 2017
Published: September 2017
Ruling period: Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018 | Year ended 30 June 2019 | Year ended 30 June 2020
Date scheme commenced: 1 July 2015

Ruling: Q1: Is the company entitled to an immediate deduction for the cost of the vessel? | A1: No. | Q2: Is the company entitled to a deduction for the decline in value of the vessel in year one, the period before it is first used for the purpose of producing assessable income? | A2: No. | Q3: Is the company entitled to a deduction for the portion of the decline in value of the vessel for the period it is used for the purpose of producing assessable income? | A3: Yes. | Q4: Is the company entitled to a deduction for the portion of the decline in value of the vessel for the time it is used for racing and other non-income producing activities? | A4: No. | Q5: Is the company entitled to a deduction for the costs for commissioning the vessel and initial repairs? | A5: No. | Q6: Is the company entitled to a deduction for the income producing portion of the maintenance and insurance costs of the vessel? | A6: Yes. | Q7: Is the company entitled to a deduction for the club membership? | A7: No.


Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1. | Income Tax Assessment Act 1997 section 25-10. | Income Tax Assessment Act 1997 section 26-45. | Income Tax Assessment Act 1997 section 40-25. | Income Tax Assessment Act 1997 section 40-40. | Income Tax Assessment Act 1997 Division 32.

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income, or a provision of the ITAA 1997 prevents it. A number of significant court decisions have determined that for an expense to be an allowable deduction: ● it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense ( Lunney v. FC of T ; (1958) 100 CLR 478), ● there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income ( Ronpibon Tin NL v. FC of T , (1949) 78 CLR 47), and ● it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income ( Charles Moore Co (WA) Pty Ltd v. FC of T , (1956) 95 CLR 344; FC of T v. Hatchett , 71 ATC 4184). Whether a loss or outgoing is of a capital nature has been set down by the High Court in Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 5 ATD 23; 5 ATD 87; 61 CLR 337. An expense is capital in nature where: ● the nature of the advantage has lasting and enduring benefit, or ● the payment is 'once and for all' for the future use of the asset or advantage rather than being recurrent and ongoing. Vessel purchase cost The cost of the vessel is considered to be a capital expense as it provides a lasting and enduring benefit and the payment is a one-off payment, not a periodic one. As the vessel is a capital asset, the purchase cost is capital in nature and therefore no deduction is allowed under section 8-1 of the ITAA 1997 for the cost of the vessel. However, as outlined below a depreciation deduction is allowed under Division 40 of the ITAA 1997 for the income producing use of the vessel. Depreciation Section 40-25 of the ITAA 1997 allows a deduction for the decline in value (depreciation) of a depreciating asset you hold, to the extent the asset is used for a taxable purpose. A vessel is regarded as a depreciating asset for Division 40 of the ITAA 1997 purposes. The table in section 40-40 of the ITAA 1997 identifies who is the holder of a depreciating asset. Under item 10 of the table, the legal owner of the depreciating asset is the holder. Therefore the company holds the vessel. Taxable purpose is defined in paragraph 40-25(7)(a) of the ITAA 1997 to mean for the purpose of producing assessable income. Depreciation in year one In this case, the vessel was acquired for the purpose of incorporating it into the income producing activities provided to clients. However, as yet, the vessel has not been used for that purpose or any other income producing purpose. The activities described as marketing the vessel are not regarded as an income producing activity or purpose. Similarly, when the vessel is being used for racing, accommodation and/or private purposes, no assessable income is being derived by the company in relation to this use. Accordingly, the vessel has not been used for a taxable purpose and therefore no deduction for its decline in value is allowable under Division 40 of the ITAA 1997 in the 20XX-YY financial year or in year one. Depreciation - taxable and non-taxable purpose When the company starts using the vessel as part of its programs and derives assessable income from the use of the vessel, then a depreciation deduction is allowed. The depreciation deduction is reduced when the vessel is used for a purpose other than a taxable purpose (subsection 40-25(2) of the ITAA 1997). Therefore for the days when the vessel is being used for racing and/or private purposes and not for income earning activities, no depreciation deduction is allowed. That is, where the owners and/or staff of the company are using the vessel for accommodation or races, any allowable depreciation deduction is reduced accordingly. When the company starts to derive assessable income from the use of the vessel, then a portion of the depreciation deduction is an allowable deduction. As the vessel is not used fully for a taxable purpose, then the depreciation deduction needs to be calculated accordingly. The relevant records need to be kept in relation to the use of the vessel. For the days the vessel is used for income producing purposes, this use is regarded as being for a taxable purpose. For the days that the vessel is being used for races, or other non-income producing activities, this use is regarded as not being for a taxable purpose. For the days where the vessel is in the marina or elsewhere and not specifically being used for any purpose, these days are apportioned as per the taxable/non-taxable use. Although the vessel has the company name on while in the marina, this does not mean it is being used for a taxable purpose under Division 40 of the ITAA 1997. For example, if in a year the vessel is used for training/coaching for 50 days and used for races and other non-income producing activities for 70 days and sitting in the marina for 245 days, then the allowable depreciation deduction would be: 50 allowable taxable purpose days = 5 of the annual depreciation amount. 120 days total use 12 The Commissioner has issued Taxation Ruling TR 2016/1 Income tax: effective life of depreciating assets which lists the effective life of vessels as being 15 years. Therefore it is accepted that a vessel is generally depreciated over 15 years unless there is manufacturer's specifications or other documentation to show that a different effective life is more accurate. If the company only intends to keep the vessel for five years, then this does not mean that the effective life for Division 40 of the ITAA 1997 purposes is five years. Refer to the Guide to depreciating assets for further details on how to calculate the allowable depreciation deduction. This booklet can be found on the ATO website ato.gov.au. The depreciation of equipment on the vessel is apportioned similarly according to its taxable and non-taxable use. Marketing costs Advertising and marketing expenses are deductible under section 8-1 of the ITAA 1997 to the extent that the expenses are sufficiently related to the production of assessable income. In this case, the company's business receives market exposure in relation to the costs incurred in having the business name on the vessel. Such signage displayed on the vessel is considered to be in the nature of advertising and is considered to be a marketing/advertising cost for the business. Therefore the cost for the signage of the business and company's name on the vessel is an allowable advertising deduction under section 8-1 of the ITAA 1997. Although the signage may be on the vessel permanently, this does not mean that the vessel itself is being used entirely for income producing purposes. Additionally, when the vessel is being used to promote other businesses, this does not relate to the company's assessable income. That is, the costs of purchasing and maintaining the vessel and/or sails is not considered to be an advertising expense and therefore is not considered to be an allowable marketing deduction. Repair costs Section 25-10 of the ITAA 1997 allows a deduction for the cost of repairs to premises used for income producing purposes, to the extent that the expenditure is not capital in nature. Taxation Ruling TR 97/23 Income tax: deductions for repairs explains the circumstances in which deductions for repairs are allowable. TR 97/23 states that what is a repair is a question of fact and degree in each case having regard to the appearance, form, state and condition of the particular property at the time the expenditure is incurred and to the nature and extent of the work done to the property. TR 97/23 indicates that expenditure for repairs to property is of a capital nature and not deductible where: ● the extent of the work carried out represents a renewal or reconstruction of the entirety, or ● the works result in a greater efficiency of function in the property, therefore representing an 'improvement' rather than 'repair', or ● the work is an initial repair. Repair costs are deductible where they are incurred during the period the property is held for income producing purposes and are attributable either to damage that occurs during your income producing use of the property or to defects that emerge suddenly during that time. The repairs to the vessel are not attributable to damage that occurred during the income producing activities of the vessel. That is, the repairs to the rigging in early 20ZZ, broken shackles and abraded reef lines from the vessel delivery are regarded as initial repairs and capital in nature. Other costs such as the commercial registration, commissioning, installing equipment and upgrading the rigging are also capital in nature. Therefore no deduction is allowable under section 25-10 or section 8-1 of the ITAA 1997. Maintenance and insurance costs Maintenance costs are allowed under section 8-1 of the ITAA 1997 if there is a sufficient connection between the expenses and the production of assessable income. The intended income producing business activity in relation to the vessel is to receive payments from customers who wish to participate in programs which incorporate the use of the vessel. The costs associated with the commissioning and setting up of the vessel for use in the company's income earning activities, that is costs incurred prior to the first use of the vessel by paying clients are capital in nature as they relate to the structure of the business rather than the daily activities from which the business gains its assessable income. Any costs related to establishing that business structure are not an allowable deduction under section 8-1 of the ITAA 1997 as they are of a capital nature. To date, the activities have been preliminary to the carrying on of your intended income producing business activity with the vessel and you are still in the course of setting up the relevant aspects of the business. It is considered that, when the vessel is ready to be incorporated into the income earning activities and the company has accepted its first clients for the relevant packages, the company has commenced its relevant income earning activities. The associated maintenance costs are then an allowable deduction under section 8-1 of the ITAA 1997 as the expenses relate to the income earning activities of the company. However before that time, such expenses are incurred at a point too soon to be regarded as income producing expenses. Similarly, a portion of the insurance of the vessel is an allowable deduction after the commencement of the income producing activities. Entertainment expenses A general prohibition on the deductibility of entertainment expenses is provided by section 32-5 of the ITAA 1997. However, there are exceptions which are set out in Subdivision 32-B of the ITAA 1997. Entertainment means entertainment by way of food, drink or recreation. Recreation includes amusement, sport or similar leisure-time pursuits (sections 32-10 and 995-1 of the ITAA 1997). You are taken to provide entertainment even if business discussions or transactions occur. The expenses of purchasing and using a vessel are generally regarded as expenses "in respect of providing entertainment." Therefore a deduction will be denied by section 32-5 of the ITAA 1997 unless the expenses fall within one of the exceptions. The only exception that is relevant to the company is the one provided under section 32-45 of the ITAA 1997 which relates to promotion and advertising expenses. This section sets out three situations in which these types of entertainment expenses will be deductible. Section 32-5 does not stop you deducting a loss or outgoing for ● providing entertainment if you provide it to an individual under a contract to supply him or her with goods or services in the ordinary course of your business; and you incur the loss or outgoing to promote or advertise to the public your business or its goods or services. ● providing or exhibiting your business's goods or services if you incur the loss or outgoing to promote or advertise those goods or services to the public. ● providing entertainment to promote or advertise to the public a business or its goods or services. But the exception does not apply if some people have a greater opportunity to get the benefits of the entertainment than ordinary members of the public have. Therefore where the use of the vessel relates to your business income producing activities, a deduction is not disallowed under section 32-5 of the ITAA 1997. However where the vessel is being used for racing, none of the exceptions apply and any associated expenses would be disallowed under section 32-5 of the ITAA 1997. Membership fees for recreational club Section 26-45 of the ITAA 1997 provides that you cannot deduct a loss of outgoing to the extent you incur it to obtain or maintain: (a) membership of a recreational club; or (b) rights to enjoy (otherwise than as a member) facilities provided by a recreational club for the use or benefit of its members. As the cost of membership of a recreational club is specifically denied under section 26-45 of the ITAA 1997 no deduction is allowed for the relevant club membership fees.

Relevant facts: The company is providing services across three main domains. | The company purchased a vessel. The company started marketing the vessel soon after. | The company is undergoing commercial registration for the vessel. | The company aims to use the vessel for their income producing activities. | Through association with entity B and the company's agreement to promote each other's business and for the company to promote the vessel brand, discount on the purchase price of the vessel was secured. Entity B agreed to commission the vessel fully up to race specification. | Entity C has provided an investment into the company to get the vessel in the water and to develop this part of the business. The amount is contributed as an interest free loan for the company. After some years, the company will sell the vessel, (or renegotiate) and the company will return the money to Entity C. | In Year one, after purchasing the vessel, the company will optimise the vessel for performance and safety, develop crew competence to minimum industry standards and develop brand awareness. | The cost for commissioning the vessel in year one includes expenses to register and equip the vessel as a registered training vessel and to meet training standards. | There was minor damage to the rigging from excessive pumping in heavy wind. Several aspects of the rigging have been upgraded to align with local conditions. Feedback on these upgrades is being given to the vessel company. | In year's two to five, the company will be able to operate relevant training with up to X clients at a time at a cost. | The cost of the vessel and the company's time are included in the package costs offered to clients. | The vessel will be fully insured at all times. | Ongoing annual costs include marina costs, insurance, equipment upgrades, meeting standards, race registrations and maintenance costs. | Ongoing costs also include berthing fees, slipping the vessel for cleaning every six weeks, minor running repairs such as broken shackles and abraded reef lines from the delivery of the vessel. Costs also include signage and club membership. | The company has major tenders in submission with some entities. | The vessel has been used for accommodation and hosting business meetings. | Some of these activities have led to new business opportunities. | The company's general client base cannot 'book the vessel'. The vessel is not available for charter. It is a registered training vessel. The company needs to protect the brand and company's reputation. | The use of the vessel should increase as the company catches up with the maintenance of skills program, complete all standard operating procedures and begin to run more income producing activities later this year. | In year three, there may be a small amount of personal use if the minimum number of sea days is exceeded to regain and maintain appropriate commercial qualifications. | Every week the company works on promoting the business and the vessel and following up on leads. Two possible engagements will deliver traceable return on investment back to the business. | Currently the company has focused on simple race events that build market presence and provide direct experience for taking clients out. | Only the company and ad hoc crew use the vessel in the race meetings. When the company's own familiarity with the local race circuit and the vessel is sufficiently developed to meet the risk management needs, the company intends to offer mid-week race experience to clients as part of a package. | The race series provide a broad exposure to people as well as opportunity to test the suitability for the race series as a possible avenue for clients.