Horse Trading Stock Issues to Avoid

One of the key areas in thoroughbred taxation is accounting for trading stock and ensuring the tax closing value is properly ascertained.

You’d be quite surprised of the enormous difference to the tax position of any racing player where trading stock problems occur.

From my many years of experience of horse industry consulting and educating, I’ve gathered a strong understanding as to where the problems are in this area and this article will share what these are.

Acquiring of trading stock, via purchase or natural increase, is the largest expense any industry player will incur, and I expect this article will assist in not only enhancing your tax position but securing compliance with the ATO.

Trading stock compliance checklist

1.  Exclude GST in the closing stock figure

A GST registered taxpayer is entitled to claim back theGST for horse stock acquired for a “creditable purpose”.

If the closing value of the horse is valued using the “cost”method, be sure to exclude the GST you claimed on the horse, i.e. the horse should be valued at the GST “exclusive” value. This value will equate to the purchase amount claimed as an income tax deduction.

2. Include other “acquisition” costs in the“cost” closing value basis

This figure is not just the GST exclusive cost of the horse.

The term ''cost'' for the purposes of the Tax Act is considered to mean the cost of the stock to the taxpayer including charges in getting it into its existing condition and bringing it to the place where it is ''on hand''.

Case law and ATO pronouncements note that stock “cost” includes items such as freight, insurance and duty. In 12 CTBR Case 19 , the Board stated that a narrow interpretation should not be given to the phrase ''cost price'' and that it did not mean the ''invoice price'' or ''purchase price'', i.e. the price as between buyer and seller.

Agent buying commission is also considered to be a cost of getting the horse “on hand”.

Example

A UK broodmare was acquired at Tattersalls for AUS$100,000.The cost of freighting her to Australia, initial insurance and agent's commission amounted to $30,000.

If this mare is valued at cost, her closing value will be $130,000 ($100,000 plus $30,000), not merely the invoice price of $100,000.

3. Disregarding capital gains tax implications when converting from hobby to business

Often horse industry businesses are started by a person or entity that previously ran their activity on a hobby basis.

If the hobbyist transfers a prior racehorse to a new entity to start the business, say a good filly, they must be mindful that if that horse interest was acquired for greater than $10,000 (including GST), and its market value has increased in excess of this value, capital gains tax is payable on this excess. If the horse has been owned for at least 12 months, a 50% CGT discount applies.

Furthermore, if this filly was owned by an individual, an election can be made to introduce the horse into the new business at either “cost” or “market value”. If using market value, the CGT consequences must be considered.

4. Not including a value for horses acquired via gif

If a horse was acquired and the acquisition involved aCGT event (CGT events are identified in Div 104). In this case, the item's cost is its market value when the taxpayer last acquired it.

It’s especially important to note this as I have seen too many gifted horses that come into a breeders stock listing without a value, on the basis they were acquired as a gift. This is frustrating as a tax deduction goes begging!

5. Using the write-down rules for foals acquired via natural increase

Only eligible horses acquired under a contract can utilise the special write-off rules.

For the purposes of the mare and stallion “write-off” rules a horse is “acquired under a contract” when it is acquired either by sale from an auction house or privately (say via an agent, “on-line” or directly with the seller). Note this does not mean a horse acquired by “gift” or from another party for no consideration. Remember, under contract law you cannot have a “contract” unless one of the parties gives “consideration”.

By definition, the above excludes the acquiring of a horse by natural increase. This view is further supported by taxation ruling TR 2008/2, the current breeding and racing industry ruling.

It appears a horse, per the legislative authorities, has to be “born” to be acquired under a contact. It’s contentious, I agree, but that’s the current ATO position, supported by many other leading tax authorities.

6. Reducing “cost” closing value for a horse that is partially sold

It’s very common for horses, especially yearlings and weanlings, to be partially sold either via auction or privately.

Where this occurs, the cost of the horse in the stock schedule should be reduced to the extent of the percentage sold. This ensures the taxpayer obtains the benefit of a lower cost closing stock value.

For example, if a colt with a tax closing value of $100,000 is 90% sold at auction, its cost closing value should be reduced to $10,000, which represents the 10% held post sale.

7. Not utilising a different closing stock method from year to year

The basic trading stock tax rule is that opening stock should always equal the closing stock of the previous tax year.

However, this doesn’t mean that the taxpayer cannot change the closing stock method from year to year, mainly for tax planning purposes, bearing in mind that the closing stock methods available to horses are:

* Cost

* Market Selling Value

* Replacement Value

* Special Closing Value, i.e. the “write-off”rules.

If you need convincing, the decision in a famous trading stock case, Australasian Jam Co Pty Ltd v FC of T, noted that:

"The section in terms allows the taxpayer considerable freedom of choice. He may adopt one method of valuation for one part of his stock, and another method for another part. And he is not bound to adhere from year to year to any method of valuation for any part of his stock: he may change the basis as to the whole or any part of his stock from year to year at will…”

8. Proper disposal value for a horse that ceases to become trading stock

The Tax Act provides that where an item which is held by a taxpayer as trading stock stops being so held, but continues to be owned by the taxpayer, the taxpayer is treated as having sold it at cost at arm's length and in the ordinary course of business, and as having reacquired it for the same amount.

This has the effect that the amount is included in the taxpayer's assessable income at the time of the change in the status of the item. In addition, appropriate adjustments may be required on the eventual disposal of the item, depending on the nature of the item after the change.

In summary, the horse now becomes a “hobby” horse, and its capital gains tax cost base is the original “cost” of the horse – which is not necessarily its final closing stock value.

9. Nanny horses – tax treatment

Many breeders have these horses, mainly to help calm young or unruly horses.

Under tax law, these horses are termed as “working beasts”, i.e. not held for resale.

Working beasts in a ‘‘business’’ other than a ‘‘primary production business’’ are not plant, instead are treated as trading stock. They do not qualify as plant. For closing stock purposes, best tax practice is to value these at cost.

Other animals that might be considered working beasts include show horses, racing dogs, guard dogs and tracking dogs.

10. Utilising average cost as a basis for valuing closing stock for horses

Excuse the rant, but I have too often seen this and it is very wrong!

Under this method the cost of each item of a particular type which is on hand at the end of an accounting period is taken to be the weighted average of the cost of all such items which were:  

(a) on hand at the beginning of the accounting period; and  

(b) acquired during the course of the accounting period.  

The average cost method is acceptable to the ATO where the actual cost of stock cannot be ascertained. In a large cattle or sheep business, say, it is not feasible to trace the actual cost of each item.

However, for a thoroughbred related business, it is easy to identify each horse and, accordingly, the ATO do not consider this method as being acceptable to horses.

Please do not hesitate to contact the writer if you wish for me to clarify or expand on any of the matters raised in this article.

CONTACT BAUMGARTNERS 

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DISCLAIMER

Any reader intending to apply the information in this article to practical circumstances should independently verify their interpretation and the information’s applicability to their circumstances with an accountant or adviser specialising in this area.