Australian Tax Office Racing Audit Update
By Paul Carrazzo CPA, www.carrazzo.com.au


NOW into my 13th year as the feature tax writer for The Australian Bloodhorse Review, it has only been twice in that whole period that I haven’t submitted a quarterly article. I honestly can’t remember how it happened the first time, but I sure know why I didn’t submit an article for the previous January 2006 issue - the ATO Racing Industry Audit.
The audit, as many of you well know, has really escalated in the past six months, primarily due to owners and breeders belatedly becoming the focus of this ATO audit. Of course, they were always going to be, it’s just that the ATO have taken their time sorting out jockeys, trainers, vets and
farriers (with more still to do).
As this magazine, and our accounting firm, primarily focuses on breeders and owners, I have wasted no time in going the “extra yard” to receive on-going updates from the ATO “National Horse Breeding and Racing Team”, based in Newcastle.
As a result of their findings in this audit, this ATO team has been periodically conducting free public “Horse racing and breeding” information seminars, the latest series commencing in New South Wales in November 2005.
Acknowledging the seriousness of this audit, I made sure I was at Randwick racetrack on November 28, 2005 to attend the last of the NSW seminars - I had little option as the Victorian seminars aren’t due to commence until March 2006!
So, missing the January article was all about “holding back” this crucial audit update article until I had attended the late November ATO seminar. I have no regrets either, as what came out of this seminar was most interesting and more than I had previously received from the ATO via everyday client matters.
As I did in my last article re the GST “Horse Industry” fact sheet, I will focus on those areas that the ATO either highlighted at the seminar or has emphasised to me at recent client-related meetings.

ATO racing audit update - the story so far
IT IS NO great surprise that the ATO has really homed in on whether industry players are conducting a “business” for income tax purposes or an “enterprise” for GST purposes, just as they did when producing the abovenoted GST fact sheet.
Per latest ATO feedback, they advise that of the field audits they have conducted, they have adjusted approximately 65% of the horse industry cases they have reviewed and that 3000 letters and questionnaires will have been sent to racehorse owners up until February 2006.
Furthermore, at least 500 audits are scheduled from the end of July 2005 to August 2006.
I’m sure I have your attention by now and I comment below on the areas the ATO has been emphasising during this audit process:

1. Horse racing only activities under scrutiny as a “business”
The seminar spent the most amount of time on the issue of whether “horse-racing” activities (as distinct from “horse-breeding” activities) are a “business” for tax purposes.
This was done intentionally by the ATO as it is a subjective area and a significant amount of its audits have resulted in racehorse owners having their prior GST and income tax return lodgments amended from “business”/“enterprise” to “hobby” status.
In essence, these adjustments have meant that owners are:
- having their GST registration immediately cancelled;
- refunding all GST previously claimed; and
- having previous tax returns adjusted for horse racing tax losses previously claimed.
NB. If an owner races horses that they bred and their taxation breeding business is also legitimate “enterprise” for GST purposes, generally GST credits and tax deductions can be claimed for such racehorses. This typically happens if a “home bred” filly with broodmare potential is retained and raced by the breeder.

Why is the ATO attacking horse racing?
PUT simply, the ATO believes horse racing is a “game of chance” and that most owners do not have a “realistic expectation” of profit. In essence, they are currently unlikely to accept horse racing activities as a GST “enterprise” or taxation “business”.
This policy applies even though the owner may have invested significant money, has a history of success, used all the right vets, has a successful trainer, keeps proper records, has prepared a credible business plan and uses many consultants within the activity. Scary stuff for our industry, wouldn’t you say? This is not to say that horse racing activities can never be accepted by the ATO as a business, however they emphasise that an owner “. . . bears heavy onus if inherently unprofitable and must show other indicators are present in sufficient strength to outweigh this factor.”
The ATO hold their very “anti-racing” position based on their statistics that show that horse racing activities only have a “less than 5% chance” of being profitable. I have made key players in the industry well aware of this current ATO position and at the moment they are formulating their own statistics that will be aimed at rebutting this long-held ATO statistic - especially relevant to “higher
end” buyers who are consistently buying from the major yearling sales venues.

2. Bloodstock Taxation Schedules are required
A SERIOUS business should maintain proper records. This is a key “business” factor in the eyes
of the ATO. In the past few months many of my horse breeding and racing clients have been asked to produce “Bloodstock Schedules” as part of mandatory ATO reviews of their GST “enterprise” status.
Thankfully, we have always been able to produce these schedules as it is one of the standard services we provide when preparing horse industry tax returns and accounts. In many special projects we have undertaken as part of the audit, we have also put them together for “one-off” clients who do not have one.
Not surprisingly, the ATO seminar made a major reference to the need for horse breeders and owners to have bloodstock schedules. The presenters were quite surprised by how many people were unable to produce them, especially people claiming to be “serious” breeders.
I must agree with the ATO on this point - how can a serious horse breeder not know the profile and tax value of their bloodstock if they want to seriously monitor if a taxation profit or loss is being
made on the sale of their horses?
Broodmares, foals and yearlings etc are “trading stock” of a breeding business and a taxpayer
must always have a sound basis for arriving at “closing stock” values in their tax returns. To not
have one is not a good look if you want to prove the existence of a breeding and/or racing business with the ATO.
For your future reference, I will construct a sample “Bloodstock Taxation Schedule” below.

Example - Bloodstock Taxation Schedule
Anthony the Tuna fisherman had a bit of luck with his “hobby” racehorses over the Spring Carnival and decided it was time to dabble in his first love - horse breeding.
Firstly, Anthony attends the William Inglis and Magic Millions mare sales in April and June 2006
and ends up buying the following horses:
• Port Lincoln Princess (1994), cost $66,000 (inc GST), acquired in foal on April 15, 2006.
• Under the “write-off” rules, this mare can be written-down at 33.33% p.a (max write-off % allowed) as she was 11 yearsold at time of purchase. This “reduction amount” is pro-rated for the time
owned in the tax year, thus the “reduction amount” is $4,155 in the 2005/06 year.
• Tugela Girl (1992), cost $44,000 (inc GST), acquired barren on April 16, 2006.
• Under the “write-off” rules, this mare can be written-down to $1 at year end as she was 12 years
or greater at time of purchase.
• Lee’s Lady (1998), cost $110,000 (inc GST), acquired in foal on April 16, 2006.
• Under the “write-off” rules, this mare can be written-down at 20% p.a. as she was seven years-old at time of purchase. This “reduction amount” is pro-rated for the time owned in the tax year, thus
the “reduction amount” is $4,100 in the 2005/06 year.
• Boss Diva (2000), cost $440,000 (inc GST), acquired barren, but with a foal at foot by
“Redoute’s Choice”. Acquired on June 28, 2006.
• Under the “write-off” rules, this mare can be written-down at 14.28% p.a (appx) as she was five years-old at time of purchase.
This “reduction amount” is pro-rated for the time owned in the tax year, thus the “reduction amount” is $234 in the 2005/06 year.
• As this mare was acquired with a “foal at foot”, an accredited valuer has to allocate the cost of
the “package” of horses. He values the “Redoute’s Choice” foal at $220,000 (inc GST) and the
mare at the same value. This colt foal will be sold as a yearling and is valued at “cost”.
• Makybe Millions (1999), cost $150,000 (no GST), acquired in foal on 28 June 2006.
• Under the “write-off” rules, this mare can be written-down at 16.66% p.a (appx) as she was six years-old at time of purchase. This “reduction amount” is pro-rated for the time owned in the tax
year, thus the “reduction amount” is $205 in the 2005/06 year.
Tony, looking to diversify his breeding interests, is also advised by his bloodstock agent to buy a share in the recently retired “Golden Slipper” winning stallion prospect, “Giant’s Highway” (2003).
The share was acquired on May 15, 2006 for $220,000 (inc GST). After taking account of the
above acquisitions and associated details, Anthony’s breeding Bloodstock Taxation Schedule will look like the table below at June 30, 2006:
Assumptions
1. It is assumed that Tony is registered for GST and can claim back all of the GST for his
purchases.
2. The closing stock value of all horses is calculated using the special closing value rules (ie “write-off”). Cost or market selling value are also options.
3. “Giant’s Highway” was only two years-old at June 30, 2006, thus the “write-off” rules are not available. This stallion share is thus valued at “cost”.
NB. Refer to my web site at www.carrazzo.com.au for my September 2001
“Stock write-downs revisited” article for more discussion on these rules.

3. GST returns - extra verification
THOUGH not mentioned at the seminar, the ATO has certainly gone into “overdrive” when it comes to the verification of GST returns lodged by owners and breeders. Verifying GST returns has been
a practice of the ATO since the inception of GST, but it appears that as a direct result of the audit, they are heavily scrutinising any returns lodged by owners and breeders, especially those lodged
in the June 2005 quarter onwards.
In effect, the ATO will not release any refund until they are happy that all is in order, especially in terms of:
• whether the owner or breeder is conducting an “enterprise”- often special questionnaires are required to be completed;
• are all tax Invoices available; and
• if the owner/breeder is under the “cash” basis of GST accounting, has the expense been paid by the end of the quarter that the GST credit is being claimed.
The owners/breeders most likely to be scrutinised are “start-ups”, those claiming more than
$10,000 per quarter in refunds, or those who have consistently claimed refunds since lodging their returns.
NB. It is often at this stage that Business Plans and Bloodstock Schedules are requested as verification of an enterprise.

4. Business Plans - more important than ever
IN THE past 10 or so years I have been relentless in reinforcing the need for Business Plans to be prepared for “start-up” horse businesses. The ATO had continually reinforced this point to accountants and in 1997 finally produced a tax ruling that put their long held verbal view in writing,
ie “Income tax: am I a business of Primary Production?”.
This racing industry audit is compelling evidence that the ATO is serious about requiring plans for anyone wanting to demonstrate they are carrying on a business, especially in relation to horse racing activities. Not only was this highlighted at the Randwick seminar, but many of my clients
have been asked to produce them as part of the audit process.
If you are about to start a horse business, I STRONGLY suggest you get one prepared.

5. “Black Type” in mare pedigrees
IN MY latest article I welcomed the fact that the ATO was more specific in its GST racing industry fact sheet as to what constitutes a breeding business. I was especially interested in their observation that mares within the business should have “. . . black type quality in their recent bloodlines”. I also made the observation that “. . . whether this means black type within the first
two, three or four generations I am still trying to establish with the ATO, and you’ll know when I do.”
Well, the seminar did comment on this, and one of the slides clearly stated that the “. . .
mare needs to have ‘black type’ breeding in first two generations, the type of breeding that would
gain acceptance of progeny into viable sale”.
Be very, very mindful of this criteria when buying your next broodmare! Indeed, if some of your
mares have struggled as producers and do not meet this “black type” criteria, I would seriously consider they be replaced with mares that do.

6. Stallions need to have “market appeal”
SIMILAR to the above, the ATO is now being specific as to the type of stallions we should be using in trying to demonstrate a business.
They have not been overly specific on this point, other than to quote on a seminar slide that “. . . stallion needs to have market appeal (commerciality).”
Get the message? Needless to say, you should possibly rethink your mating strategies if using stallions that, say, cost $5000 or less.
In this regard, one of the seminar slides also noted that a “commercial” breeding business should ensure that “. . . progeny of commercial stallions will sell for 2.5 times - 3 times service fee if out of quality mare”. Again, reject this advice at your own peril!

7. Need to have “control” of your stock
THE ATO has made more than a few observations relating to people trying to demonstrate a
business who do not have adequate control of the stock they are racing or breeding.
For instance, the ATO appears very cynical of people who have breeding businesses and do not entirely own the broodmares or race fillies, the latter intended to be used for future breeding.
For instance, a breeder may have many mares and race fillies that are only owned to the extent of, say, 10% to 25%.
The ATO argues that such a business lacks commercial reality as the breeder may struggle to
mate the mares in the most commercial manner if the majority owners do not share their pedigree savvy or are not prepared to invest in the stallions required for sale ring success.
I don’t entirely agree with their view as this should be judged on a “case by case” basis, however I thought it would be worth sharing with you anyway.

GST ON MARE AND STALLION IMPORTS - UPDATE
IN MY last article I promised to update you if there had been any major changes in the racehorse import and export rules that were outlined in the new “GST for the racing industry fact sheet.”
On a review there appears not to be, though I would like to stress the often overlooked point that,
in the racing industry, any treatment to (or training of) an animal while overseas means that it is unlikely that the animal will be returned in an unaltered condition. This includes a mare returning
to Australia in foal. Therefore, it is unlikely that the re-importation of race animals or animals used
for breeding would be a nontaxable import.
You must pay GST on the value of a taxable import, however this amount is often NIL. If the value
of the import is nil, you do not have to pay GST on the import.
If a horse is exported from Australia and then re-imported to Australia, GST will be payable on the import only if the value of the animal is greater than its value prior to being exported from Australia.
The amount of GST payable will be calculated on the amount by which the value of the live animal
has increased. Refer to the useful example below provided by the ATO in the fact sheet:
Example: GST payable on re-import of breeding livestock
A horse racing syndicate sends its best mare to New Zealand to be serviced by a past Melbourne Cup winning stallion.
On export the mare is valued at $250,000. When the syndicate re-imports the mare, her value has increased as she is in foal. Customs now values the mare at $300,000 (this includes the cost of transport and associated insurance and may reflect such things as the stallion service fee paid).
The value of the taxable importation is $50,000 ($300,000 less $250,000). Therefore the racing syndicate must pay $5,000 GST (10% of $50,000).
Readers are welcome to contact me to clarify or expand upon any of the matters raised in
this article.

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 particular circumstances with an accountant specialising in this area.