More On Tax with Paul Carrazzo

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2nd July 2009

Breednet - Media Release - Wednesday, 1 July 2009

This office issued a special release to the racing and breeding industry on 14 May 2009 re the Budget announcement relating to the intended changes to the "Non-Commercial Loss" ("NCL") rules affecting the deductibility of business losses for High Wealth Individuals (HWls).
The new NCL rules proposed were to ensure losses from unprofitable business activities cannot be used to reduce salary, wage and other income of high income earners by tightening the application of the NCL rules.
Individuals with an Adjusted Tax Income ("ATI") of over $250,000 will instead have losses quarantined to the business activity, i.e. they can only be applied if the activity makes a profit into the future.

Individuals who do not meet the above income requirement, but who can nonetheless objectively demonstrate that there business is commercial can apply to the ATO to exercise discretion, via a private ruling application, to allow the loss. Individuals can also apply for the ATO to exercise discretion when there are exceptional circumstances (e.g. El, drought, fires etc).

In the past few days the ATO have released draft legislation re these new rules and upon review and related discussions with senior officers in Treasury, I am now in a position to comment with greater certainty on the application of these new rules.

Adjusted Taxable Income (UATIn) now defined

These rules only affect individuals (or partners who are individuals) with an ATI of over $250,000. To date, we could only speculate on what ATI meant for the purpose of these rules.

The draft legislation now defines what ATI is, vis-a vis:

o Taxable income for that year;
o Reportable fringe benefits for that year;
o Reportable superannuation contributions for that year; and
o Total net investment losses for that year.

Reportable Superannuation Contributions ("RSCs") now part of ATI

The surprise inclusion in this amount is reportable superannuation contributions, a component that may make many HWls, many of whom have "salary sacrifice" arrangements with their employers, subject to these new changes, i.e. by pushing ATI over $250,000.

RSCs is defined as the sum of the following:

I:J The amount contributed to a super fund during that year by an individual's employer or associate of that employer. In effect, this also includes "salary sacrificed" contributions of the employer on behalf of the employee; and

I:J The individual's deductible personal super contributions for that year.

"Total net investment losses" - what are they?

The inclusion of these is also a worrying development as many HWls partake in negatively geared investments, e.g. via property or shares.

Per the ATO definition, you will make a "total net investment loss" when the amount of allowable deductions you claim for your financial investments and rental properties is more than the gross income you receive from those investments.

The only consolation out of this definition is that tax free pensions are not included in ATI, a relief for many older taxpayers who are involved in breeding and/or racing as a business.

Other issues clarified by the draft legislation
In summary, these are:
I:J The ATO has confirmed that carried forward revenue losses are taken into account when calculating ATI, given that "taxable income" is inclusive of this deduction.

For example, if a HWI has wages income of $350,000 in the 09/10 tax year
and has a carried forward tax loss of $125,000 arising from his prior breeding activities, this loss when deducted takes 09/10 taxable income to $225,000 ($350,000 less $125,000). Assuming no other ATI amounts, he avoids these changes as ATI is less than $250,000;

I:J In calculating ATI, a deferred/quarantined loss under the NCL rules cannot be taken into account;

A deferred Non Commercial Loss in existence prior to 1 July 2009 can be deducted by the HWI to reduce taxable income when the relief provisions have been met, i.e. a private ruling has been approved;

CJ If a HWI has a loss "quarantined" under these new rules, this loss can be deducted in a future tax year when ATI falls under $250,000 and one of the four NCL commerciality tests is met;

CJ The ATO confirmed that it is very likely that the person who can provide a "viability report" required with a private ruling application is that defined in taxation ruling TR 2007/6, the current ATO ruling relating to the application of the current NCL rules.
This ruling notes that an appropriate "independent source" includes:

" industry bodies or relevant professional associations, government agencies, or other taxpayers conducting successful comparable businesses. "

CJ If a HWI seeks a private ruling and is unsuccessful, the loss derived for that year can still be quarantined and carried forward as the ruling is only addressing the commercial viability of the business, not its income tax business status. status.

ATO accepting comments on draft legislation

Comments on this draft legislation must be lodged with the ATO before 26 July 2009. You can be assured that the industry will closely evaluate these new changes and relevant comments will be passed on. The racing and breeding industry derives serious investment from HWls and it is imperative that these new rules does not drive these people out of the industry. Our office, as usual, will be very active in this process.
You are welcome to contact me if you wish me to clarify or expand upon any of the matters raised in this article.

PAUL CARRAZZO CPA
CARRAZZO CONSULTING CPAs
22 BLACKWOOD ST, NORTH MELBOURNE VIC 3051
TEL: (03) 9329 7044
FAX: (03) 9329 8355
MOB: 0417 549 347
E-mail: paul.carrazzo@carrazzo.com.au