 ESCAPE
THE NEW HORSE LOSS RULES!
Well, what a joy to finally pass on some
good news re the new horse loss rules for high income earners.
No, they haven’t gone away, unfortunately,
but there can be a legitimate way to avoid them if your employer
co-operates.
These loss rules are part of what is known
in the tax world
as the “Non-Commercial Loss (“NCL”) rules.
For
the uninitiated, individuals (or partners who are individuals)
whose adjusted taxable income (“ATI”) exceeds
$250,000 will have to quarantine and carry forward this loss
unless a successful private ruling is lodged with the ATO.
No longer can they refer to other ATO rules as to whether
a loss can be deducted. These rules operate from 1
July 2009.
The
ATI includes the sum of:
•
Taxable income for that year (e.g. wages less work related
deductions);
•
Reportable employer superannuation contributions (“RESCs”)
for that year;
•
Total net investment losses for that year; and
•
Reportable fringe benefits for that year.
In effect, many
high income earners will be forced to seek the ATO’s
approval before any loss can be claimed from a business activity
(e.g. breeders/owners, wine makers, pastoralists
etc) on or after 1 July 2009, i.e. this tax year onwards.
In tax speak, the “Commissioner’s discretion” is
required for the tax loss to be deductible.
TAX TIP - Employer
reimbursement of horse business expenses
An employee who is
also carrying on a horse loss-making business can avoid these
new NCL rules by having their employer reimburses
their horse business expenses under an effective salary sacrifice
agreement.
The “employer” can also be a family
company that pays significant wages to family members, i.e.
your typical “Mum
and Dad” company.
The ideal scenario is where the employee
has their employer reimburse the entire amount of their business
expenses
under a salary sacrifice agreement. In these circumstances,
the employee effectively obtains the benefit of a deduction
and, in addition, the NCL rules have no application because
the business is no longer in losses (i.e. as all the
expenses have been reimbursed by the employer). There are
a number
of pertinent points to note in relation to this strategy,
as follows:
1. The ATO has confirmed that, where an
employer reimburses an employee's business expenses under
an effective
salary
sacrifice agreement, the reimbursement will not be subject
to FBT.
This is because the taxable value of each
reimbursement will be reduced to nil under the 'otherwise
deductible'
rule (i.e.
the 'otherwise deductible' rules basically applies where
the employee would have been entitled to a deduction under
the Tax Act had the expenses not been reimbursed by the
employer). This is the case notwithstanding the taxpayer's
business
loss would otherwise be quarantined under the NCL rules.
2.
The employee will basically end up salary packaging the GST-exclusive
cost of the horse business expenses,
assuming
the employer is entitled to a GST input tax credit in respect
of the reimbursement under the GST Act. Note, however,
that any business expenses reimbursed by the employer are
not
also be deductible to the employee (i.e. there is no 'double
dip' available).
Note also that expenses that are reimbursed
under a salary sacrifice agreement are not “reportable
fringe benefits”.
This is important where an employee is unable to avoid
the NCL rules by salary sacrificing all their business expenses
(or at least sufficient business expenses to convert the
loss-making business into a profitable one) and is not
able
to satisfy the NCL rules because of the new “$250,000
income” test.
Specifically, when a taxpayer is calculating
ATI for the purposes of assessing whether the $250,000
income test
is satisfied, any reimbursed expenses are not required
to be
added back. Therefore, an employee should there consider
salary sacrificing sufficient business expenses to satisfy
the income test.
In these circumstance, if the business
activity has incurred a loss (i.e. after adjusting for reimbursed
expenses),
the loss is deductible against the taxpayer's other income,
provided
one of the four "objective" NCL rules are met.
This
strategy is complex and hopefully the example below will
make the strategy clearer.
Example – reduce ATI
to under $250,000 and avoid new loss rules
Bert is a high
income earner working for a leading investment bank. His
salary is $450,000 p.a. For the purposes of this
example, his ATI is the same figure.
Bert is also a keen horse
breeder and has bred commercially for many years. For the
2010 tax year, his horse sales income
was only $60,000, however his expenses were $220,000, thus
his horse tax loss for 2010 is $160,000 ($60,000 income less
$220,000 expenses).
Under the new NCL rules, Bert could only
claim this $160,000 loss immediately if he successfully applies
to the ATO for
a private ruling, such ruling having to demonstrate that
his horse activity has long term “commercial viability”.
This is so as Bert’s ATI is $450,000, i.e. in excess
of $250,000.
So, how can Bert still “claim” his
horse expenses for 2010?
Bert would approach his employer
and ask that all of his $220,000 of horse expenses be paid
directly by his employer
under a “salary sacrifice” arrangement. Accordingly,
his salary income is reduced to $230,000 ($450,000 less $220,000)
and he no longer has to meet the new NCL income tests. How
do we prove he is in the same tax position as if he’d
been able to claim his $160,000 loss against his salary?
See calculations below.
Non-packaging (paying $220,000 of
horse expenses from "own
pocket")
| Salary |
$ 450,000.00 |
|
|
| |
|
|
|
| Less: Horse tax loss |
$ (160,000.00) |
|
$60,000 sales less
$220,000 business expenses |
| |
|
|
|
| Taxable income after horse loss |
$ 290,000.00 |
|
|
| |
|
|
|
| Less: Tax on $290,000 (excl M Levy) |
$ 105,350 |
|
|
| |
|
|
|
| After tax position |
$ 184,650 |
|
|
| |
|
|
|
Packaging $220,000 horse "business costs" with
employer
| Salary |
$ 230,000 |
|
$450,000 less $220,000
horse expenses |
| |
|
|
|
| Add: Horse business sales income only |
$ 60,000 |
|
|
| |
|
|
|
| Taxable income after adding horse income only |
$ 290,000 |
|
|
| |
|
|
|
| Less: Tax on $290,000 (excl. M Levy) |
$ 105,350 |
|
|
| |
|
|
|
| FBT cost |
$ - |
|
no FBT applies |
| |
|
|
|
| After tax position |
$ 184,650 |
|
|
| |
|
|
|
Notes
1. In example 2, the employer is paying
for Bert's $220,000 of horse costs via a valid "Salary Sacrifice"
arrangement. His salary is reduced to $230,000 to fund this.
2. As employer
has paid all of the business expenses in example 2, the business "P&L" of
Bert will
only disclose the $60,000 of sales income.
3. There is no FBT payable on this
salary sacrifice arrangement, thus Bert is in the same after tax-position
as if he had fully funded the $220,000 of horse business
expenses.
4. Due to
Bert's packaged salary being only $230,000, he need not consider the new
loss rules as
his ATI is less than $250,000 and a "profit" has been derived on
his horse business, i.e. $60,000.
5. If the packaging arrangement had still
resulted in a loss being derived by Bert, i.e. the employer
wasn't able to package sufficient horse expenses, the loss is still deductible
against Bert's salary
income, provided one of the four "objective" NCL tests are met. These "objective
tests" are far easier
to meet and reliance on a successful (and costly) ATO ruling is not required.
6. An individual partner in a partnership
can also take advantage of this arrangement, but only his/her
share of the business expenses can be packaged. You are welcome to contact
me if you wish me to clarify or expand upon any of the matters raised in
this release.
Prepared by: 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
Web Site: www.carrazzo.com.au
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. |
FROM THE PRESIDENT’S
DESK
Racing’s
Night of Champions will return to the Grand Pavilion at Rosehill
Gardens this year on 12 August 2010. As
you may be aware, Racing’s Night of Champions is in aid
of Redkite who support children and their families through
cancer.
*Conditions
apply, see 
WINNERS ARE GRINNERS
BOBS & BOBS
EXTRA UPDATE
For
further information please contact:
STOP
PRESS 1 – MATTHEW TALBOT RACE DAY, 22 MAY 2010
STOP
PRESS 2 – THE CARRAZZO SYDNEY TAX SEMINAR