Chartering your boat can be a great option, provided you get proper financial and legal advice about what to expect in terms of likely income and tax obligations. Last month we spoke to Mark O’Donoghue from specialist boat finance company Finlease about popular loan packages. Now we explore some common charter vessel scenarios and discuss recent changes to tax law that could impact on your decision to charter. Individual circumstances vary widely so it’s important to obtain proper legal, financial and tax advice from your lawyer, financial advisor and the ATO; this article is intended as a brief introduction to the topic and is not to be read in lieu of professional advice.
The first thing to understand about chartering your boat is that the tax law is not designed to subsidise the private use of a pleasure vessel. The law allows you to claim certain deductions if you can prove that your vessel is a business; it won’t allow you to claim the costs of keeping your boat if it’s being used purely for recreation.
Generally speaking to prove that your boat is a business you need to show that the boat is at the ‘heart of the enterprise’ or at the centre of business activities. There’s a good summary of the tests the ATO applies to determine whether boat hire arrangements amount to the carrying out of a business at the following link: http://www.ato.gov.au/businesses/content.asp?doc=/content/34224.htm
Most lay people would say that defining a business is a relatively straightforward affair. If an enterprise is designed to make you money, and it’s likely to do so either now or at some time in the not too distance future, then there’s a good chance that you’ve got a commercial operation on your hands. However the definition of a business, for the purposes of taxation law, becomes more complex in the grey area between a hobby that generates income and a fully fledged commercial enterprise.
Tax law gets interesting in the situation where someone owns a boat, they derive charter income from it, but for some reason they can’t satisfy the ATO’s definition of a business. For example: their vessel may only be chartered for a few days a year, it may earn little income, or there may be a significant disproportion between income and running costs.
Up until recently, if a boat owner derived income from their boat, but couldn’t prove that they were engaged in a bona fide business, then the law said that they couldn’t offset deductions against this income. This meant that the owner wasn’t able to reduce their tax liability by claiming deductions for the costs of running the boat. (Note: not all the costs of keeping, operating and maintaining a charter vessel are allowable deductions- please seek advice from the ATO and/or your tax advisor.)
In July of 2007 this situation changed following an amendment to taxation legislation: see Income Tax Assessment Act 1997 – section 26.47: Non-business boating activities. The change to the law followed an intense period of lobbying by industry action group CBISC (Charter Boat Industry Survival Campaign.)
The CBISC campaign was established in 2002 and spearheaded by Finlease’s Mark O’Donoghue who, recognising the substantial threat to the charter industry that the ATO’s interpretation of existing tax law represented, effectively disengaged from his business for 18 months while changes to the law were being debated. He emerged from the process an acknowledged expert in charter boat finance, with an extremely detailed understanding of the needs and obligations of the industry: ‘We’ve lived and breathed this thing for nearly ten years, and really more expertly for the last seven or so… We can’t advise our clients, that’s not our role. But what we can do is make it very simple for them to understand what is available on the market, what they need to think about when it comes to buying a charter boat, and what outcomes they should expect.’
The law now says that if you can’t prove that you are engaged in a charter business which passes all of the tests of a business as prescribed by the ATO, you can still claim some deductions to offset against this income. However if your deductions are higher than your income, you can’t claim them all in one financial year; allowable deductions in excess of your boat income are ‘quarantined’ and in some circumstances may be claimed in later financial years. Here’s an example from the legislation:
‘Carrying forward and deducting a quarantined amount:
Ian owns a boat which he leases to a charter operator. In Year 1, Ian has available $100,000 in deductions relating to his income-earning boating activities, including interest, depreciation, running costs and management fees. He earns only $40,000 income from leasing the boat. Therefore he can only deduct $40,000. The remaining $60,000 is carried forward to Year 2 (the quarantined amount).
In Year 2, Ian has $95,000 of boating deductions and no income from the boat. Provided the deductions are otherwise allowable, the quarantined amount will accumulate to $155,000 and be carried forward to Year 3. Ian cannot claim any of the $95,000 of boating deductions in Year 2.
In Year 3, Ian has $60,000 of boating deductions and $150,000 of income from the boat. The deductions from Year 3 plus the quarantined amount from Year 2 adds up to $215,000. Therefore, Ian can claim a deduction of $150,000 and carry forward $65,000 to Year 4.’
(Note: there are certain exceptions with regard to quarantined deductions. We again recommend the advisability of obtaining professional advice and contacting the ATO.) O’Donoghue commented that the change to the law introduced greater certainty for people involved in charter operations and he believes that a properly financed charter boat can be an extremely attractive option. Here are two real life examples he uses to illustrate the range of charter opportunities.
In the first example a client buys a new boat and puts it into an established Whitsunday charter fleet.
‘The boat’s going to work 25-28 weeks per year, it’s going to gross income in excess of $120,000 and it’s going to provide a net income to the owner of maybe $35,000. If the boat is geared sensibly- in other words not 100% financed, maybe 70% financed- then there’s a very good prospect that they are going to have a business in its proper sense with all of the benefits of deductabilities and depreciations. They can look at it very much like an investment in property with similar negative gearing implications…’
In the second example, a client offers an older model boat for charter in a regional waterway within driving distance of their Sydney home.
‘It’s really only going to be doing 80 days a year maximum. It might only gross $60,000 per year and it might only net to the owner $15,000 per year. In that instance, trying to 100% gear a brand new boat is never going to pass muster from a fully blown business point of view. But it may produce a wonderful hobby based business.’ ‘Instead of getting all your negative gearing implications, what you are going to get is a boat which is going to have all the costs of insurance, marina berths and maintenance covered as a part of the business.’
‘It’s going to have $15,000 worth of net income from the owner and he’s going to get at least $15,000 worth of deductions to offset against that revenue in addition to having the running costs of the boat covered. So that could be a wonderful outcome- almost like a part time business.’
As O’Donoghue points out, the possible tax ramifications are very different depending on the charter boat’s age, location and anticipated usage. The Whitsunday model may suit an owner with a