The High Court's dismissal of a bloodstock syndicate's challenge to an Inland Revenue decision around write-downs on a colt's purchase price sends a message to the thoroughbred industry and to all business start-ups, says a tax expert.
Deloitte tax partner Greg Harris said the dismissal of a case brought by five investors in a syndicate managed by Waikato's Te Akau Stud owner David Ellis sends the message that any business - regardless of the industry it operates in - needs to develop a comprehensive business plan at the outset and to take steps to implement it from day one.
The five plaintiffs, members of the unincorporated Te Akau Stallion Syndicate formed in 2008, challenged income tax assessments disallowing their share of write-downs or reductions of the $550,000 (plus GST) purchase price of a colt named Roman Gladiator in the 2008 and 2009 income years.
In his judgment, Justice Brewer said the purchase was the catalyst for formation of the syndicate, whose objectives were to buy, train and race the colt, and others, with a view to increasing their value as thoroughbred stallions, to carry on business as thoroughbred stallion owners, and any other business associated with the racing industry. The colt was never used as a stallion because it became too dangerous to remain intact, attacking and injuring a jockey on Christmas Day 2008.
It was gelded in October 2009 and sent to Singapore to be a racehorse. The colt made no income in the 2008 and 2009 years. Ellis, as spokesman for the syndicate, said no decision had yet been made whether to appeal.
Meanwhile, he could not comment.
Deloitte's Harris said the decision was "not about penalising a taxpayer for bad luck or taking business risks".
It was about having evidence of actions to support a business start-up.
He said the decision could have an impact on the bloodstock industry by creating a different standard for the owners of a stallion compared with that for a breeding mare.
The judgment said the colt's pedigree made it a suitable candidate to be a stud stallion and its price reflected that potential.
The plaintiffs joined the syndicate on the basis the colt would be used as a stud stallion if feasible, and understood and intended that the colt would be trained and raced. If it were a successful racehorse, it would earn money for the investors and its worth as a stud stallion would be greatly increased.
Acquiring a colt for development as a stud stallion was a highly risky venture, said the judge.
Evidence was given that only about 5 per cent of good pedigree colts sold annually at Karaka ended up standing at stud. The evidence was that Ellis had greater success, perhaps about 30 per cent, but the risk of failure was still high.
The practical work of developing the colt was delegated to Ellis as manager.
Only one syndicate member was on the syndicate's management committee and the syndicate agreement made clear that the powers of the manager to determine the future of the colt, extending to gelding, were extensive.
The syndicate members paid proportionate shares of the ongoing costs around the colt.
Because the syndicate was unincorporated, each member deducted these costs and claimed their shares of the write-downs individually.
The plaintiffs rejected any idea they were part of a hobby racing syndicate.
Justice Brewer acknowledged the plaintiffs' argument that if they had had an established breeding business, then all that they did in acquiring and developing the colt would have been recognised as pursuant to that business.
"But that begs the question. It is necessary first to establish a breeding business. Buying a colt with the fixed intention of racing it and a contingent intention of one day standing it at stud does not establish a breeding business.
"If it did, then anyone buying a thoroughbred with the intention of racing it and possibly breeding from it would be in the business of breeding livestock."
But the fact the venture of breeding was speculative did not stop a breeding business starting.
"If that were the case, then no breeding business would ever exist.
"But in the face of that risk, a commitment to a plan and structure to get the colt from acquisition to the end point of being able to service mares is to be expected.
"The syndicate agreement speaks more of an objective that the colt be developed so as to be worth as much as possible when the time came to make decisions about its stud future.
"The decisions actually made went to the best interests of the colt's racing career. The decisions as to any potential stud career were left to the future.
"This demonstrates a lack of commitment to a profit-making structure for breeding.
"The only structure actually in place was the structure to seek profit from potential race winnings.
"Accordingly, the plaintiffs did not carry on a bloodstock breeding business." However he disagreed with Inland Revenue that there was no business at all, saying there was clearly a racing business.
Deloitte's Harris said running a breeding business with a stallion was very involved, including requiring advertising his availability and having binding contracts with mare owners.
"In contrast breeding with a mare only requires contracting with a stud for servicing without any advertising or investment in expertise or infrastructure. A mere intention to breed from a mare may be sufficient to justify a business," Harris said.
- © Fairfax NZ News