As it happened the yacht chartering business lost money from inception in 2006 until the Commissioner's most recent tax amendment to LGC in 2013. While the Australian Taxation Office (ATO) were no fan of this tax framework, that is besides the point. Taxation law explicitly prevents deducting expenses incurred from boating activities that are not 'carried on as a business' (s.26-47), at least to the extent they are not being offset against income from the boat or yacht itself. Hence, the ATO argued that LGC were ineligible to deduct their yacht chartering tax losses against profits from Mr Lee's other more profitable business ventures which were transferred in by way of a trust distribution.
Taxpayer's Contentions
The legal argument from the taxpayer's perspective is as follows:
Section 26-47(2) provides that boating expenditure exceeding boating income shall be quarantined to be offset against boating profits in future years if they may arise.
Section 26-47(3) provides that there are exceptions to the above rule, including exclusion (b) being an entity which uses a boat 'mainly' for letting it on hire in the ordinary course of a business.
The taxpayer (LGC) at all relevant times advertised the fully-manned super yacht for charter to the public, performed the required administrative tasks itself as any other yacht charter business would, acted commercially & professionally at all times and continually invested in the business venture with a clear goal of becoming a leading yacht charter brand in tropical Queensland and nearby pacific islands.
Commissioner's Contentions
The exception found in s.26-47(3) only applies if the taxpayer 'mainly' holds a boat for letting it on hire in the ordinary course of a business. The usual meaning of the word 'mainly' is "for the most part".
The Commissioner predominantly relied on the fact that Mr Lee appeared to be in most (potentially all) years LGCs main client and that the business as it existed did not have a reasonable prospect of making a profit. The Commissioner concluded that the yacht was not held 'mainly' or 'for the most part' to be used in carrying on a business. Rather, this was venture was more of a personal hobby for Mr Lee and his family.
The Decision
(Justice Logan)
"First and foremost, Mr Lee is an honest man who gave generally reliable evidence, to the best of his recollection. Secondly, Mr Lee is, characteristically, laconic. Thirdly, though he is entrepreneurial and decisive in matters of business, he seeks out what he considers to be sources of relevant advice and experience before making decisions. Fourthly, he has a very particular respect for the taste, business judgment and attention to detail of his wife, Mrs Keri Craig Lee, especially in matters of decoration, presentation, durability and suitability of fit out for charter operations and standards of crew turnout and service. Theirs is a long and enduring marriage. They will celebrate their 30th wedding anniversary this year." 1
"A feature of the charters of the Keri Lee III is that the predominant charter party is Mr Lee (other charterers were Lenda Finance SA and a Mr Jeff Jacobs).
During the course of his cross-examination, Mr Lee was taken to three of these (charters). These (three) do entail charters for less than the publically advertised rate for the Keri Lee III (US$175,000 per week, fixed in response to the persistent adverse impact of the GFC on demand). Mr Lee’s evidence was that there would have been a good commercial reason why those particular charters were below the ordinary rate. At the time when these charters were undertaken, Mr Lee had no particular reason to expect that, some four years later, he would be asked to recall the precise occasion for these particular charters and the particular, related reason for these charter fees. As I have now stated more than once, I regard Mr Lee as an honest witness. On this subject, one reason why I accept his evidence as accurate is that, over the period in question and in respect of both LGC and KLC he was meticulous in ensuring that he paid a commercial charter rate." 2
"In late 2009 or early 2010, KLC was approached by a movie producing company who advised that they were interested in using the Keri Lee Ill for a movie. Mr Lee recalls that this was part of the “X-Men” movie series starring Hugh Jackman." 3
"Mr Lee’s answers were, in my view, honest and candid. They were also revealing. When he came to cause LGC and the KLC to embark upon these ventures, Mr Lee brought a very particular background of experience to bear upon his decision-making. That background lay not just in his gradually developing and evolving belief, described above, that it would be possible to operate a super yacht charter business based in Australia which looked to charters in Australian and South Pacific waters. It also lay in his earlier business experience, derived from the successful operation of a rurally based business, of the vicissitudes that can attend such a business and a correlative disposition on his part to take a long term view as to profitability. I find that this informed and continued to inform his thinking about the super yacht venture. He brought that same disposition to the operations of each of the taxpayers. Mr Lee was, in effect, backing a value judgment which he made in respect of what he considered, in the long term, would eventually prove to be a profitable business. Further, returns which others might not regard as acceptable were, in light of his rural experience, acceptable to him." 4
"What is evident over this period (as it is also in respect of the later ownership and operation of the Keri Lee II and Keri Lee III), is that Mr Lee was not rigidly following a pre-ordained business plan in respect of charter operations for the vessels. He was reacting to circumstances and to an ever growing understanding of the super yacht charter industry...[C]ases such as this are not to be resolved by resort to some mechanical annotation of a checklist for the presence or absence of factors, one of which is the presence or otherwise of an anterior business plan. There is nothing in s 26-47 of the ITAA97 which mandates that there must be some sort of formal business plan for dedications not to be quarantined. Even were there a formal plan written in advance, if the evidence in practice showed an unexplained disregard of that plan and uses inconsistent with the operation of the vessel as a business, form could not triumph over substance in terms of the conclusion to be drawn. On the whole of the evidence in relation to the period from when the idea of a super yacht operation first occurred to Mr Lee to the first charter of the Keri Lee I, the irresistible conclusion, in my view, is that Mr Lee did not cause the acquisition of or operate that vessel as a private venture, as opposed to for and as a business. Further, his end, which was that of LGC, was that the vessel would be operated at a profit. " 5
"It bears repetition that the rule and the material exception to the rule established by s 26-47 of the ITAA97 do not preclude charters to related parties. The rule and the exception are neither to be construed nor administered as if they did. That a pattern of related party chartering is evident is neither more nor less than one relevant part of an overall factual matrix against which one must measure whether the activity concerned is within or outside the terms of an exception. When, as here, another feature of that pattern is the great predominance of charters at commercial rates, its role becomes supportive rather than destructive of a conclusion that the vessel is being used or held mainly for letting on hire in the ordinary course of a business being carried on by KLC." 6
"Mr Lee was...scrupulous in ensuring that the use of each vessel was at commercial charter rates. When not under charter, each vessel was held for that purpose (for letting on hire). Each of the taxpayers continuously presented themselves to the world at large and operated and was administered internally as a business. That presentation, operation and administration was a reality, not a façade. They were a manifestation of the expectation and purpose of making a profit." 7
"[E]ach vessel was used or held, certainly mainly, but in my view, exclusively, for letting on hire in the ordinary course of a business carried on by LGC and by KLC." 8
Logan J held that the taxpayer's appeal should be allowed in full. LGC was, and is carrying on a business.
Whether or not one of an entity's most frequent customers is a related party is not a key consideration in determining whether or not a business is being carried on. In fact, many businesses which solely service related parties are treated as companies under both the Corperations Act and Taxation Laws. This "I only service related parties" line certainly wouldn't be a viable excuse for a profitable company attempting to define itself outside of particular taxation laws (i.e. GST).
The other noticeable point is that this case proceeded from ATO objection directly to the Federal Court. Taxpayers generally have a right to have their objection heard by the Adminstrative Appeals Tribunal before proceeding to the Federal Court, although it is not a necessary precursor. These are signs of a confident taxpayer who appeared unhappy with the ATOs audit and conclusions. The most advantageous aspect of appealing directly to the Federal Court is that the taxpayer can recoup all costs incurred during the appeal proceeding from the ATOs objection decision. An order to costs is not available in the tribunal, this might be considered another 'win' for the taxpayer.
Appendix
The case is here: http://www.austlii.edu.au/au/cases/cth/FCA/2016/322.html
1. (p18)
2. (p118 & 119)
3. (p105)
4. (p85)
5. (p59 & 60)6. (p123)
7. (p128)
8. (p129)
All legislative references are to the Income Tax Assessment Act 1997.
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