Adapting to change

There is nothing so dynamic as change. We must at all times be conscious of our changing environment and adapt to ensure survival.

The horse-racing industry is no different; it is a very large and important part of our national economy. It is diverse, involving agriculture, business, gaming, entertainment and recreation. It is an economically significant industry that deserves the attention of the general public, media and government.

No longer is this the activity of the 'plantocracy'. The industry is now commercially driven and the participants invest to make a profit.

The breeding sector is a serious agricultural activity which enjoys all the incentives afforded the risk and investment that is a constant in the farming world. The professionals go through years of study in an effort to develop their careers as trainers, veterinarians and jockeys.

The industry provides employment for grooms, exercise riders and the hundreds who administer the business - the regulators and administrators.

The policy, as it relates to taxes generated by the industry, needs to be properly structured to provide equity and incentives for investment.

The current income tax regulations related to income and expenditure incurred in racing horses were formulated at a time totally different to the realities of today. The current view adapted from a case presented many years ago is that "... the training and racing of horses was not a business conducted on commercial principles, and that the profits from the venture would not be liable to income tax, and conversely, the losses sustained could not be set off against taxable income obtained from other sources".

In the particular case that provided the precedent, the current income tax regulations argued that what is contemplated under the Income Tax Law (of 1945) as a business is a commercial undertaking with the object of making a profit. The question of motive was debated.

Irrelevant

The current income tax law stated that although motive is irrelevant, it is irrelevant only so far as the application of the profits are concerned, but where it can be shown that the prime reason for the activity is pleasure or in the nature of recreation, hobby or pastime, that activity does not fall within the meaning of the word 'business' in the Income Tax Law (of 1945).

The court's view was that the taxpayers' motive was a pastime, or hobby, in which winning was important.

This ruling has been challenged and the regulations existing in other countries should guide the authorities to a more relevant structure for an efficient taxation system for the industry.

It is interesting to note that the American IRS recognises the issues 'Hobby Loss' and 'Passive Loss'. They appreciate that the two problems faced by horse owners, when audited by the IRS, are the 'hobby loss' and the 'passive loss' rules.

To prevail, owners must demonstrate that they have exercised prudent business planning, followed good business practices and have documented their business activities.

In general, the tax laws referring the 'hobby loss' rule provide that to deduct expenses that exceed income, the taxpayer must demonstrate that he is engaged in his horse-related activity with the intention of producing a profit.

Initially, the burden of proof falls upon the taxpayer. However, if a profit can be shown in two of seven consecutive years, beginning with the first loss year, the burden shifts to the IRS to disprove the "general presumption of profit intent".

The IRS cites nine factors in determining whether an activity is a hobby or business.

They are very basic business points covering management style, degrees of knowledge of the taxpayer, utilisation of expert advisers, time and effort the taxpayer spends in the activity, the expectation for asset appreciation and the presence or absence of recreational aspects.

Enjoy the business

From the IRS's perspective, a hobby correlates with fun, while a business means work: In other words, it is okay to enjoy the business, but only if you have a convincing profit motive.

In order to deduct losses incurred as a result of equine business activities from other income, an owner must be able to prove that he is materially participating in the activity. Material participation is satisfied by establishing that the owner spends 500 or more hours actively participating in the business during any taxable year.

In addition to the above, horses may be depreciated as three or seven-year property. The 2009 Economic Stimulus Bill provides an expensing allowance and bonus depreciation for horses purchased.

We have provided a synopsis of some of the rules as it relates to taxation in the USA. The regulations related to other countries are being researched and will form part of the appeal process with the Income Tax Department.

Howard L. Hamilton, CD, JP, is a former chairman of Caymanas Track Limited. He is the current president of Thoroughbred Owners and Breeders' Association. He can be contacted at howham@cwjamaica.com.