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Julie Butler, FCA describes some tax considerations related to horse racing.

Julie Butler

Tax–efficient Sponsorship

Sponsorship is currently an essential element of the commercial viability of the racing industry.  Since 1994 the owner is in a position to benefit from the financial rewards of the fiscal advantage of well structured and compliant sponsorship.  All trainers are aware that “tax breaks” for the owners can provide financial and emotional incentives to increase the number of horses in training.  The whole of the racing industry is acutely aware of the need to keep owners happy…..

Owning Racehorses is “tax free”

The ownership of racehorses is generally “tax free” i.e. outside the scope of tax.  This means that whilst winnings and profits on disposal of racehorses are not taxable there is a balance in that the costs of training are not deductible.  In the minds of HMRC (H M Revenue & Customs) racing is therefore deemed to be a recreational activity or in the case of a company a non-taxable activity.

Racing and the “owner breeder” – is it tax allowable?

When is racing “taxable”?

For the owner breeder, racing is often an integral part of a stud farm’s activities and should be taxed (and in balance achieve tax relief) as part of the breeding activity, yearlings are transferred from stud to racing and returned to stud after their racing career.  The tax case that directs the allowability or otherwise of the cost of racing is Sharkey v Wernher.  The arguments put forward for allowability are that for the future commerciality of the stud the horse will need to be tested on the racecourse to determine whether it has the appropriate physical qualities such as speed, stamina and courage to justify the horse retention for a breeding career.  Where this can be justified, a breeder’s racing activities can be regarded as an integral part of his breeding trade for tax purposes; the expenses of racing become an allowable deduction and winnings taxable as trading income.  HMRC accept more readily that fillies should be considered as tax allowable as statistically a higher percentage return to their breeders’ stud operations.  HMRC look very closely at the evidence to support the justification.

Test of racecourse – ownership and publicity

As part of establishing the “test of the racecourse” argument it is important to ensure that the name of the Stud is also promoted and that the ownership of the horse is in the name of the stud (as opposed to the individual owner) to give maximum promotion.  The publicity angle of stud ownership will apply to the race card, publications etc.

Racing – the profile

Horse racing is currently a high profile sport and one that achieves maximum television coverage.  Many companies use the vehicle of the racing industry to promote their services and products through advertising and sponsorship.  The expenses incurred in connection with racing by companies which do not operate a racing or breeding trade can achieve tax allowability.  Common examples of such expenditure include the company owning and running a racehorse via the medium of sponsorship and advertising.  The claims for these types of expenses to be tax allowable are always examined with caution by HMRC.

The private company

In order to successfully claim a deduction for racing expenditure as tax allowable it may be more difficult when the directors of the company themselves have a known interest or history in racing, particularly where it is in a private company.  HMRC may argue that the expenditure has been incurred because of the personal interest of the directors rather than for the benefit of the trade (see below).  There is also the risk that there may be a taxable benefit on the directors of the company where HMRC regard the company’s racing expenditure as a benefit for the director.  Such tax treatment is more likely to be promoted by HMRC where the company is a close company as defined by Section 414 ICTA 1988, e.g. where it is more likely that a director shareholder will be able to influence the authorisation of the spending of the company money.

Incurred for the Benefits of the trade of the Company

The basic understanding of the rule for deductibility of the expense is found in Section 74 ICTA 1988.  It is stated that expenditure will be deductible if it is wholly and exclusively incurred for the benefit of the trade of the company.  In general, a company will be able to obtain tax relief for racing expenses (and conversely will be taxed on any race winnings).  Where the detail of the expenditure can satisfy HMRC that this is incurred to promote the companies trade or business activity for example by increasing awareness of its products services and brands then tax relief can be achieved.  As already discussed advertising and sponsorship may help satisfy this criterion.

Sponsorship expenditure driven by the needs of the family rather than the needs of the business

Executive Network Selection v O’Connor SPC 056

The relevant section of the decision is included below:

Here Mr Toms and his co-director, Mr Kemp, were witnesses of the highest integrity.  We are entirely satisfied from their evidence that the sponsorship payments were laid out for the purpose of EN’s trade.  But, however hard we review the evidence we cannot displace from our minds the conclusion that ‘personal benefit’ played a part in the decision to make the sponsorship payments.  The benefit to Mrs Toms’ trade was more than an incidental result of the expenditure.  The decision to fund Mrs Toms in year 1 in her stocking-up with competition horses must, we think, have been a joint decision of both Mrs Toms and Mr Toms in which the long-term capital requirements of her personal business were a key ingredient.  The decision to provide part of the cost of Mrs Toms’ new horse box in year 4 was another decision to lay out funds for the purpose of her business.  The annual decision as to the quantum of the sponsorship was, once again, directed as much at the needs of Mrs Toms’ business as at the benefits obtained from sponsorship.  It seems to us, therefore, that the non-trade purpose (from EN’s point of view) of benefiting Mrs Toms’ business coupled with the furthering of the children’s equestrian careers can properly be described as conscious motives of the decision-makers so far as concerned the decision to make the payments with which this appeal is concerned.  The interposition of the BEF [the British Equestrian Foundation] from 1 January 1991 onwards does not alter our conclusion that benefiting Mrs Toms’ trade was a purpose of the expenditure.  It is not, therefore, strictly necessary for us to apply the concluding sentence in the passage cited from Lord Oliver’s speech. However, even if we were wrong so far, we would still be against EN.  It seems to us that the non-trading result (i.e. funding Mrs Toms’ business as distinct from EN’s) was a result that was so inevitably and inextricably involved in the sponsorship activity that the result must have been a purpose of the activity.  In this connection we cannot accept Mr Ewart’s [appearing for the company] argument that that passage, which develops Lord Brightman’s reasoning in Mallalieu, is confined to the three instances of expenditure on necessities of life, i.e. clothing, food and accommodation.  Nothing in Lord Oliver’s amplification of the Mallalieu reasoning suggests that he regarded Lord Brightman’s reasoning as being limited in the manner suggested by Mr Ewart.  Even if the motive to provide funding for Mrs Toms’ business and for advancing the equestrian careers of the children had not been a conscious motive (which we think it was), it was we think inescapably one of the objects for incurring the sponsorship expenditure.

The point of interest is that, although the benefit of the sponsorship was the business of Executive Network, the motivation for the expenditure was private.

Promoting or advertising the company’s products or services

A company will only be able to claim a deduction for the cost of keeping and training a racehorse (or a number of racehorses) if it can show that the expenditure is for the purpose of promoting or advertising the company’s products or services.  The ability to claim the tax relief will be dependent on the facts.  In such circumstances any prize money from the horse will be taxable.  In any case, the cost of purchasing a horse is unlikely to be deductible since it presents capital expenditure but tax relief is achieved should the horse be written down to much lower value (which is too often the case in racing).

The factors to be considered when trying to determine whether advertising expenditure is incurred wholly and exclusively for the benefit of the trade include:

• Is there evidence that the horse is being used for advertising purposes?  (Where the horse is named after the company or its products then the expenditure is more likely to be accepted as advertising).
• What is the purpose behind the expense – is it to provide a corporate entertaining package or is it genuine advertising?  What do the minutes and authorization documentation set out with regard to the expenditure?
• What is the form of the advertising and is it in keeping with the company’s size, structure and image?  Is it part of a comprehensive marketing and ”PR” report?
• Is the amount spent reasonable in relation to the benefits claimed from the advertising or promotion?  What is the percentage of total spent?
• Is the advertising likely to generate more business and has the decision to advertise in this way been based on commercial principles?  Can such inflow on new business be supported by fact?

The facts behind the promotion of business through racing

It will be essential to support the arguments for the promotion of the business through racing with facts e.g. statistics, Company Minutes, marketing reports, documentation of authority for expenditure etc, etc.

Racehorse Sponsorship v Advertising

As already mentioned, in 1994 owner-sponsorship was introduced into the sport of racing.  The change allowed owners to be sponsored and the sponsor to advertise on the jockeys silks and horse rugs etc.  Before entering into any sponsorship agreement, companies should consider how the agreement can be best structured for tax so that the maximum relief is obtained for the company.  Claiming a deduction for a sponsorship payment should be no different to claiming a deduction for advertising expenditure if the structure is correct and documentation is in place..

Sponsorship Criteria

In structuring sponsorship agreements there are a number of basic principles which should be followed as set out below:

1. It is helpful if the horseracing sponsorship is not the only promotional activity and that it forms just one part of a company’s programme.  It is essential if the reason for the sponsorship is documented beforehand, for example in the minutes of the company’s Board meetings.

2. The sponsorship expenditure should be revenue in nature in the hands of the payer since no deduction will be given where the company is incurring expenditure of a capital nature, e.g. fixed assets such as the acquisition of a racehorse, or a share in a racehorse.  It is for the recipient to decide how the money should be spent and even if the recipient chooses to acquire a racehorse the expenses to the company of keeping the racehorse should still be deductible as a revenue expense.  This can present quite a nightmare for the company auditor in carrying the tests between capital and income.

3 .The main benefit of the sponsorship expenditure must be to the trade or business activity of the company, and the company needs to show that the sponsorship payment falls into the same category as its normal marketing and promotional activities.  A deduction will be available if the company can show that the sole purpose of the payment is to help market the company’s products and services and that any benefit to horseracing is incidental.  This is not a principle that the horse racing industry might support or enjoy.

4. The sponsorship agreement for racehorses and race meetings should be included in the trading company whose trade is to benefit from the sponsorship and not, for example, in a non-trading holding company of the group.  Where a horse or race is to be named after the company it should be named after a trading company rather than a holding company and the sponsorship should have a clear benefit to its trade or business activity.

The question of Corporate entertaining

A benefit to a company of sponsorship is that it may provide the company with a structured corporate entertaining package, for both staff and clients.  A company will only achieve a tax allowable deduction for entertaining expenses if it relates to the entertaining of staff (although the staff could face personal tax liabilities).  Sponsorship deals that include an entertaining package should be carefully structured and recorded so that the entertaining element, if any, can be separately identified and the size of any disallowed expenditure identified.  It may be preferable to agree an allocation of cost, showing the element which relates to entertaining, with the provider of the packages, rather than leave it to HMRC to suggest an apportionment on a basis which would disadvantage the company.  It is essential that good, cross-referenced bookkeeping clearly identifies the difference between client and staff entertaining.

Rewarding of staff

The difference between entertaining clients and rewarding of staff is significant for tax purposes, i.e. the size of the company tax bill.  Where an employee is involved in entertaining clients then this is claimed as client entertaining and the company will not achieve tax relief on a deduction for the expense.  There will also be no benefit taxable on the employee where the employee is entertaining clients and not purely there for the pleasure.  Where the company is solely entertaining employees, for example by paying for a day at the races the company will be able to claim a tax deduction for the expense but the employee will be taxable on the benefit received.

Summary

There are many ways of achieving tax efficiency through racehorse sponsorship.  The key is review, planning, structure and documentation – as with any tax planning there are judgement calls to be made by the tax adviser and the rules have to be explained to the client at an early stage.