Many of us enjoy a flutter on popular horseracing events such as the high profile Grand National and Derby, but the stakes are much higher for the owners of the competing horses. This year there was prize money for the winners of around £800,000 and £600,000 respectively in those two races alone, and when such large amounts are paid out effectively as tax-free windfalls, it can place the horseracing industry in an appealing light to prospective investors. However, it surely begs the questions – why do such winnings remain tax-free?

Coutts client, and successful horse breeder and racehorse owner Mary Morrison explains that such large prize funds are actually few and far between, commenting that "where prize money is concerned …there really is not much incentive for people to become involved. When the winner's prize sometimes hardly covers a month's training fees, the entry fee and transport expenses, I am sure some wonder why they do it at all!" Despite these difficulties, Mary enthuses that the breeding side of the industry is tremendously "rewarding and fulfilling", and nothing can beat the feeling of seeing your "offspring" make it to the racetrack.

It is probably the seemingly unending expenses incurred by racehorse owners that keeps the prize funds tax-free. High costs coupled with the fact that winnings can be unpredictable and rare means that a key trait required for those in the industry is patience. Mary comments that, for small scale owners, to win a race is "a rare and dreamlike occasion", and indeed "if your horse ever arrives at the start, that is a huge success in itself".

The availability of tax 'trading' losses would be invaluable, providing an opportunity to save tax in other areas by reducing general income such as investment income. Yet whilst winnings from horseracing remain tax-free, losses are not available for use in this way. Indeed it is H M Revenue and Customs' (HMRC) awareness that there are far more losers than winners (monetarily) in this industry which presumably prevents a change in these rules.

However, this is not to say that it is impossible to make horseracing a taxable activity, and the exception to the above treatment is where commerciality can be proven. For example, racecourses, like many sporting arenas, can provide a good opportunity for high profile advertising. If a business sponsors a horse, using it as advertising (and importantly not entertaining), the expense can potentially be an allowable deduction, reducing taxable business profits. HMRC is likely to look closely at such expenditure. There are ways to demonstrate that the sponsorship is genuine and commercial, rather than, as HMRC may try to argue, as the business funding a director's hobby. Good examples include if the horse is named after the company/business that owns it (if complying with naming rules), and if the budget spent on the horse is in keeping with the company's previous advertising strategy and budget.

Possible contrary tax treatment of stud farming

Whilst it can be easy to assume that all activities connected to horseracing are tax-free and therefore not reportable, it is frequently the case that a racehorse owner is also involved in stud farming, which can be a trading activity and taxable in its own right.

HMRC offers a definition of stud farming as being "the occupation of land for the purpose of breeding thoroughbred horses,…a very expensive and high-risk activity. In some cases it may be carried on by wealthy individuals essentially as an adjunct to their racing activities. Nevertheless, for tax purposes it is treated as farming and thus……as the carrying on of a trade regardless of its commercial viability." (HMRC Business Income Manual 55701).

Despite the comment regarding "commercial viability", problems arise where HMRC view the activities as a hobby rather than a business. In acknowledgement of the difficulties newcomers to horse breeding have in generating profits, HMRC Policy Division agreed to extend the usual 5 years loss relief available to farmers for their initial set-up period to 11 years for stud farmers. However, this is only available if the business is at least "potentially" profit-making and The Thoroughbred Breeder's Association has stressed the importance of being able to demonstrate this point clearly. Legislation does include as a condition of the loss relief that there is a reasonable expectation of profits, and that the business is run on a commercial basis.

Difficulties can arise when HMRC's view of what constitutes a commercial business differs from that of the stud farmer. Where a stud farm breaches the legislative requirements from HMRC's point of view, but losses are still claimed, a potential Revenue challenge should be considered.

Dominic O' Connell, head of tax at Coutts, notes that, in his experience, the people in the 'industry' are usually "very driven due to a passion for the actual horses" but stresses that "it is imperative to closely monitor the financial side of the stud farming activities particularly as one very successful racehorse returning [to the stud] can dramatically change the whole complexion of the 'business' ".

In fact, due to the differing tax treatment, it is important to ensure that a clear division is made between the activities of horseracing and horse breeding, as interaction between the two can be strong.

Timing is an essential element of tax planning where both activities are pursued, and particular attention should be given to transfers of animals from the stud farm into race training or vice versa. Market value is the usual basis of such a transfer and due to the tax-free status of horseracing, an advantage can be obtained if the horse is worth more when returned to stud, as the increase in value accrues tax-free to the owner. Conversely, if the horse has decreased in value, there will be no allowance for the loss.

With so much to consider, it is important to ensure that individuals involved in horseracing and particularly stud farming activities take tax advice from the outset, to ensure that reliefs are maximised in what can be an expensive and demanding industry, albeit one which Mary still enthuses is a "permanent challenge…. exciting and exhilarating!"