Edited version of private ruling

Authorisation Number: 1011547499775

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Ruling

Subject: Deductibility of losses from share scam

1. Are you entitled to a deduction for money paid for the acquisition of shares that was misappropriated?

No.

2. Has there been a capital gains tax (CGT) event with regards to money paid for the acquisition of Company C shares that was misappropriated which would give rise to a capital loss?

Yes.

3. Has there been a CGT event with regards to money paid for the acquisition of all other shares that was misappropriated which would give rise to a capital loss?

No.

This ruling applies for the following period<s>:

Year ended 30 June 2009

Year ended 30 June 2010

The scheme commences on:

1 July 2008

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You subscribed funds for shares. The opportunities to subscribe for shares in various companies were offered to you on the basis that within a reasonable time these companies would be listed and traded on a Stock Exchange at values many times the initial subscription prices.

You invested a total of $A in A shares in Company A and a further $B in B shares in Company B.

You received an unsolicited telephone call advising that shares you held in Company A were unlikely to be of any value to you as 'it was unlikely that the company would be listed and publicly traded on a Stock Exchange in the foreseeable future. You were also advised that a client who wished to acquire the shares you held in Company A and Company B to assist that client in the mitigation of some taxation matters and that they would exchange those shares for shares in Company C, which is a large company whose shares are publicly traded.

The original basis of the transactions was that you would agree to exchange shares in Company A at $a per share and Company B for $b per share for C shares in Company C at $c per share. The effect of these transactions was to require from you a cash contribution of $Z, and you paid these funds.

You received telephone calls and emails advising that there was an error in the setting up of the transaction and that insufficient margin had been allowed within the transaction to satisfy regulations and that the quantity of Company A shares that you held was incorrect. The transaction was reset on the basis that the exchange would be based on Y Company A shares at a sale price of $y for a total value of $ in exchange for X shares in Company C at $x per share. This exchange would result in a shortfall of $W after allowing for the funds already paid and this amount would be margin lent to you so that there was no requirement to transmit additional funds. The Company C shares would be available to you to sell on market within four to six weeks of the exchange being completed.

You received telephone advice that each of the Company C shares involved in the transaction had options or warrants attaching to them on the basis of three options for each share permitting the holder to purchase additional shares at $v per share. (You independently contacted Company C and a representative of the company confirmed that there were in existence shares with warrants attached as per what you described). You were requested to make a payment of $U to pay for U Company C options in order to convert them to shares. These funds were paid.

There were subsequently many telephone calls and emails endeavouring to finalise these transactions so that you were in a position to sell the Company C shares. You were advised that for the transactions to complete you were obligated to pay tax on the value of the transfer. This was assessed $T. You advised that you did not have access to this amount of funds as your resources for funds had been virtually exhausted. You requested that the transaction be broken into several components so that you could pay a lesser amount and then use part of the Company C sale proceeds to fund the remainder of the transaction. This was ultimately agreed and you transferred $S.

You received a telephone call which advised that the previous transactions were all part of a bogus scheme and that the authorities were aware and had succeeded in freezing substantial funds in relation to these transactions. You were asked that you provide copies of all documentation of transfers of funds. You were told there would be a long delay before funds would be released and there would be no guarantee of a full refund.

You received another call with an alternative deal relating to the Company A Plus and Company B shares involving an exchange of these shares for Company P shares. The initial suggestion was to transfer A Company A shares at $r per share and Q Company B shares at $q per share (these shares had been consolidated since purchase) in exchange for P Company P shares at $p per share. You were advised that this transaction would be finalised by a 50% margin loan of $N and the balance of $N to be paid by you. You paid this amount.

A short time later you were contacted again and were advised that you had been the recipient of a two for one bonus issue of Company A shares, which meant that you had 3A shares rather than A shares. They wished to restructure the deal to trade the 3A shares at $m per share. The effect of this was to increase the number of P shares to L at $l per share. This increased the margin loan to $L and required you to pay an additional $K. There was a considerable delay before you were able to pay these funds as you had difficulty raising this amount. You finally paid it in two instalments.

Subsequent to completing these payments you were advised that there were taxes to be paid on the total value of the transfer amounting to $J. You raised these funds and prior funds by arranging and drawing down on various credit cards and paid them.

Later you were advised that the owner of the P shares wished to change the structure of the deal due to substantial increase in the traded price of P shares. They advised that they would credit back the shares at $l per share and then create a sale to you at $i per share and then guarantee to on sell the shares for you at $h per share. He requested that you pay an additional $G to finalise this transaction. You advised that you could not raise these funds. It was finally agreed that you should pay an additional $F and the advisor would fund the balance of the transaction. You paid this amount.

You pursued this matter for several weeks until you received advice from the Police advising that the advisor was a bogus company and that your funds were most likely lost.

In a separate situation you received an unsolicited telephone call offering to acquire from you AA shares in Company AA at $aa per share in exchange for BB shares in Company BB at $bb per share. This required you to pay $CC difference, which you paid. The basis of the deal was that the BB shares would be on sold at $dd per share, within one month of the transactions being finalised.

Subsequently you received a telephone call advising that there were warrants attaching to these shares that enabled you to pay an additional $ee per share. You advised that you did not have funds available to complete this transaction. You were then advised that the advisor would fund the balance of the transaction if you paid a further $FF. You paid these funds. Subsequently you have been advised that the advisor is a bogus company and that the principals have disappeared and there is no likelihood recovery of any of these funds.

You received an unsolicited telephone call offering to purchase for your shares in Company AAA on the basis that there was to be a share buyback occurring in the near future at a considerably higher price compared to the current market price.

You agreed for them to buy AAA shares in Company AAA at $aaa per share and paid $BBB. Subsequently you were advised that the company was only buying back blocks of shares in multiples of 5AAA shares. You were advised to purchase an additional 4AAA shares, which were offered at $CCC. You advised you could not afford to pay for 4AAA shares. The advisor then offered to 50% margin loan for the 4AAA shares and you paid a net amount of $DDD.

You were advised that a sale of all shares at $EEE had been arranged, but subsequent to that contact was lost. The listed telephone number no longer answered and emails you sent were not replied to. The last telephone call you had from a representative of the company apologised for the delay in sale and settlement and assuring you it was imminent. The Police notified you that the advisor had been added to their list of fraudulent firms.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 8-5

Income Tax Assessment Act 1997 Section 25-45

Income Tax Assessment Act 1997 Subsection 102-10(2)

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Paragraph 104-25(1)(b)

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Paragraph 108-5(1)(b)

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Section 25-45 of the Income Tax Assessment Act 1997 (ITAA 1997) provides a deduction for a loss incurred through theft, stealing, embezzlement, larceny, defalcation or misappropriation by an employee or agent of the taxpayer. The loss must be in respect of money which has been included in the taxpayer's assessable income and must be discovered in the income year in which the deduction is claimed.

You are not entitled to a deduction under 25-45 of the ITAA 1997 because the losses are not in respect of money which has been included in your assessable income.

If a loss caused by theft, stealing, and so on, is not deductible under section 25-45 of the ITAA 1997, it may still be deductible under section 8-1 of ITAA 1997, the general deduction provision, provided the loss caused by the relevant criminal action represents 'that kind of casualty, mischance or misfortune which is a natural or recognised incident of a particular trade or business' (C of T (NSW) v. Ash (1938) 61 CLR 263, per Rich J at p 277).

Case law supports our finding that the loss, if due to misappropriation, is not deductible under section 8-1 of the ITAA 1997 but is capital in nature.

In AAT Case 4069 (1988) 19 ATR 3117; 88 ATC 244 the taxpayer company, at the suggestion of its solicitor, entrusted moneys to that solicitor as its agent for the purposes of acquiring gold bullion and its immediate pre-arranged re-sale at a profit. However, the solicitor misappropriated the money in advance of the proposed scheme. The company claimed as a deduction the loss incurred as a result of its dealings with the solicitor.

Mr P M Roach, Senior Member, determined that a deduction was not allowed because the taxpayer proposed to embark on a course of action intended to produce a profit and the sum of money to be invested in that project was capital as it was to provide the profit-making structure. The act of misappropriation by the solicitor occasioned the loss, not any dealing in bullion.

In a New Zealand case, Calkin v. IRC (1984) 7 TRNZ 100, the taxpayer engaged the services of an agent to conduct investments. The taxpayer paid the agent considerable sums to be invested on his behalf. Whilst the taxpayer did not sight evidence that investment transactions had taken place, he received approximately half of his initial capital investment by way of profits on his investment. In reality no investments were made by the agent who was subsequently imprisoned as a consequence of the misappropriation of the taxpayer's (and others) funds. The New Zealand Court of Appeal confirmed the earlier judgment of the High Court which concluded there was no evidence to suggest that business by way of investment activity had commenced. The Court of Appeal concluded that the taxpayer's losses were of a capital nature and were not incurred in the course of carrying on a business.

The view that a loss due to possible misappropriation is not deductible but is capital in nature is supported by Income Tax Ruling IT 2228. Although IT 2228 deals specifically with futures transactions, the same principals can be applied to any transaction involving the use of a broker or investment adviser. IT 2228 states at paragraph 36:

Furthermore, it seems that there may be a number of cases where taxpayers engaged in futures transactions may have incurred losses not from futures contracts themselves but from futures brokers or dealers acting in a fraudulent manner. In managed accounts, for instance, a taxpayer may have deposited $20,000 with a broker to enter into futures contracts on the taxpayer's behalf. The taxpayer may be advised by the broker at a relevant time that losses amounting to $10,000 have been suffered. In fact, the losses will not have been incurred from genuine futures transactions. They may be incurred from fictitious transactions and, in some cases, from misappropriation of the taxpayer's funds. It is difficult to say the losses incurred in these circumstances are losses incurred in carrying on a business or in carrying out a profit-making undertaking or scheme. They have more the character of losses of capital. Claims for deduction for losses incurred in these circumstances should be disallowed.

Therefore, you are not entitled to a deduction for the amount invested in shares where the amounts were misappropriated.

Capital gains tax

You had entered into a contract to buy and sell shares. Payments were made based on information provided to you.

As a result of entering into this arrangement, it is considered that you acquired contractual rights. These contractual rights are CGT assets (paragraph 108-5(1)(b) of the ITAA 1997).

CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied (paragraph 104-25(1)(b) of the ITAA 1997).

In DTR Nominees Pty Ltd v. Mona Homes Pty Ltd (1978) 138 CLR 423 it was recognised that a contract can come to an end merely by being treated as being at an end by the parties. It was held in Fitzgerald v. Masters (1956) 95 CLR 420 at 432 that:

Where an 'inordinate' length of time has been allowed to elapse, during which neither party has attempted to perform, or called on the other to perform, it may be inferred that the contract has been abandoned. ... What is really inferred in such a case is that the contract has been discharged by agreement, each party being entitled to assume from a long-continued ignoring of the contract on both sides that (in the words of Rowlatt J.) "the matter is off altogether".

You received unsolicited telephone calls in relation to the exchange of shares you held plus cash payments with shares in overseas companies. The first transaction involved the transfer of your shares for shares in Company C. During the process of this transaction you received a phone call informing you that it was a scam. You were also offered a different exchange for your shares. As you accepted this second offer, you have abandoned the original contract to exchange your shares with those in Company C with the effect that the contract was discharged (subsection 104-25(2) of the ITAA 1997) and CGT event C2 happened. You did not receive any proceeds from this event. Accordingly, you will make a capital loss as the capital proceeds are less than the asset's reduced cost base (subsection 104-25(3) of the ITAA 1997).

Subsection 102-10(2) of the ITAA 1997 provides that you cannot deduct from your assessable income a net capital loss for any income year. However, it can be applied against your capital gains for a later income year.

For the other transactions, you have received advice from the relevant authority that all of the entities involved are bogus and undertaking fraudulent activities. There is no evidence that you have abandoned these contracts, accordingly, CGT event C2 has not happened in relation to these and no capital loss can be claimed.

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