Edited version of private advice

Authorisation Number: 1051812926345

Date of advice: 04 March 2021

Ruling

Subject: CGT - losses (investment)

Question

Are you entitled to a deduction for the money you lost in the scam?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You entered into an arrangement which you thought was an investment.

To fulfill your obligations under the arrangement you provided funds to the other party.

The other party did not do anything to fulfill their obligations under the agreement.

You continuously followed up with them; however, you could not recover your money.

The other party was declared bankrupt.

It was later revealed that the other party had scammed others in similar arrangements. They were later prosecuted and imprisoned for these scams.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income except to the extent they are losses or outgoings of capital or of a capital, private or domestic nature.

Case law has found 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.

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. In IT 2228 the Commissioner discusses the income tax implications of the various aspects of futures trading. Paragraph 36 deals with losses sustained as a result of fraudulent action of futures brokers or dealers. While your case does not involve a broker or dealer of futures, the same principles apply.

The Commissioner states:

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 case, 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 deductions for losses incurred in these circumstances should be disallowed.

In your case, although it was your intention to make an investment, no income earning activity actually commenced. The funds you gave to the other party have the character of a loss or outgoing which is of a capital nature rather than a revenue nature. As the loss is capital in nature, you are not entitled to a deduction under section 8-1 of the ITAA 1997.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).