Edited version of private advice

Authorisation Number: 1052099595314

Date of advice: 30 March 2023

Ruling

Subject: Section 8-1 deduction

Issue 1

Question 1

Is the amount lost by the taxpayer through a payment misdirection scheme (the Scheme) conducted by an unknown person, deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in the income year ended 30 June 20XX?

Answer

Yes

This ruling applies for the following period(s)

1 July 20XX to 30 June 20XX

The scheme commences on

XX XXX 20XX

Relevant facts and circumstances

The taxpayer is an Australian resident private company.

The taxpayer is in the business of providing services to the XXXX industry.[1]

Invoices were issued to the company by a supplier.

The purchase of the supplies was on revenue account and did not relate to the capital structure of the taxpayer's business.

An employee of the taxpayer received an email that purported to be from the original supplier of the goods, requesting that the amounts invoiced be paid into a new bank account (the Scheme Bank Account).

The employee paid the amounts invoiced into the Scheme Bank Account.

Payment of the invoices was part of the employee's duties.

The employee followed the required processes and obtained authority from management in making those payments.

The taxpayer's bank account (the bank account), from which these payments were made, included only deposits assessable to the taxpayer in the income year ended 30 June 20XX.

The payments were made from the overdraft facility linked to the bank account. The account was in overdraft at the time of each payment.

After the transfer it was realised the Scheme Bank Account details were provided through the Scheme, which involved compromise of the supplier's or the taxpayer's email system and was conducted by an unknown party.

None of the funds paid to the Scheme Bank Account have been recovered, and it is not anticipated that any will be recovered.

The taxpayer's business insurance policy does not cover these losses.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Issue 1

Question 1

Is the sum lost by the taxpayer through a payment redirection scheme conducted by an unknown party deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in the income year ended 30June 20XX?

Summary

Yes, the sum is able to be deducted by the taxpayer under section 8-1 of the ITAA 1997 in the income year ended 30 June 20XX as it is a loss incurred in connection with the carrying on of a business for the purpose of gaining or producing assessable income.

Detailed reasoning

Deduction under general provisions

Section 8-1 of the ITAA 1997

Section 8-1 of the ITAA 1997 allows a deduction for any loss or outgoing necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income however you cannot deduct a loss or outgoing to the extent the amount is a loss or outgoing of a capital, private or domestic in nature or a provision prevents it from being deductible.

Section 8-5 of the ITAA 1997 provides that an amount may also be deductible under another provision of the ITAA 1997 or the Income Tax Assessment Act 1936 (together, the Act). Where an amount is deductible as specific deduction under another provision, section 8-10 of the ITAA 1997 requires that you only deduct the amount under that specific provision only.

Subsection 8-1(1) of the ITAA 1997 states:

You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a ^* business for the purpose of gaining or producing your assessable income.

However, subsection 8-1(2) states that you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your exempt income or your non-exempt non-assessable income; or

(d) a provision of this Act prevents you from deducting it.

In this case, the relevant elements that need to be satisfied for the amount to be deductible under section 8-1 of the ITAA 1997, are as follows:

•        The loss is incurred;

•        There is the relevant nexus between the loss and the carrying on of a business for the purpose of gaining or producing assessable income;

• The loss is not of a capital or private or domestic nature;
• The loss is not incurred in gaining or producing exempt income or non-exempt non-assessable income.

The loss is incurred

The first requirement is that the loss is incurred.

A loss is incurred where it has been paid or where it has not been paid but results in a presently existing pecuniary liability.

Payments were paid from the taxpayer's bank account, which included only deposits assessable to the taxpayer, in the income year ended 30 June 20XX.

The payments were paid into a Scheme Bank Account, belonging to an unknown person.

The payments were not recoverable by the taxpayer.

As money was paid into a Scheme Bank Account by the taxpayer was not recoverable, a loss (arising from theft of the money) was incurred by the taxpayer for the purposes of section 8-1 of the ITAA 1997.

Relevant nexus between the loss and the carrying on of a business for the purpose of gaining or producing assessable income

Expenditure will generally be deductible under subsection 8-1 of the ITAA 1997 if its essential character is that of expenditure that has a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income, provided that the expenditure is not of a capital, private or domestic nature.

In Charles Moore & Co (WA) Pty Ltd v. FCT (1956) 95 CLR 344; 11 ATD 147 (Charles Moore Case) the High Court suggested that three questions determine the deductibility of losses caused by dishonesty under section 8-1 of the ITAA 1997:

(i)    Is the 'occasion of the loss' found in the income earning activities or business operations of the taxpayer?

(ii)   Is the nature or character of the loss of that 'kind of casualty, mischance or misfortune which is a natural or recognised incident' of the income earning activities or business operations? This was a reference to the comments of Rich J in Commissioner of Taxation (NSW) v Ash (1938) 61 CLR 263 (Ash's Case), at page 277.

(iii) Is the loss one of capital, or of a private, domestic or capital nature?

In the Charles Moore Case, the previous day's takings of the taxpayer's department store were stolen at gunpoint from two employees while on their way to the bank. The High Court allowed a deduction for the loss on the grounds that the act of banking takings was an integral part of the taxpayer's business activities and the risk of robbery was inherent to the act of banking.

Occasion of the loss

Taxation Ruling TR 95/33 provides guidance on relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings.

Paragraph 13 of TR 95/33 provides that in the case of a company, the relevant purpose is the corporate purpose. This requires an examination of the purpose, motive or intention of the company's directors, officers and employees.

It is understood that an email was received by the taxpayer, ostensibly from the supplier, for supplies used in the ordinary course of business. The email provided a new bank account (the Scheme Bank Account) and requested that payment for invoices issued be made to that account.

The employee, operating within their employment role, made total payments into the Scheme Bank Account.

The employee followed established procedures by obtaining authorisation to make the payments.

There is no known connection between the employee and the person or persons that conducted the Scheme.

In the given circumstances, objectively the sole purpose of the bank transfers by the employee was to pay invoices in the pursuit of assessable income (albeit that the employee was mistaken in doing so).

The act of making payment to a supplier in respect of outstanding invoices, for supplies used in the ordinary course of business, is considered an integral part of the taxpayer's business activities.

Natural or recognised incident' of the income earning activities or business operations

An inherent risk associated with making a payment to a supplier is paying an invoice which is falsified or contains incorrect information, because of a payment misdirection scheme.

As the taxpayer incurred a loss in making payments to a supplier, there is the relevant nexus between the loss and the carrying on of a business for the purpose of gaining or producing assessable income.

The loss is not of capital or private or domestic nature.

In relation to the issue of determining whether expenditure is of a revenue or capital nature, the decision of the High Court of Australia in Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 (Sun Newspapers) is the leading authority.

In Sun Newspapers, Dixon J stated that there are three matters to be considered when deciding whether expenditure incurred is revenue or capital:

i)     the character of the advantage sought;

ii)    the manner in which the advantage is to be used, relied upon or enjoyed by the taxpayer;

iii)   the means adopted to obtain the advantage, such as by recurring payments.

The character of the advantage sought provides the best guidance as to the nature of the expenditure because it says the most about the essential character of the expenditure itself. The decision of the High Court in G P International Pipecoaters Pty Ltd v Commissioner of Taxation (1990) 170 CLR 124 at 137 emphasised this stating:

The character of expenditure is ordinarily determined by reference to the nature of the asset acquired. For the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid: Sun Newspapers Ltd. and Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 at 363...

The advantage that the taxpayer sought in making the payments was an expectation that the payments would enhance its current business operations, on revenue account.

As each of the payments were incurred by the taxpayer in the operation of the business concerned with the regular inflow of revenue, and in the belief of staff that the payment was to satisfy the obligation to pay for supplies on revenue account (and not in relation to the profit yielding structure of the business), each payment is not of a capital nature.

In addition, as the money paid to the supplier was not appropriated by the taxpayer or any representative of the taxpayer for private or domestic purposes, the loss, resulting from the payment, is not of a private or domestic nature.

Neither is it in relation to gaining or producing your exempt or non-assessable non-exempt income.

The payments were made out of the taxpayer's bank account, principally used to deposit amounts assessable to the taxpayer and to pay operating expenses.

The losses resulting from those payments were incurred in the course off carrying on the business for the purpose of gaining or producing the assessable income of the taxpayer, and not in relation to producing exempt or non-exempt non-assessable income.

As the losses were not private or domestic in nature, in relation to gaining or producing exempt or non-assessable exempt income and not excluded by another provision of this Act, it is not excluded from being deductible under subsection 8-1(2) of the ITAA 1997.

Excluded from deduction under section 8-1 by another provision of the Act

There is no other provision which applies to the taxpayer to exclude a deduction under section 8-1.

Conclusion

As the losses were not capital, private or domestic in nature, not in relation to gaining or producing exempt or non-assessable exempt income, and not excluded by another provision of this Act, subsection 8-1(2) of the ITAA 1997 does not apply to disallow the loss from being deductible.

As there is the required nexus between the payments and the carrying on of the taxpayer's business and the loss is not excluded from deduction under subsection 8-1(2) of the ITAA 1997, the total payment is an allowable deduction to the taxpayer under subsection 8-1(1) of the ITAA 1997 in the income year ended 30 June 20XX.

[1] From the taxpayer's 2020 income tax return.

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).