• The impact of this case on ATO policy is discussed in Decision Impact Statement: Lean v Commissioner of Taxation (Published 21 September 2010).

LEAN v FC of T

Judges: Emmett J

Edmonds J
Perram J

Court:
Full Federal Court, Sydney

MEDIA NEUTRAL CITATION: [2010] FCAFC 1

Judgment date: 28 January 2010

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Edmonds J

26. I have had the advantage of reading a draft of the reasons for judgment of Emmett J. I agree with his Honour ' s conclusion that the appeal should be dismissed for the reasons his Honour gives. I merely want to add some observations of my own on the scope of s 25-45 of the Income Tax Assessment Act 1997 ( " the 1997 Act " ) and its application to the facts of a case such as this.

27. His Honour ' s reasons and conclusion are predicated on what a Full Court of this Court said in
EHL Burgess Pty Ltd v Federal Commissioner of Taxation 88 ATC 4517 ; (1988) 80 ALR 639 at 647 :

" If income, when received, has been used to pay off the taxpayer ' s debts and so has left the taxpayer ' s hands, there can be no misappropriation of or in respect of that money. The benefit arising from the reduction in the liabilities of the taxpayer cannot be the subject of a relevant misappropriation. Likewise, income which has been or is to be included in the assessable income of a taxpayer, but has been dealt with in such a way that it has become mingled generally in the finances of the taxpayer and can no longer be traced or identified as income of that description cannot be the subject of a s 71 deduction. The section requires that the misappropriation be of or in respect of money that is or has been included in assessable income. That criterion must be established on the facts of the case. It should perhaps be added that the criterion may be established (as is demonstrated by the words ' or has been ' ) although the loss has occurred after the derivation of the income, provided the identity of the money lost as assessable income has not been obliterated. "

28. What the Full Court said is undoubtedly correct.

29. The Court was there dealing with s 71 of the Income Tax Assessment Act 1936 ( " the 1936 Act " ) which, at the relevant time, read:

• " 71 Where a loss incurred by the taxpayer through embezzlement, larceny, defalcation or misappropriation by a person, including an agent, employed by the taxpayer, not being a person employed solely for private or domestic purposes, of, or in respect of, money that is or has been included in the assessable income of the taxpayer is ascertained in the year of income, that loss shall be an allowable deduction. "

30. Section 25-45 of the 1997 Act now reads:

" You can deduct a loss in respect of money if:

• (a) you discover the loss in the income year; and
• (b) the loss was caused by theft, stealing, embezzlement, larceny, defalcation or misappropriation by your employee or * agent (other than an individual you employ solely for private purposes); and
• (c) the money was included in your assessable income for the income year, or for an earlier income year.

• Note: If you receive an amount as recoupment of the loss, the amount may be included in your assessable income: see Subdivision 20-A. "

31. Clearly s 25-45, like its predecessor s 71, requires an identity between the money misappropriated and the money included in assessable income. On the other hand, in many cases, certainly for accruals basis taxpayers, it will not be money that is included in assessable income but the amount of a receivable. The subsequent discharge of that receivable by the payment of currency or the delivery of a bill of exchange is not included in the assessable income of such a taxpayer. In my view, there is no room for the operation of s 25-45 in such cases because the money that is misappropriated, whatever it is, cannot be money which has been included in the assessable income.

32. What is said in the preceding paragraph presupposes that, for the purposes of s 25-45, the term " money " extends beyond currency and encompasses modern mediums of money exchange such as cheques and other negotiable instruments. In this day and age, I think that must be the preferable construction.

33. Equally, where as here, a taxpayer makes a capital gain from the disposal of an asset (CGT Event A1), it is not money that is included in his assessable income but an amount calculated by reference to the provisions of Part 3-1 of the 1997 Act starting with the capital proceeds from the disposal and the cost base of the asset. Money equal in amount to the amount of the capital proceeds may well be received by the taxpayer; indeed, in most cases, will be received, but that money is not included in the assessable income of the taxpayer. If that be right, then the money misappropriated on the facts of the present case, could never give rise to an allowable deduction under s 25-45.

34. The point of these observations is that, in my view, s 25-45 has an extremely limited field of operation; it is limited to income derived by cash basis taxpayers by the receipt, actual or constructive, of money, in the sense referred to in [ 32 ] above, where the same money is lost in and through circumstances which trigger the application of the section.