• 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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Perram J

35. The question in this appeal is whether the appellant taxpayer is entitled to claim a deduction for money lost following its investment in what turns out to have been a fraudulent scheme, probably of the Ponzi variety. The scheme, whose precise mechanics were not fully laid bare in the evidence, was conducted by a rogue, Mr Shane Heffernan. This evidence suggested that Mr Heffernan was a sophisticated criminal and that the taxpayer was far from being alone in being gulled by him. In July and August 2001 the taxpayer made two investments in Mr Heffernan ' s scheme which totalled approximately $ 4.63 million. This was done by means of two electronic fund transfers to nominated bank accounts in Hong Kong.

36. Before the Administrative Appeals Tribunal ( " the Tribunal " ) there was considerable debate as to the nature of the taxpayer ' s " investment " . The Tribunal found, and it is not disputed, that the taxpayer ' s purpose in transferring the funds and dealing with Mr Heffernan was to derive profit both from trading and capital investment as opportunities presented themselves to Mr Heffernan. The Tribunal concluded, and it is not in dispute, that Mr Heffernan misappropriated the taxpayer ' s money shortly after each of the two electronic transfers were made.

37. Section 8-1 of the Income Tax Assessment Act 1997 (Cth) ( " the Act " ) is the general deduction provision. It provides:

• " (1) 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.
• (2) However, 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-assessable non-exempt income; or
  • (d) a provision of this Act prevents you from deducting it.
• For a summary list of provisions about deductions, see section 12-5.
• (3) A loss or outgoing that you can deduct under this section is called a general deduction.
• For the effect of the GST in working out deductions, see Division 27. "

(asterisks, notes and emphasis omitted)

38. Because the taxpayer ' s purpose in making the investments was the derivation of profit the Tribunal concluded that the first, positive, limb of s 8-1(1) of the Act was satisfied. However, it also concluded that the loss was of a capital nature with the consequence that it fell within the second, negative, limb of s 8-1(2)(a) and was, therefore, not available as a general deduction.

39. This conclusion flowed from the Tribunal ' s finding that the breadth and generality of the activities which Mr Heffernan portrayed to the taxpayer did not permit the taxpayer ' s deposit of $ 4.112 million to be characterised as a revenue item.

40. Essentially, so the Tribunal thought, the taxpayer ' s interest in the moneys advanced was in the nature of a capital investment and was not some kind of enterprise carried on in the course of gaining or producing assessable income by the taxpayer: cf.
Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation (1956) 95 CLR 344 at 349-350 . In an attempt to avoid the conclusion that the investment was capital in nature, the taxpayer had argued that he was carrying on business through or with Mr Heffernan, but the Tribunal was not persuaded that this was so.

41. The conclusion that the loss was capital in nature and not deductible under the general deduction provision then made relevant the taxpayer ' s alternate argument, with which this appeal is concerned, based on s 25-45 of the Act. It provides:

" 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. "

(asterisks and notes omitted)

42. The taxpayer ' s argument was straightforward. There was no debate that the requirements of subsection (a) and (b) were satisfied. Further, subsection (c) was satisfied because the taxpayer had included in his 2002 return an amount of $ 2,804.049 reflecting the exercise by the taxpayer of share options in the United States (which had netted a total of $ 5,608,099), and it was those proceeds of sale which had been electronically transferred to the accounts controlled by Mr Heffernan. In that sense the share sale profits were the money stolen by Mr Heffernan.

43. It is necessary then to turn to the language of s 25-45 itself. Because " assessable income " is a measure of money rather than money itself, it cannot literally be true that money is ever " included " in " assessable income " if the word is given its ordinary meaning of treating something as part of a whole. This suggests the presence of an ellipsis and a corresponding need to understand the expression " included in your assessable income " as meaning, in effect, returned as assessable income.

44. The Commissioner argued, and the trial judge accepted, that the money which was lost had to be the same as the money which was included in the assessable income. The contrary was not really argued before this Court. The question which arises is the highly artificial one of determining whether one sum of money is the same as another. To be clear, neither the word " same " nor the concept of " identity " appear in s 25-45 of the Act, but the need for an identity between the money lost and the money returned inevitably arises from the reference in subsection (c) to " the money " which, as a result of the definite article, can only refer to the word " money " when it first appears in the section.

45. The concept of two sums of money being the same is problematic. It is notorious that the meaning of " money " is mercurial both in law and economics. It extends from the simple concept of cash and coins through negotiable instruments and on to debts and other more obscure interests. Given that money is very often a medium of exchange it is particularly susceptible to changes in form. Cash, if placed by a depositor in a bank account becomes a debt; if a cheque is drawn the debt " becomes " a negotiable instrument and new debts and relationships arise. All of these, in some sense, represent the same money.

46. That observation ensures that the kind of " sameness " demanded by s 25-45 cannot be concerned only with the form that the money takes. This Court has previously determined that the section requires the money in question to be traceable. In
EHL Burgess Pty Ltd v Federal Commissioner of Taxation 88 ATC 4517 ; (1988) 80 ALR 639 ( " EHL Burgess " ) the Full Court, speaking of s 25-45 ' s predecessor, s 71 of the Income Tax Assessment Act 1936 (Cth), said (at 647):

" The section requires that there be a tracing of moneys so that what has been misappropriated can be identified with that which has been or is included in the assessable income. There is no deduction for all losses arising from misappropriation. "

47. Whilst I would agree that traceability is a necessary condition to establish the identity of two sums of money I do not think that it is always a sufficient one. I do not understand EHL Burgess to hold to the contrary. The difficulty in this case is to identify some stable criterion by which identity, in that sense, may be judged.

48. It is tempting, no doubt, to say that money must always maintain the same " nature " . But that concept is itself somewhat elusive. The Tribunal found that both the investments and the loss were capital in nature and that capital quality might, it could be thought, be contrasted with the " nature " of the money immediately before its investment. The learned trial judge went down this path and characterised the money included in the return as income and the money invested with Mr Heffernan as capital. Having that different quality the money, though traceable, could not be the same money. With respect, however, the money never had the quality of being income. This was for two reasons. First , it was in truth a capital receipt resulting from the disposal of a capital asset, namely, the shares resulting from the exercise of the United States share options. Such a receipt was not income according to ordinary concepts. It was returned in the taxpayer ' s assessable income only because s 102-5(1) of the Act required net capital gains to be so returned.

49. Secondly , even if that were not so, money does not ever partake of the quality of being income which, in truth, is but a measure of an amount of money derived. As a quantity, it is conceptually distinct from the revenue it gauges; it is the difference between the measure and the measured, between the number and the thing.

50. It follows that an approach to identity which focuses on the capital or revenue nature of the money which has been lost is likely to prove difficult to apply. A better approach is, I think, to ask whether the money has been used in a way which is other than interim. Had the proceeds of sale of the stock been stolen from the taxpayer ' s broker ' s account whilst awaiting the taxpayer ' s instructions, the holding by the brokers would have been, in that sense, interim. If the taxpayer himself had placed the money in his own cheque account whilst choosing between different investment options then that too would have been an interim use.

51. The taxpayer, however, was not using his money in such a way when he placed it with Mr Heffernan. That investment was a wholly new enterprise. Whilst it was true that the investment was derived, in a traceable form, from the money realised on the sale of the stock it was not the same money. Perhaps another way of reaching the same conclusion is to observe that the taxpayer ' s decision to invest the proceeds of one investment in another denied the possibility that the same money was at both ends of the transaction.

52. It is not, in that circumstance, necessary to deal with the Commissioner ' s alternative contention based on s 51AAA of the Income Tax Assessment Act 1936 (Cth).

53. Edmonds J is of the view that s 25-45 of the Act is limited in its operation to income derived by cash basis taxpayers on the receipt of money understood as cash or other ready means of exchange. There is, with respect, much to be said for this view. It is difficult to see, in practice, how the provision could practicably operate outside those circumstances. However, I would hesitate to close the door finally on that issue; the concept of money is perpetually evolving as are the frauds perpetrated to obtain it, and the enterprises in which those frauds occur.