Edited version of private ruling

Authorisation Number: 1011788923330

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Ruling

Subject: Deductions

Questions and answers:

Are you entitled to a reduction to your individual income tax rate?

No.

Are you entitled to a deduction for losses you sustained when money you sent overseas was stolen?

No.

Has any capital gains tax event occurred to enable you to make a capital loss?

Yes.

This ruling applies for the following period:

1 July 2008 to 30 June 2011.

The scheme commenced on:

1 July 2008.

Relevant facts:

You are a resident of Australia for taxation purposes.

You withdrew money from your bank account and remitted to a person based overseas who convinced you to invest money with him for the purpose of futures trading. You subsequently found that you been defrauded of this money.

The perpetrator has been caught and jailed overseas.

A lawyer has advised you that the money you lost cannot be recovered so you have abandoned any legal action against the perpetrators.

Relevant legislative provisions:

Income Tax Rates Act 1986 Section 12(1).

Income Tax Rates Act 1986 Schedule 7, Part 1.

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Section 8-1.

Income Tax Assessment Act 1997 Section 25-45.

Income Tax Assessment Act 1997 Section 102-5.

Income Tax Assessment Act 1997 Section 102-10.

Income Tax Assessment Act 1997 Section 102-20.

Income Tax Assessment Act 1997 Section 104-5.

Income Tax Assessment Act 1997 Section 104-25.

Income Tax Assessment Act 1997 Section 108-5.

Income Tax Assessment Act 1997 Section 110-25.

Income Tax Assessment Act 1997 Section 110-55.

Income Tax Assessment Act 1997 Section 116-20.

Reasons for decision

Assessable income and tax rates - general

Income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that if you are a resident of Australia for taxation purposes, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Salary and wages, interest and rent are all examples of ordinary income.

Section 6-10 of the ITAA 1997 provides that the assessable income of a resident taxpayer will also include amounts of statutory income. These are amounts that are not ordinary income but which are included in your assessable income by other provisions of the tax law.

Capital gains are an example of statutory income and are included in a taxpayer's assessable income under the provisions of section 102-5 of the ITAA 1997.

Tax rates

The rates of tax applicable to individual taxpayers who are residents of Australia for taxation purposes are prescribed by law in Schedule 7 of the Income Tax Rates Act 1986.

For individuals who were residents of Australia for tax purposes in the 2010 income tax year, the applicable tax rates were as follows:

The following rates are applicable for individuals who are residents of Australia for tax purposes in the 2011 income tax year:

There is no provision in the tax law for these prescribed rates of tax to be reduced for individual taxpayers. Accordingly, you are not entitled to a reduction in your individual income tax rate.

General deductions

The general deduction provisions of the tax law are contained in section 8-1 of the ITAA 1997 which allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, or in carrying on a business to gain or produce assessable income. Deductions are not allowed under section 8-1 of the ITAA 1997 if the outgoing for which a deduction is sought is capital, private or domestic in nature.

Taxation Ruling IT 2228 Income tax: Futures Transactions provides guidance on the nature of losses incurred by a taxpayer in circumstances where the loss is caused by a futures broker or dealer acting in a fraudulent manner, or by the misappropriation of the taxpayer's funds. Taxation Ruling IT 2228 specifies that losses sustained in such cases are capital in nature.

In your case, the actions of the individual in stealing your money amount to the misappropriation of your funds. As stated above, such losses are capital in nature and not deductible under section 8-1 of the ITAA 1997.

Deductions for loss by theft, stealing, embezzlement, larceny, defalcation or misappropriation

Section 25-45 of the ITAA 1997 provides a specific deduction for a loss incurred by a taxpayer through theft, stealing, embezzlement, larceny, defalcation or misappropriation by an employee or an agent of the taxpayer.

There are several conditions which must be met for a deduction to be allowed under section 25-45 of the ITAA 1997. One of these conditions is that the loss must be in respect of money which has been included in a taxpayer's assessable income. If this condition is not met, no deduction is allowable under section 25-45 of the ITAA 1997, regardless of whether or not the other conditions are met.

The requirement for an amount to be included in a taxpayer's assessable income for a deduction to be allowable under section 25-45 of the ITAA 1997 was discussed in EHL Burgess Pty Ltd v. Federal Commissioner of Taxation (1988) 88 ATC 5417; (1988) 19 ATR 1407 (EHL Burgess) where it was made clear that:

'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 deduction under section 25-45 of the ITAA 1997'.

It was further explained in EHL Burgess that where the loss occurs after the derivation of the income, the lost money's identity as 'assessable income' must not have been 'obliterated'.

In other words, if money returned at some point by a taxpayer as assessable income (salary and wages from employment for example) is deposited by the taxpayer into a mortgage or a line of credit facility, the character of that money is irretrievably altered because of its assimilation into the taxpayer's general finances. The money is no longer identifiable as assessable income. Instead, the money simply becomes part of the balance of funds available for the taxpayer to either redraw from their mortgage, or to draw down on their line of credit. As a result, the money's identity as assessable income has been obliterated and any later theft or misappropriation of that money will not result in an allowable deduction under section 25-45 of the ITAA 1997.

In your case, you sent money to an individual who subsequently stole that money. Although the lost money may have been earned by you at some point and previously declared as assessable income, any character that money had as income was lost when it was paid into your bank account and became capable of being withdrawn at a later stage.

You are not entitled to a deduction under section 25-45 of the ITAA 1997 for the lost amount because the lost amount cannot be said to be an amount that was included in your assessable income.

Capital gains tax

Paragraph 108-5(1)(b) of the ITAA 1997 includes legal rights in the definition of capital gains tax (CGT) assets. Accordingly, a legal right to sue another individual for a loss is a CGT asset.

In your case, we consider that you have a legal right to sue the perpetrators of the theft of your money to recover your loss and that right is a CGT asset.

When a CGT event happens to a CGT asset that you own, you make either a capital gain or loss at the time of the event.

You make a capital gain if the capital proceeds (the amount you received, or are entitled to receive from the CGT event) are more than the asset's cost base. You make a capital loss if the capital proceeds are less than the reduced cost base of the asset.

The five elements that make up the cost base of a CGT asset are:

· The first element: money or property given for the asset.

· The second element: incidental costs of acquiring the asset or that relate to the CGT event.

· The third element: costs of owning the asset.

· The fourth element: capital costs to increase or preserve the value of your asset or to install or move it.

· The fifth element: capital costs of preserving or defending your ownership of or rights to the asset.

The reduced cost base of a CGT asset has the same five elements as the cost base, except for the third element which is replaced by a balancing adjustment relating to certain depreciating assets, but not to assets such as a right to sue.

If, as a result of a CGT event, you have a net capital gain in an income year, that net capital gain is included in your assessable income and you are taxed on that gain at your marginal tax rate.

Your net capital gain is:

your total capital gains for the year

minus

your total capital losses for the year and any unapplied net capital losses from earlier income years

minus

any CGT discount and small business CGT concessions to which you are entitled.

If your total capital losses for the income year are more than your total capital gains, the difference is your net capital loss for the year.

You cannot deduct capital losses or a net capital loss from your income. However, you can carry forward a net capital loss to later income years to be deducted from future capital gains.

CGT event C2 - cancellation, surrender and similar endings

To determine if you have made a capital gain or loss, it is necessary for us to determine whether or not a CGT event has happened to your right to sue.

CGT event C2 in section 104-25 of the ITAA 1997 happens if your ownership of an intangible CGT asset (such as a right to sue) ends in certain ways, including because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited. The time of the event is when you enter into the contract that results in the asset ending. If there is no contract, the event happens when the asset ends (subsection 104-25(2) of the ITAA 1997).

In your case CGT event C2 is relevant in respect of your right to sue the individual for stealing your money.

You have stated that you have abandoned legal action against the perpetrator because you have been advised by your lawyer the lost money cannot be recovered. Accordingly, we consider that you have abandoned your right to sue to recover this loss and that as a result, CGT event C2 happened in relation to your right to sue.

The time of the event was when you made the decision not to pursue legal action.

In this case, you will have made a capital loss equivalent to the reduced cost base of the asset.

The first element of your reduced cost base will be the Australian dollar equivalent of the total amount of money you lost.

Conclusion

You are not entitled to a reduction in the rate of income tax you pay.

You are not entitled to a deduction for the amount of money you lost when money you sent overseas was stolen.

Your right to sue the perpetrator to recover the money you lost is a CGT asset.

CGT event C2 happened when you made the decision to abandon your right to sue the perpetrator of the theft of your money.

You have made a capital loss equivalent to the reduced cost base of the asset.

You are not entitled to deduct a capital loss against your income but you can use it to reduce your capital gains for the income year in which the loss happened. If the result is a net capital loss for the year, you are entitled to carry the loss forward to reduce capital gains made in future years.