Edited version of private advice

Authorisation Number: 1012681317562

Ruling

Subject: Deductions

Question

Are you entitled to a deduction for misappropriated amounts?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commenced on

1 July 2010

Relevant facts and circumstances

You are a one director, one shareholder private company small business entity (Company).

It was discovered that an employee of the Company had been falsifying invoices to overstate the amounts owing to mainly the larger suppliers of the business. The employee had then been transferring these overstated amounts into their own bank account as part of the electronic bank transfers to the actual suppliers.

Once discovered another employee of the Company determined the extent of the misappropriated amounts.

All affected BAS returns for the periods involved were amended and the over claimed GST was repaid.

The Company's income tax returns had been lodged prior to the discovery of the misappropriated amounts and the amounts in question having been claimed as a tax deduction as part of the materials expense.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Section 8-1 of the 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 purposes 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.

To be entitled to a tax deduction under section 8-1 of the ITAA1997 the loss would have to be incurred in carrying on a business for the purposes of gaining or producing assessable income.

In Charles Moore & Co (WA) Pty Ltd v. Federal Commissioner of Taxation (1956) 95 CLR 344; (1956) 11 ATD 147; (1956) 6 AITR 379 (Charles Moore) the High Court held that, as the daily banking of takings by a department store was an ordinary part of its income-producing activities, the loss of the takings by armed robbery en route to the bank was deductible as a loss incurred in gaining or producing assessable income. The Court referred to the following statement by Rich J in Commissioner of Taxation (NSW) v. Ash (1938) 61 CLR 263 at 277; (1938) 5 ATD 76; (1938) 1 AITR 447:

There is no difficulty in understanding the view that involuntary outgoings and unforeseen or unavoidable losses should be allowed as deductions when they represent that kind of casualty, mischance or misfortune which is a natural or recognized incident of a particular trade or business the profits of which are in question. These are characteristic incidents of the systematic exercise of a trade or the pursuit of a vocation.

The Court in Charles Moore held (at CLR 351) that the loss was not on capital account: 'we are here dealing with a loss incurred in an operation of business concerned with the regular inflow of revenue, not with a loss of or concerning part of the "profit yielding subject".'

For the same reasons as given by the Court in Charles Moore, the loss of your money through misappropriation perpetrated by your employee was incurred in an operation of business not with a loss of or concerning part of the profit yielding subject.

Therefore the loss to you through the misappropriation of funds is deductible