Edited version of your written advice

Authorisation Number: 1012840346109

Date of advice: 15 July 2015

Ruling

Subject: Deductibility of misappropriated funds

Question and answer

Are you entitled to a deduction for theft by a person, other than an employee or agent, under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No.

This ruling applies for the following periods:

Year ended 30 June 200X

Year ended 30 June 200X

The scheme commences on:

1 July 200X

Relevant facts and circumstances

You are a Director of the company trustee of a family trust and a beneficiary of the trust.

You established the trust to engage in share trading activities.

Following discussions with a relative, you withdrew funds from a bank account and transferred them overseas to what you were told was the bank account of a share broker.

You have not received any return on the funds you transferred and believe you have been defrauded.

You made a statement (copy provided) to the Australian police in relation to the funds you transferred and how you believed you had been defrauded.

The statement details various conversations you had with your relative about certain investments and how and when you transferred the funds.

In the statement, you contended that you knew nothing about investing in the share market.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

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.

In your application, you assert that you were running a business of share trading at the time of your losses.

There is no one rule that determines if you are in business; however, the following are indicators that you may be:

• You have made a decision to start a business and have done something about it such as registered a business name or got an ABN.

• You intend to make a profit or genuinely believe you will make a profit from the activity, even if you are unlikely to do so in the short term.

• You repeat similar types of activities.

• The size or scale of your activity consistent with other businesses in your industry.

• Your activity is planned, organised and carried on in a businesslike manner.

This may include:

• Keeping business records and account books

• Having a separate business bank account

• Operating from business premises

• Having licenses or qualifications

• Having a registered business name.

To support your contention that you were engaged in a share trading business, you have provided the following information:

• You partnered up with professional full time share traders so you could develop your skills to make a quick profit and put in place efficient systems to execute trades.

• You purchased software systems to purchase and monitor the trades in a timely manner.

• You attended numerous seminars on how to trade shares and investments for a profit.

• You were not working and were relying on growing the share trading activities of the trust to derive revenue. 

• Your intention was to multiply wealth via the share markets. Your intention was to continually invest the profits back into the business.

• You had strategies in place before you executed the trades.

• Your main intention was to buy, hold for a very short time and sell at a profit.

• You had a mentor who claimed that they were an expert.

• You believed that you would make considerable profit running the business so you set up a new tax structure from the beginning to accommodate this.

• You undertook research on what would be the most cost saving brokers to use for conducting the trades.

• You had been provided with a detailed summary of the businesses that you were investing in, looking at market conditions, market segments, past performances, business statistics, market shares and more.

• The basis of all decision making was conducted on the basis of going after short term profits as opposed to long term holding profits.

• Having realised you had been defrauded you lost the desire and urge to continue trading.

In your case, you made bank transfers to an overseas entity on the basis of advice from a relative. At the time of making the police statement, you stated that you knew nothing about investing in the share market.

Consequently, from the information provided, we do not see how your actions at the time could be construed as running a business. You merely transferred funds overseas after discussions with another person and had the same goal as any investor, to make a satisfactory return on your investment.

Therefore, despite your assertions to the contrary, we do not consider that you were engaged in the business of share trading at the time you transferred the funds.

Taxation Ruling IT 2228 Income tax: Futures Transactions (IT 2228) 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.

It is stated in paragraph 36 of IT 2228 that losses sustained in such cases are capital in nature

They may be incurred from fictitious transactions and, in some cases, from misappropriation of the taxpayer's funds. It is difficult to say the losses incurred in these circumstances are losses incurred in carrying on a business or in carrying out a profit-making undertaking or scheme. They have more the character of losses of capital. Claims for deduction for losses incurred in these circumstances should be disallowed.

In your case, the actions of the persons defrauding you of your funds amount to the misappropriation of your funds by those persons. Such losses are capital in nature and not deductible under section 8-1 of the ITAA 1997.

Additional information

You make a capital gain or capital loss only if a CGT event happens. The gain or loss is made at the time of the CGT event.

In the case of fraud or embezzlement, the relevant CGT asset will be the right to sue the persons responsible for stealing your money.

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 when the asset 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, the time of the event will be when you formally abandon your right to pursue legal action.