Edited version of your written advice

Authorisation Number: 1013056815547

Date of advice: 20 July 2016

Ruling

Subject: Capital loss

Questions and answers

Can you claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in the # income year, for the loss you sustained in a foreign investment company which turned out to be a fraudulent company?

No.

Can you claim a capital loss in the # income year, for the loss you sustained in a foreign investment company which turned out to be a fraudulent company?

Yes.

Can you claim a deduction under section 25-45 of the ITAA 1997 in the 2013-14 income year, for the loss you sustained in a foreign investment company which turned out to be a fraudulent company?

No.

This ruling applies for the following period

Year ending 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts

On 27 February 2014 you opened an account with an agent.

That agent proposed to act as your options trading and investment agent.

From # until # you made the following transactions:

# transferred $ for options trading

# transferred $ for options trading

# transferred $ for options trading

# transferred $ for options trading

# transferred $ for options trading

# your relative transferred $ on your behalf for options trading

On # you were informed by your agent that they were bankrupt and your money had been lost.

The money that was lost had been included in your assessable income over several years and was funded from your bank account.

On # you reported the loss to the Australian Competition and Consumer Commission.

On # you received a letter from the Australian Securities and Investment Commission advising that the Securities and Futures Commission of # are conducting an investigation into the owners of the bank accounts you transferred money into.

Assumptions

None

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1.

Income Tax Assessment Act 1997 section 108-5.

Income Tax Assessment Act 1997 paragraph 108-5 (1)(b).

Income Tax Assessment Act 1997 section 104-25.

Income Tax Assessment Act 1997 subsection 104-25(3)

Income Tax Assessment Act 1997 section 116-30.

Reasons for decision

Allowable Deductions

Section 8-1 of the ITAA 1997 allows a deduction from your assessable income for 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.

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

d) a provision of ITAA 1997 prevents you from deducting it.’

Are you carrying on a business?

Whether a business is being carried on depends on the 'large or general impression gained' (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548) from looking at all the indicators of carrying on a business, and no one indicator will be decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). These indicators are described in Taxation Ruling TR 97/11. Outlined below are matters that would generally be taken into account in weighing-up the indicators to establish whether a taxpayer is carrying on a business.

General indicators of a business:

Significant commercial purpose or character

This indicator generally covers aspects of all the other indicators. The business should be carried out on such a scale and in such a way as to show it is being operated on a commercial basis and in a commercially viable manner and that the taxpayer's involvement in the activity is capable of producing a tax profit.

Purpose and intention to engage in business and nature of the activities

The taxpayer should be able to demonstrate an intention to derive assessable income from the business activity. A taxpayer should also be able to demonstrate that appropriate activities have been carried out by that taxpayer, or on the taxpayer's behalf, to allow this to occur.

Intention to make a profit and prospect of profits

The taxpayer's involvement in the business activity should be motivated by wanting to make a tax profit and the taxpayer's activities should be conducted in a way that facilitates this. This will require examining whether objectively there is a real prospect of making such a profit from participating in the business, that is, from the carrying on of a business of that taxpayer.

Repetition and regularity

The taxpayer's activities should involve repetition and regularity and have an air of permanence about them.

Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business

The taxpayer's activities or those conducted on the taxpayer's behalf should, unless circumstances dictate otherwise, be based around business methods and procedures of a type ordinarily used in ventures that would commonly be said to be businesses. The activities should be carried out using accepted practices.

Organisation, systematic, business like manner

The activities conducted by, or on behalf of the taxpayer, should be carried out in a systematic and organised manner. This will usually involve matters such as the keeping of appropriate business records by the taxpayer. If someone else carries out the activities on the taxpayer's behalf, there should be regular reports provided to the taxpayer on the results of those activities.

The size and scale of the activity

The business should be large enough to make it commercially viable.

Hobby or recreational pursuit

There is a hobby when

● it is evident there is no intention to make a profit from the activity

● losses are incurred because the activity is motivated by personal pleasure and not to make a profit

● there is no system to allow a profit to be produced in the conduct of the activity, and/or

● there is an intention by the taxpayer to carry on a hobby, a recreation or a sport rather than a business.

After weighing up the above indicators of whether a business is being is carried on against the information you have provided, the overall impression gained is that your activity was not carried on as a business for income tax purposes. The activity was carried on in a similar manner to that of an investor or speculator in that:

● you had no business or trading plan

● you mainly relied on advice from others to make your investment decisions

● you spent a limited amount of time on the activity

● you did not actually participate actively in the activity

● your activities mainly amounted to transferring funds to a supposed overseas account

● there was no real prospect of making a profit, and

● your actual activities were not carried out in a similar manner and was not based around business methods of a type ordinarily used in ventures that would commonly be said to be businesses.

In view of the above, we consider that the loss is not deductible as a business expense under section 8-1 of the ITAA 1997.

Isolated transaction

The term 'isolated transaction', in relation to a non-business taxpayer refers to any transaction entered into by the taxpayer. Taxation Ruling TR 92/4 discusses the circumstances under which losses from isolated transactions are deductible for income tax purposes. A loss from an isolated transaction entered into by a non-business taxpayer is regarded as deductible under section 8-1 of the ITAA 1997 if:

(i) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain, and

(ii) the transaction was entered into, and the loss was made, in the course of carrying out a commercial operation.

In your particular case, the information you have provided indicates that you had an intention to make a profit when you entered into the activity. However, we do not accept that the loss was made in the course of carrying out a commercial operation. We consider that, as the activity was fraudulent and fictitious, there was not bona fide commercial operation. As such, we consider that the loss is not deductible under section 8-1 of the ITAA 1997 and that it is capital in nature.

Capital loss

A Capital Gains Tax (CGT) asset under section 108-5 of the ITAA 1997 is any kind of property, or a legal or equitable right that is not property. It also includes part of, or an interest in, property or a legal or equitable right that is not property. Examples include land and buildings, debts owed to a taxpayer, or a right to enforce a contractual obligation. Generally you make a capital gain or a capital loss if a CGT event happens to a CGT asset you own.

As a result of entering into the arrangement with the foreign company, it is considered that you acquired contractual rights. These contractual rights are CGT assets for the purposes of paragraph 108-5(1)(b) of the ITAA 1997. The most relevant CGT event for consideration in this case is CGT event C2 in section 104-25 of the ITAA 1997. CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset:

● being redeemed or cancelled; or

● being released, discharged or satisfied; or

● expiring; or

● being abandoned, surrendered or forfeited; or

● if the asset is an option - being exercised; or

● if the asset is a convertible note - being converted.

As per paragraph 104-25(3) of the ITAA 1997, you make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

In this case, you invested through an overseas based company. You registered and opened an account with them. You received email confirmations from them relating to the activities. You engaged them as your agent from early # until #, when they advised you that they were bankrupt. You were no longer able to contact them and upon realising that it was a scam and you had lost your money, you reported it to the Australian Competition and Consumer Commission.

In a recent letter from the Australian Securities and Investment Commission they have requested your voluntary assistance. They are assisting The Securities and Futures Commission of # in their investigations into fraudulent activities carried out by the entity that you transferred funds to.

Based on the above facts, it is considered that you have abandoned the contract with the foreign company with the effect that your rights under the contract have been discharged. Accordingly, it is considered that CGT event C2 in section 104-25 of the ITAA 1997 happened. The timing of the event would be evidenced by your actions subsequent to your last correspondence (email) from the other parties (your agent) to the arrangement. In this case this occurred in the # income year.

Income tax Assessment act 1997 section 25-45

Lean v FCT (2010) 75 ATR 213. There, a taxpayer sold shares he owned in the US and transferred the proceeds of $4.63 million to a funds manager who operated out of Hong Kong. However, apart from the repayment of $150,000, the funds were misappropriated. The Full Federal Court held that, to be deductible under s 25-47, the moneys were required to have retained their character as income at the time of their misappropriation, and that this had not happened once the sale proceeds had been transferred to Hong Kong. In particular, the Court held that once money received as income is deployed by the taxpayer, personally or by way of an agent, for expenditure or investment, then the characterisation as income is no longer appropriate and the loss cannot be said to have been incurred in respect of the money included in assessable income.

Edmonds J observed in Lean that s 25-47 has ‘an extremely limited field of operation’ because of the requirement of an identity between the money misappropriated and the money included in assessable income.

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.

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.

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 where the same money is lost in and through circumstances which trigger the application of the section.’

In your case:

You received income, you include that income in your tax return, you accrued savings in a bank account from that income, and you then use that money to transfer funds for investment purposes.

When the money is in your savings account and is transferred to an agent for expenditure on investments, it has lost the character of ‘amounts included in assessable income’.