Edited version of your written advice

Authorisation Number: 1013109708102

Date of advice: 19 October 2016

Ruling

Subject: Investment Scam - fraud - deductibility / capital nature

Question 1:

Can you claim an income tax deduction for the purchase of faulty computer products because you were a victim of fraud?

Answer:

No.

Question 2

Has a capital gains tax event occurred so that you can claim a capital loss from your fraudulent investment?

Answer:

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You signed X contracts with a company for the purchase of relevant software that was supposed to tell you when to buy or sell investments; and the provision of your managed computer account. The relevant details of these X contracts are as follows:

On XX you signed a contract with a company for them to provide to you through their business the purchase of the following system:

(a) Relevant programs

(b) One computer with the relevant programs installed and various levels of online support.

(c) A Manual.

The purchase price for the system was a certain amount and the contract stipulated that it was non-refundable.

On XX you signed a contract to operate an investment account and deposited a certain amount into this account as investment funds.

You transferred the amount for the contracts to the company.

The computer that you received that was supposedly loaded with the relevant programs did not work.

The demonstration account did not work.

You have not undertaken any investment activities.

As a result of the programs not working you requested a refund of all of the money that you had paid.

On XX you requested and signed a withdrawal form to withdraw the money that you had deposited into your investment account with the company. This money was refunded to you.

The provider has not refunded the money that you paid for the computer, the relevant programs and the manual.

The company is not contactable.

You are aware of other people who have lost money on the relevant programs.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-45

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 110-55

Reasons for decision

Question 1

Summary

You cannot claim an income tax deduction for a faulty computer products and manual that you purchased from a company allegedly involved in a scam.

Detailed reasoning

General deductions

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) provides for general deductions for expenditure to the extent that it is incurred in the gaining or producing of assessable income, or in the carrying on of a business to gain or produce assessable income. No deduction is allowable to the extent that the expenditure is private, domestic or capital in nature.

Apart from seeing the expenses that you incurred as capital costs, we also see the purchase of the computer products as preliminary to the earning of any income, the costs have been incurred at a point too soon and your investment activity did not eventuate. There has been no nexus between the expenses incurred and the derivation of any income.

Capital nature of losses due to misappropriation

In Taxation Ruling IT 2228 Income Tax: Futures Transactions (IT 2228) (Partially Withdrawn - withdrawn paragraphs 37 to 43 dealing with 'basis trading') the Commissioner discusses the income tax implications of the various aspects of futures trading. It specifies that losses of a taxpayer's funds due to misappropriation have the character of losses of capital.

In paragraph 36 of IT 2228 the Commissioner deals with losses sustained as a result of the fraudulent actions of futures brokers or dealers. The Commissioner states:

36. Furthermore, it seems that there may be a number of cases where taxpayers engaged in futures transactions may have incurred losses not from futures contracts themselves but from futures brokers or dealers acting in a fraudulent manner. In managed accounts, for instance, a taxpayer may have deposited $20,000 with a broker to enter into futures contracts on the taxpayer's behalf. The taxpayer may be advised by the broker at a relevant time that losses amounting to $10,000 have been suffered. In fact, the losses will not have been incurred from genuine futures transactions. 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 money that you placed in the investment account was refunded to you so there has been no loss of that money invested.

You have paid an amount for faulty computer products or products that do not work. The purchase of this product is capital in nature; therefore you are not entitled to a deduction 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. The loss must be in respect of money which has been included in the taxpayer's assessable income and must be discovered in the income year in which the deduction is claimed.

The requirement that the income has been included in the taxpayer's assessable income was discussed at EHL Burgess Pty Ltd v Federal Commissioner of Taxation (1988) 88 ATC 5417; (1988) 18 ATR 1407 (EHL Burgess):

...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 s71 deduction [the predecessor to section 25-45 of the ITAA 1997].

The requirement that the income has been included in the taxpayer's assessable income was also discussed in the more recent case of Lean v FCT (2010) 75 ATR 213:

(1) In order to satisfy s 25-45, the money that was misappropriated must be capable of being characterised as the same money that was included in the taxpayer's assessable income. It must be possible to identify misappropriated money with the money included in the taxpayer's assessable income.

(2) The act of a taxpayer in applying money of the taxpayer towards expenses or investment is sufficient to break the necessary connection between money included in the taxpayer's assessable income and a subsequent misappropriation. By applying the money towards expenses or investment the taxpayer has received the benefit of the money that was assessable income.

(3) Where the money that was included in the assessable income of a taxpayer has left the taxpayer's hands, there can be no relevant misappropriation of, or in respect of, that money.

ATO ID 2003/1029 Deduction: Losses from misappropriation of money by an investment broker details a situation where a share investor engaged a broker to act for them in the purchase of shares. The taxpayer was not in the business of share trading. The taxpayer paid an amount of money to the broker for the shares, via a private line of credit into which their employment income was deposited and used in a manner similar to a normal bank account. The shares were never purchased on the taxpayer's behalf and the broker could not be contacted or brought to account. The loss was irrecoverable. In these circumstances the taxpayer could not satisfy the requirement that the money lost had been included in their assessable income for the income year or an earlier income year and therefore the amount was not deductible under section 25-45 of the ITAA 1997.

In the taxpayer's case it was found:

Whether or not the taxpayer had at some point returned as assessable income the employment income they deposited into their line of credit facility, it is considered that the character of that money was irretrievably altered because of its assimilation into the taxpayer's general finances. The money was no longer that of 'assessable income' but rather was simply part of the current balance of funds available to, or owing by, the taxpayer under their line of credit. The specific sum of money paid to the broker for the shares cannot be identified as an amount which had been returned by the taxpayer as assessable income.

In your case, you paid an amount for a computer, computer products and a manual that did not work. No amount was included in your assessable income therefore you are not entitled to a deduction under section 25-45 of the ITAA 1997.

Question 2

You cannot claim a capital loss in relation to the computer, products or manual because no CGT event has happened to this equipment.

Detailed reasoning

A capital gain or capital loss can only be made if and only if a CGT event happens. The capital gain or capital loss is made at the time of the CGT event.

In your case your CGT asset is the computer, products and the manual, the fact that these items don't work doesn't mean that a CGT event has happened to them.

The other potential CGT asset that you have is the right to sue the company (to seek compensation for your equipment not working and any associated financial loss).

The CGT event that may be relevant in this situation is CGT event C2 - cancellation, surrender and similar endings. CGT event C2 occurs if the CGT event ends by cancellation, surrender, redemption, release, discharge, satisfaction, abandonment or forfeiture of an intangible CGT asset.

As you are unable to establish that any of these actions have occurred in relation to the right to sue, CGT event C2 has not occurred at this time. You therefore have not made a capital loss at this time.