Edited version of private advice

Authorisation Number: 1051564996859

Date of advice: 15 August 2019

Ruling

Subject: Income tax

Question 1

Is the amount $X fraudulently paid to an incorrect bank account of a supplier by an employee from cash-flow which was included in assessable income earnt during the year ended 30 June 20XX, deductible under either section 25-45 of the Income Tax Assessment Act 1997 (ITAA 1997) or the general deduction provisions in section 8-1 of the ITAA 1997?

Answer

Yes, under section 8-1 of the ITAA 1997.

Question 2

If the payment is not considered tax deductible is it a capital loss?

Answer

Not applicable

Question 3

Is the insurance recovery received in July 20XX considered assessable income in the 20XX year if the deduction is allowable in 20XX?

Answer

No

Question 4

Is the insurance recovery received in July 20XX considered assessable income in the year the assessable recoupment is actually received?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20YY

The scheme commences on:

20XX

Relevant facts and circumstances

Your employee paid invoices totalling $X, that were sent to you as part of a scam, believing that they were legitimate. The invoices were for supplies you purchase to use in your business.

After discovering the scam you contacted the Police and your bank but neither the Police nor the bank has recovered any of the funds paid.

You lodged a claim with your insurance company for recovery of these funds and received $Y your maximum claim amount according to your insurance policy on July 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 8-1

Income Tax Assessment Act 1997, section 25-45

Income Tax Assessment Act 1997, Subdivision 20-A

Income Tax Assessment Act 1997, subsection 20-20(2)

Income Tax Assessment Act 1997, paragraph 20-35(1)(b)

Reasons for decision

All references made in these reasons for decision are to the Income Tax Assessment Act 1997 unless otherwise stated.

Question 1

Summary

The amount of $X fraudulently paid to an incorrect bank account of a supplier is deductible under the general deduction provisions in section 8-1.

Detailed reasoning

For section 25-45 to apply the cause of the loss must be as a result of the employee stealing, embezzling or misappropriating the funds for their own use. There are a number of elements required to satisfy section 25-45 in order for the loss of money to be deductible, however the main element is that the act of theft, stealing, embezzlement, larceny, defalcation or misappropriation was made by your employee or agent.

These terms require an intent and knowledge on the part of the employee to have transferred the funds without the owner's consent. There is no evidence to suggest that this requirement was satisfied in this case as your employee believed that the invoices were legitimate. Therefore the loss of money cannot be deductible under section 25-45.

Section 8-1 allows a deduction for any loss or outgoing necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income however you cannot deduct a loss to the extent the amount is an outgoing of capital, private or domestic in nature or a provision prevents it from being deductible.

The relevant elements that need to be satisfied for the amount to be deductible under section 8-1 are as follows:

• the outgoing is incurred
• there is the relevant nexus between the loss or outgoing and the carrying on of a business for the purpose of gaining or producing assessable income, and
• the outgoing is not of a capital or private or domestic nature.

Taxation Ruling 95/33 Income tax: subsection 51(1) - relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings (TR 95/33) provides guidance on when an outgoing is considered to have the requisite connection to the carrying on of a business for the purpose of gaining or producing assessable income.

Paragraph 4 of TR 95/33 provides that where the outgoing does not produce any income or the amount is less than the outgoing, it is necessary to consider all the circumstances surrounding the expenditure.

Paragraph 13 of TR 95/33 provides that in the case of a company, the relevant purpose is the corporate purpose. This requires an examination of the purpose, motive or intention of the company's directors, officers and employees.

There are a number of judicial decisions that have concluded that the outgoings as a result of fraud did not have the requisite connection with carrying on of a business including:

• LEAN v Federal Court of Taxation [2010] FCAFC 1 - the taxpayer transferred funds for investment purposes not for a business purpose and subsequently those funds were misappropriated.
• The Applicant and Commissioner of Taxation [2004] AATA 1293 - the taxpayer intention was to make a profit from the sale of shares however it was found that the taxpayer was not carrying on the business of a share trader. The funds were misappropriated and were lost.
• Commissioner of Taxation (NSW) v Ash [1938] HCA 68 (Ash) and E.H.L Burgess Pty Ltd v Commissioner of Taxation [1988] FCA 383 - where the misappropriation of money was made by employees who were considered proprietors and directed the money for their own purposes and not in the course or furtherance of the ordinary activities of the business.

In Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation [1956] HCA 77 (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 on the way 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 Ash:

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.

In the decision of the High Court of Australia in Sun Newspapers Ltd v Federal Commissioner of Taxation [1938] HCA 73, Dixon J stated that there are three matters to be considered when deciding whether expenditure incurred is revenue or capital:

i)      the character of the advantage sought by the outgoing

ii)     the manner in which the advantage is to be used, relied upon or enjoyed by the taxpayer

iii)    the means adopted to obtain the advantage, such as by recurring payments.

The character of the advantage sought provides the best guidance as to the nature of the expenditure because it says the most about the essential character of the expenditure itself.

Therefore as

• you incurred the amount of $X,
• there is the required nexus between the outgoing or loss and the carrying on of your business and
• it is not capital or private or domestic in nature

it will be deductible under section 8-1.

Questions 3 & 4

Summary

Whilst you can claim a deduction for the amount of $X in the year ended 30 June 20XX the insurance recovery of $Y is considered assessable income in the year ended 30 June 20YY being the year you actually received the assessable recoupment.

Detailed reasoning

Under Subdivision 20-A, certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable.

Subsection 20-20(2) provides that an amount received as recoupment of a loss or outgoing is an assessable recoupment if you received the amount by way of insurance or indemnity, and the amount of the loss or outgoing is or was deductible under any provision of the ITAA 1997 or Income Tax Assessment Act 1936.

You lodged a claim with your insurance company for recovery of your funds and received $Y in July 20XX. You are entitled to claim a deduction for the misappropriated funds under section 8-1 in the year ended 30 June 20XX.

Paragraph 20-35(1)(b) provides that your assessable income includes an assessable recoupment of a loss or outgoing if the taxpayer has 'deducted or can deduct the whole of the loss or outgoing in an earlier income year'.

In Taxation Determination TD 2004/21, Income tax: where a fringe benefits tax liability is deductible to a taxpayer under section 8-1 of the Income Tax Assessment Act 1997, is a later refund or reduction of that liability, as a result of an amended fringe benefits assessment, an assessable recoupment for the purposes of subsection 20-20(3) that must be included in the taxpayer's assessable income under subsection 20-35(1)?, the amount of refund or reduction in FBT liability which is considered an assessable recoupment, is included in the taxpayer's assessable income for the year in which the refund or the notice of the amended assessment giving effect to the reduction is received.

Therefore in accordance with subsection 20-35(1), you are to include the insurance recovery of $Y in your assessable income for the year ended 30 June 20YY.