Edited version of private advice

Authorisation Number: 1052327980907

Date of advice: 6 November 2024

Ruling

Subject: Deductions

Question

Is the Rulee entitled to claim a deduction for the unrecovered funds transferred as a result of fraudulent activity under section 8-1 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Company A is an Australian resident private company.

Company A provides various advisory services to the infrastructure industry.

The Rulee is the head company of a tax consolidated group (the Tax Group) which includes Company A as a subsidiary member.

It is expected that the aggregated turnover for the Tax Group in the year ended 30 June 20XX will be greater than $50 million.

The Rulee does not derive any exempt or non-assessable non-exempt income in the ordinary course of its business

Company A was frauded out of $XXXX as a result of a scammer hacking the COO's email address and requesting payment be made for a capital funding acquisition. The payment was processed as per relevant procedures by those with authority acting on the request of what they believed to be the COO.

On the same day shortly after the payment request was approved, the FC spoke to the COO in person and it was at this time that Company A became aware that the COO's email address had been compromised and that the payment request was a scam.

Company A took immediate action including contacting their Bank's Fraud Department, contacting the police in Country A where the offshore account that would receive the funds is, and contacting Company A's email provider to ensure the email address for the COO was now secure.

A police report was lodged with the Country A Police the following day.

Also on the following day, the FC contacted the Australian Cyber Security Centre to lodge a report and log the crime with the relevant state Police

A complaint was submitted to Company A's bank around 6 weeks later in relation to the funds being fraudulently paid to the Country A bank account. Soon after, the Bank finalised their investigation of the complaint concluding that they would not reimburse Company A the funds that were paid to Company B.

The funds transferred as a result of fraudulent activity cannot be recovered under Company A's insurance policy and have not been recovered.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 8-1(1)

Income Tax Assessment Act 1997 section 8-1(2)

Reasons for decision

The general deduction provision in section 8-1 of the ITAA 1997 allows a deduction for a loss or outgoing to the extent that it is:

•                     incurred in gaining or producing assessable income, or

•                     necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

However, a deduction is not permitted to the extent the loss or outgoing is:

•                     capital or of a capital nature,

•                     private or domestic in nature,

•                     incurred in producing exempt or non-assessable non-exempt income (NANE), or

•                     a provision prevents you from deducting it.

The $XXXX was paid to the scam bank account from the company's funds during the 20YY income year. Therefore, the company incurred the loss or outgoing in the 20YY income year for the purposes of section 8-1 of the ITAA 1997.

The positive limbs of subsection 8-1(1) of the ITAA 1997 are not mutually-exclusive and a business expense can frequently be deductible under either. To be deductible under the first limb, a loss or outgoing must be incidental and relevant to gaining or producing assessable income (Ronpibon Tin NL v FC of T (1949) 78 CLR 47; 8 ATD 431; [1949] HCA 15). To be deductible under the second limb, a loss or outgoing must be part of the cost of trading operations to produce income (John Fairfax & Sons Pty Ltd v FC of T (1959) 101 CLR 30; 11 ATD 510; [1959] HCA 4).

In Charles Moore & Co (WA) Pty Ltd v FC of T (1956) 95 CLR 344; 11 ATD 147; [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 v FC of T (1938) 61 CLR 263:

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 relation to the negative limbs in subsection 8-1(2) of the ITAA 1997, specifically whether the loss is capital or of a capital nature, the leading Australian case is Sun Newspapers Ltd & Associated Newspapers Ltd v FC of T (1938) 5 ATD 87; (1938) 61 CLR 337. The testing is an enquiry as to whether the expenditure relates to the structure within which the profits are earned or produces an enduring benefit.

Application to your circumstances

Company A has suffered a loss of $XXXX in the process of making a payment to an outside entity as a result of fraudulent activity. As the outgoing was in line with the policies and processes the company normally uses in its day to day operations, and the fraudulent activity meant the outgoing was an unavoidable loss in line with the reasoning in Charles Moore, the loss satisfies the testing under the positive limbs of subsection 8-1(1) of the ITAA 1997.

In terms of the negative limbs in subsection 8-1(2) of the ITAA 1997, the loss was not incurred in producing exempt or NANE income, nor was the loss of a private or domestic nature.

The loss in this case arose because of a fraudulent activity by a third party and its character derives from that circumstance. The third party induced the taxpayer into making a payment in order to obtain a financial advantage to which they were not entitled at law. The loss in this case did not secure any legal rights or secure and enduring benefit. The asset that the taxpayer was frauded into making a payment for did not exist. Therefore, the loss was not capital or of a capital nature and a deduction is allowed under section 8-1 of the ITAA 1997.