ATO ID 2010/207: Deductions and expenses: reimbursement to trust account of stolen trust monies
Date of decision: 10 November 2010
Year of income: Year ended 30 June 2011
Business line: Private Groups and High Wealth Individuals

Issue
Is the reimbursement to a trust of stolen trust monies held for disbursement to clients deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. The reimbursement to the trust of stolen trust monies is deductible under section 8-1 of the ITAA 1997.

Facts
The firm operates as a real estate agency whose activities include the receipt, holding and disbursement of monies held on trust for various rental clients. A safe containing cash held on trust was stolen. The cash was to have been banked to the firm's trust account. The theft was reported to the police but the safe and its contents were never recovered. Over the ensuing months the firm was required to use its own funds to reimburse the rental trust account to enable disbursement of trust monies to its clients. The firm did not have insurance cover for this loss and has, therefore, not been compensated for the loss.

Reasons for decision
Summary: In Charles Moore & Co (WA) Pty Ltd v. Federal Commissioner of Taxation (1956) 95 CLR 344; (1956) 11 ATD 147; (1956) 6 AITR 379 ( 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 en route 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 Commissioner of Taxation (NSW) v. Ash (1938) 61 CLR 263 at 277; (1938) 5 ATD 76; (1938) 1 AITR 447: 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. The Court in Charles Moore held (at CLR 351) that the loss was not on capital account: 'we are here dealing with a loss incurred in an operation of business concerned with the regular inflow of revenue, not with a loss of or concerning part of the "profit yielding subject".' The use of a trust by the real estate agency to hold monies belonging to clients is an ordinary part of the business operations of a real estate business. Whilst the monies were not the property of the real estate agency, their loss by theft required the real estate agency to make good the loss, in keeping with its obligations to clients under the trust. Such a reimbursement to the trust was 'a natural or recognized incident' of the real estate business and constituted a loss incurred in gaining or producing its assessable income or, alternatively, necessarily incurred in carrying on a business for the purpose of gaining or producing its assessable income. For the same reasons as given by the Court in Charles Moore , the loss of the trust monies was not a loss of capital or of a capital nature to the real estate agency. The loss to the taxpayer represented by the reimbursement to the trust is therefore deductible under section 8-1 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 8-1
Case references: Commissioner of Taxation (NSW) v Ash (1938) 61 CLR 263 (1938) 5 ATD 76 (1938) 1 AITR 447
Subject references: Accountability of trustees Constructive trusts Deductions & expenses Losses from fraud, theft & embezzlement Trust accounts