ATO ID 2004/178: Deductibility of amount provided as security
Date of decision: 23 January 2004
Year of income: Year ended 30 June 2003
Business line: Private Groups and High Wealth Individuals

Issue
Can a taxpayer claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the amount provided as security to a bank to obtain a bank guarantee to satisfy the security requirements of an insurance provider?

Decision
No. The taxpayer cannot claim a deduction under section 8-1 of the ITAA 1997 for the amount provided as security to a bank to obtain a bank guarantee to satisfy the security requirements of an insurance provider.

Facts
The taxpayer's insurer required a $10,000 bank guarantee as security before insurance policies with the taxpayer would be written. The taxpayer's bank provided a Banker's Undertaking to the taxpayer's insurer to distribute funds to the maximum aggregate sum of $10,000 when requested by the taxpayer's insurer. The taxpayer's bank required $10,000 to be deposited by the taxpayer in a term deposit in the taxpayer's name with them. The taxpayer's insurer is authorised to access the money held in term deposit and disperse it to cover legal or rectification costs when settling insurance claims made against the taxpayer. Distributions to the taxpayer's insurer from the taxpayer's bank would reduce the term deposit balance held in the taxpayer's name. The taxpayer cannot access the funds held in the term deposit until six years have expired from the completion time of the taxpayer's last job that is insured with the insurer.

Reasons for decision
Summary: A taxpayer can deduct a loss or outgoing from their assessable income under section 8-1 of the ITAA 1997 to the extent to which it is incurred in gaining or producing their assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing their assessable income. As the term 'incurred' is not defined in the ITAA 1997, regard may be had to the ordinary meaning of the term as found in judicial decisions. The High Court in Federal Commissioner of Taxation v. James Flood Pty Ltd (1953) 88 CLR 492; (1953) 10 ATD 240; (1953) 5 AITR 579 provided that a loss or outgoing will be 'incurred' where the taxpayer is 'definitely committed' or has 'completely subjected' themselves to the loss or outgoing in gaining or producing their assessable income. No loss or outgoing is incurred at the time the $10,000 is provided as security, as the taxpayer is not definitely committed or completely subjected to the loss or outgoing. The $10,000 will only be accessed by the bank if and when an insurance claim is settled against the taxpayer and not when the security is originally provided. Although the taxpayer is restricted in the manner they may access the security after entering into the arrangement with the bank, this restriction is not sufficient to characterise the taxpayer as being definitely committed or completely subjected to the loss or outgoing. Furthermore, even if the taxpayer could be characterised as being definitely committed or completely subjected to the loss or outgoing, the contingent nature of the arrangement would impact on the deductibility of the security. Barwick CJ in Nilsen Development Laboratories Pty Ltd v. Federal Commissioner of Taxation (1981) 144 CLR 616; 81 ATC 4031; (1981) 11 ATR 505 provided that an impending, threatened, or expected loss or outgoing is not deductible, '... no matter how certain it is in the year of income that that loss or expenditure will occur in the future'. At the time the $10,000 is provided as security, potential amounts payable are merely impending, threatened, or expected losses or outgoings. Accordingly, even if the taxpayer could be characterised as being definitely committed or completely subjected to the loss or outgoing, as potential amounts payable are merely impending, threatened, or expected, the loss or outgoing cannot be characterised as being incurred. Accordingly, as no loss or outgoing has been incurred by the taxpayer, no deduction is available under section 8-1 of the ITAA 1997. Note: amounts withdrawn from the taxpayer's term deposit to meet payment demands by the taxpayer's insurer may be deductible under section 8-1 of the ITAA 1997 in the income year the loss or outgoing is incurred.

Legislative references: Income Tax Assessment Act 1997 section 8-1
Case references: Federal Commissioner of Taxation v. James Flood Pty Ltd (1953) 88 CLR 492 (1953) 10 ATD 240 (1953) 5 AITR 579
Related ATO interpretative decisions: ATO ID 2002/1068
Subject references: Incurred Insurance expenses