Private ruling: Investment loss
Date of advice: 26 November 2015
Published: February 2016
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Are you entitled to a deduction for the money lost as a result of a fraudulent investment? | A1: No. | Q2: Are you entitled to a deduction for the interest expenses continuing to be incurred on money borrowed to fund the investment acquisition? | A2: Yes.

Relevant facts and circumstances: You were looking for an investment which would provide an assessable income stream to supplement your existing salary to help support your family. You purchased units in a company. By purchasing the units you would be entitled to receive dividends. At the time you did a number of background checks and there was no information indicating the investment was a scam. Subsequent to making the investments you received confirmation of the receipt of funds and received 'share certificates' for some of the units you purchased. You now know the certificates were fake and the units do not exist. You noticed that the company was listed on the relevant website. You are no longer receiving any correspondence and you are confident you will not receive any money. To assist with the purchase of the units you drew down on an existing loan which you had initially set up to assist in purchasing assets which generated assessable income. You do not currently have the capacity to repay the loan in full.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income except to the extent they are losses or outgoings of capital or of a capital, private or domestic nature. To be entitled to a tax deduction under section 8-1 of the ITAA 1997 the loss would have to be incurred in carrying on a business of options trading for the purpose of gaining or producing assessable income. In Taxation Ruling IT 2228 the Commissioner discusses the income tax implications of the various aspects of futures trading. Paragraph 36 deals with losses sustained as a result of fraudulent action of futures brokers or dealers. While in your case the loss was occasioned by the fraudulent actions of Geosurvey Management Limited, the same principles apply. 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 case, 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 deductions for losses incurred in these circumstances should be disallowed. In your case, you are not considered to be carrying on a business of investing. The funds you invested have the character of a loss or outgoing which is of a capital nature rather than a revenue nature. The outlay brought into existence an asset that was to provide enduring benefits. The fact that the funds were fraudulently misappropriated does not change the nature of the loss. As the loss is capital in nature, you are not entitled to a deduction under section 8-1 of the ITAA 1997. | Detailed Reasoning - Interest: Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income or a provision of the taxation legislation excludes it. Paragraph 9 of IT 2606 provides that as a general rule, interests on money borrowed to acquire shares will be incurred in gaining or producing assessable income (deductible) where it is expected that dividends or other assessable income will be derived from the investment. Such an expectation will usually exist as shares, by their very nature, are inherently capable of generating dividends, whether in the short or long term. However, such an expectation must be reasonable and not a mere theoretical possibility; there must be a prospect of dividends or some other assessable income being received. Taxation Ruling TR 2004/4 provides the Commissioner's view on the deductibility of interest where the income-producing asset has been disposed of and the taxpayer is still liable on the balance of the loan. In general, the interest expense will continue to be deductible where: • the taxpayer borrowed money to acquire an income-producing asset • the income-producing asset has been disposed of • the proceeds from the disposal have been applied against the loan and not used for personal or non-income producing purposes • the taxpayer does not have the legal power to repay the loan ( FC of T v. Brown 99 ATC 4600, (1999) 43 ATR 1) or does not have the financial resources to repay the loan fully ( FC of T v. Jones 2002 ATC 4135, (2002) 49 ATR 188), and • is unable to avoid incurring ongoing interest liabilities. In this situation, a nexus will continue to exist between the interest outgoings and the relevant income earning activities at least until the end of the period during which the interest cannot be avoided. However, where it can be inferred that a taxpayer has: • kept the loan on foot for reasons unassociated with the former income earning activities, or • made a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred, the nexus between the outgoings and relevant income-earning activities will be broken. In your case, we accept that you had a reasonable expectation of earning assessable income from your investment. Your investment has ceased as it was discovered that the investment was a fraud. We accept that a nexus continues to exist between the interest outgoings and the relevant intended income earning activities. Therefore, you are entitled to a deduction for interest incurred under section 8-1 of the ITAA 1997.