Private ruling: Expenses - fraudulent investment
Published: November 2011
Ruling period: Year ended 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Q1: Are you entitled to a deduction for the expenses incurred to enter a fraudulent investment? | A1: No.

Relevant facts and circumstances: During the year, you came in contact with commodity brokers working for a firm. You purchased options trading on the Exchange through the commodity brokers. The purchases took place in six separate transactions over the year. Initially, you were allocated a series of options by the firm Then you were instructed to transfer a certain amount of money so the options could be purchased on your behalf. You did not initiate or make decisions regarding when or what to purchase. The company and the trades turned out to be fictitious and the commodity brokers were operating an investment scam. You lost a sum of money. The police are currently conducting an investigation regarding the matter.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1, | Income Tax Assessment Act 1997 section 25-45 and | Income Tax Assessment Act 1997 section 108-5.

Reasons for decision: Summary: As the investment loss is considered to be capital in nature, you are not entitled to a deduction under section 8-1 of the ITAA 1997. Also, no deduction is available under 25-45 of the ITAA 1997 because the investment losses are not in respect of money which as been included in your assessable income. | Detailed Reasoning - Detailed reasoning: 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. In paragraph 36 of IT 2228 the Commissioner deals with losses sustained as a result of the fraudulent actions of futures brokers or dealers. While in your case the loss was occasioned by the fraudulent actions of your representative 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 cases, 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 deduction for losses incurred in these circumstances should be disallowed. In your case, you are not considered to be carrying on a business of options trading. The funds you gave to the firm have the character of a loss or outgoing which is of a capital nature rather than of a revenue nature. The outlay brought into existence an asset that was to provide enduring benefits. The fact that the funds were fraudulently misappropriated by the firm 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 - Misappropriation of funds: Under section 25-45 of the ITAA 1997 a deduction is available for certain losses in respect of money. For a deduction to be allowed under this section the loss must have been discovered in the income year, it must have been caused by theft, stealing, embezzlement, larceny, defalcation or misappropriation by your employee or agent and the money lost must have been included in your assessable income for the income year or an earlier income year. You are not entitled to a deduction under 25-45 of the ITAA 1997 because the losses are not in respect of money which has been included in your assessable income. | Detailed Reasoning - Additional Information: As a result of entering into the investment with the firm, we consider that you acquired contractual rights. These contractual rights are a CGT asset, as per paragraph 108-5(1)(b) of the ITAA 1997. CGT event C2 will occur if an entity's ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied. The Commissioner takes the view that in certain circumstances contractual rights can be discharged or come to an end merely by being treated as being at an end by the parties. It will be considered that the entity made a capital gain/loss at the time the contractual rights end by being abandoned. In your case, your contractual rights will be considered properly abandoned only when it is reasonably certain that there is no real hope of recovering any of the funds. At this time, CGT event C2 will occur and you will make a capital loss. A capital loss cannot be offset against income. It can only be offset against capital gains you make during the income year or against capital gains in future years

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