Theft is not always theft … at least for tax purposes.
Comments (0) Australian tax law permits a deduction in taxable income where a taxpayer ’s income is stolen. In particular, section 25-45 of the Income Tax Assessment Act 1997 provides that a taxpayer can deduct a loss in respect of money if:
- the taxpayer discovers the loss in the income year,
- the loss was caused by theft, stealing, embezzlement, larceny, defalcation or misappropriation by the taxpayer’s employee or agent, and
- the money was included in the taxpayer’s assessable income for the income year or for an earlier income year.
A recent decision of the Full Federal Court – Lean v Commissioner of Taxation [2010] FCAFC 1 (28 January 2010) – examined this savings provision and found that in the circumstances of the case it did not apply. The effect of this decision is to greatly limit the operation of section 25-45.
Facts
In 2001 the taxpayer (Mr Lean) met a Mr Heffernan at a meeting organised by an organisation that provided research and services in relation to share trading. Based on the introduction, the taxpayer was led to believe that Mr Heffernan was an experienced and reputable securities trader. At this time, the taxpayer was the holder of options in Microsoft Inc. Based on the advice of Mr Heffernan, the taxpayer exercised his options and sold the shares through a US stockbroker. Mr Heffernan also recommended that the taxpayer transfer the proceeds to a “private client account” maintained by him in Hong Kong and that he would invest the money on the taxpayer’s behalf. In total, approximately AUS4,630,314 was transferred from the proceeds of the Microsoft Inc share transfers to the account maintained by Mr Heffernan. Some time after this, this money was lost. Athough it is not clear how this occurred, it appears that it was accepted that it wasnt lost through investment decisions but rather a misappropriation by Mr Heffernan.
The Administrative Appeals Tribunal found that the misappropriation was one that fell within the terms of section 25-45 as the income from the Microsoft shares were included in the taxpayer’s taxable income and it was that income that was misappropriated by Mr Heffernan.
Federal Court decison
However, the Federal Court (both single judge and the full court) disagreed with this characterisation. The Court held that the proceeds from the Microsoft transfer and the money that was misappropriated were not one and the same for the purposes of section 25-45. This was because “where money that was included in the assessable income of a taxpayer is applied by way of investment, the money has left the taxpayer’s hands, and there can be no relevant misappropriation of or in respect of that money”. As the taxpayer had instructed his US stockbroker to transfer the money to Mr Heffernan for reinvestment, the money had left his hands. In as much, the money could no longer be characterised as income from the transfer of shares and therefore there was no relevant misappropriation for the purpose of section 25-45. To the contrary, the income from the shares had been applied as instructed by the taxpayer – it had been applied for his benefit. The fact it had been later stolen was irrelevant for the purposes of section 25-45.
As a result, not only did the taxpayer lose this money but he now also needs to pay tax to the ATO for the income from the Microsoft shares.
