Deduction : losses from misappropriation of money by an investment broker

Is the taxpayer, an investor, entitled to a deduction under section 25-45 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of money which had been misappropriated by their investment broker?

No. The taxpayer, an investor, is not entitled to a deduction under section 25-45 of the ITAA 1997 in respect of money which had been misappropriated by their investment broker as the money had not been included in the taxpayer's assessable income.

The taxpayer is a share investor whose activities do not amount to the business of share trading.

The taxpayer engaged a broker to act for them in the purchase of certain shares.

A sum of money, drawn from the taxpayer's private line of credit, was transmitted to the broker in order that a parcel of shares in a particular company be acquired on the taxpayer's behalf.

The taxpayer's practice was to deposit their employment income into this line of credit facility and to use that facility in a manner similar to a normal bank account.

The shares were never purchased on the taxpayer's behalf and the broker could not be contacted or brought to account for its failure to carry out its obligations to the taxpayer. The loss of the transmitted money, discovered in the income year, was irrecoverable.

Under section 25-45 of the ITAA 1997 a deduction is available for certain losses in respect of money. Each of the following conditions must be satisfied for the deduction to be allowed under this section: • the loss must have been discovered by the taxpayer in the income year and • the loss must have been caused by theft, stealing, embezzlement, larceny, defalcation or misappropriation by the taxpayer's employee or agent ( other than an individual employed solely for private purposes) and • the money lost must have been included in the taxpayer's assessable income for the income year or an earlier income year.

In the circumstances here the taxpayer cannot satisfy the requirement that the money lost had been included in their assessable income for the income year or an earlier income year.

This requirement was discussed in EHL Burgess Pty Ltd v. Federal Commissioner of Taxation 88 ATC 5417; (1988) 19 ATR 1407 ( EHL Burgess ), where it was made clear that: ...income which has been or is to be included in the assessable income of a taxpayer, but has been dealt with in such a way that it has become mingled generally in the finances of the taxpayer and can no longer be traced or identified as income of that description cannot be the subject of a s71 deduction [the predecessor to section 25-45 of the ITAA 1997].

It was further explained in EHL Burgess that where the loss occurs after the derivation of the income, the lost money's identity as 'assessable income' must not have been 'obliterated'.

Whether or not the taxpayer had at some point returned as assessable income the employment income they deposited into their line of credit facility, it is considered that the character of that money was irretrievably altered because of its assimilation into the taxpayer's general finances. The money's identity was no longer that of 'assessable income' but rather was simply part of the current balance of funds available to, or owed by, the taxpayer under their line of credit. The specific sum of money paid to the broker for the shares cannot be identified as an amount which had been returned by the taxpayer as assessable income.

Further, once the taxpayer applied the funds to investment, the necessary connection between money included in the taxpayer's assessable income and a subsequent misappropriation was broken. In applying the money the taxpayer received the benefit of it and therefore the money that was misappropriated was not capable of being characterised as the money that had been included in the taxpayer's assessable income: Lean v. Federal Commissioner of Taxation (2010) 181 FCR 589; [2010] FCAFC 1; 2010 ATC 20 159; (2010) 75 ATR 213; [2010] ALMD 6052 at paragraph 20.

Given this, it is not necessary to consider whether the other requirements of section 25-45 of the ITAA 1997 had been satisfied. The taxpayer is not entitled to a deduction under section 25-45 of the ITAA 1997 for the loss of money misappropriated by their broker as the amount lost cannot be said to have been included in the taxpayer's assessable income for the income year or an earlier income year.

Date of Amendment Part Comment 7 March 2016 Reasons for Decision Citation corrected. Include paragraph referencing the decision in Lean v. Federal Commissioner of Taxation 2010 ATC 20 159.

Date of Amendment | Part | Comment

7 March 2016 | Reasons for Decision | Citation corrected. Include paragraph referencing the decision in Lean v. Federal Commissioner of Taxation 2010 ATC 20 159.