Is the compensation payment made by you to the Client for investment losses deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Yes. This ruling applies for the following period : Year ended 30 June 20XX The scheme commenced on: 1 July 20XX
1. You are an employee and director of an investment and stockbroking firm (the 'Firm'). 2. You received assessable income for both your role as a stockbroker and as a director in the income year ended 30 June 20XX. 3. Through your employment as a stockbroker at the Firm, you advise clients on certain companies or stocks to invest in. 4. One of your clients (the 'Client') invested in shares based on your advice. 5. As a result of the advice you provided, an investment loss of $x was made by the Client. 6. In such circumstances your employer, the Firm, will typically deduct the investment loss from your gross wage to compensate the client for their loss incurred based on investment advice provided. This is done in accordance with relevant clauses in your employment agreement. 7. In November 20XX you paid the Client the compensation amount of $x directly. The payment was made in your capacity as a stockbroker of the Firm, rather than as a director. 8. The reason you compensated the Client directly was because the Client had a terminal illness, and you wanted to expedite the compensation process as a means of reassuring the Client.
9. Your payment did not come within the situation covered in your employment agreement since the payment was not made by the Firm out of your employment entitlements. 10. The Firm did not reimburse you for any part of the compensation payment. 11. The Firm also has a policy, which is part of your employment agreement, for 'client errors' which may be used to deal with compensation to clients. Under this policy, error losses are charged against the employee's employment entitlements. Since you made the payment to the Client directly, the policy on 'client errors' was not applicable in this instance.
Income Tax Assessment Act 1997 section 8-1
Section 8-1 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing your assessable income, except where the outgoings are of capital or of a capital, private or domestic nature, or relate to the earning of exempt income or non-assessable non-exempt income, or specifically prevented from being deductible by another provision. Whether an expense is incurred in gaining or producing assessable income is discussed in Taxation Ruling TR 2020/1 Income tax: employees: deductions for work expenses under section 8-1 of the Income Tax Assessment Act 1997 . The ruling states at paragraph 16: 16. For expenses incurred by employees, the fundamental question is whether an expense is incurred in the course of earning employment income. This involves considering the proper scope of the particular taxpayer's work activities to determine if the circumstances of the expense have a sufficiently close connection to earning the employment income.
If an expense is 'incidental and relevant' to a taxpayer's income producing activities, it is likely to be considered sufficiently connected with the derivation of assessable income and therefore will be an allowable deduction under section 8-1 ( Ronpibon Tin NL & Tongkah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; [1949] HCA 15; (1949) 4 AITR 236; (1949) 8 ATD 431). Application to your circumstances As part of your role as a stockbroker at the Firm, you gave investment advice to the Client. Based on your investment advice, the Client made a loss of $x. The Client was not happy with the resulting loss from the investments you recommended. In November 20XX you paid the Client $x directly to compensate them for the losses they made as a result of investments made based on your advice.
In normal circumstances, if a complaint was made by a client, your employer will typically deduct the investment loss from your wages and make the compensation payment to the client directly, in accordance with your employment agreement. Therefore, the compensation for client investment losses is not an unusual occurrence in the context of your employment and this is reflected in the provisions in place in your employment agreement. Such an expense is likely to be considered incidental and relevant to your employment. In this case, rather than having an amount deducted from your employment entitlements (as is consistent with the Firm's usual policy), you compensated the Client directly. You did this because the Client had a terminal illness and you wished to expediate the compensation process. While the fact that you made the payment voluntarily doesn't preclude it from being deductible under section 8-1 (see the judgement of Mason J in Commissioner of Taxation (Cth) v Faichney [1972] HCA 67), we must consider whether compensating a client in these circumstances is incidental and relevant to you earning your assessable income.
In your case, your employment conditions did not require you to pay the Client directly. However, the payment did arise in connection to your employment as a stockbroker at the Firm and the nature of the payment, as compensation for client losses you were responsible for, is consistent with the types of payments that are made by stockbrokers. While the payment was voluntary and not sourced directly from your employment conditions, it was a natural consequence of your employment and incidental and relevant to your income earning activities The compensation payment is not excluded by any of the negative limbs in section 8-1 as it is not a loss or outgoing of capital or of a capital, private or domestic nature, does not relate to the earning of exempt income or non-assessable non-exempt income and is not prevented from being deductible by any other provision. Therefore, the compensation payment you made to the Client is deductible under section 8-1.