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01 Feb 1010 Federal Court affirms disallowance of deduction for misappropriated funds - Lean

The Full Federal Court (Emmett, Edmonds and Perram JJ) has dismissed the taxpayer's appeal from the decision of Stone J, who had held that a taxpayer was not entitled to a deduction under s 25-45 ITAA 1997 for half the amount of $4,630,314, misappropriated by a person who represented himself as a securities trader and investment fund manager in Hong Kong. The taxpayer had sought the deduction on the basis that the relevant half of the misappropriated money was sourced out of the taxpayer's share of assessable profits derived by him on the sale, in unrelated transactions, of US shares.

Section 25-45 requires, amongst other things, that "the money was included in your assessable income for the income year, or for an earlier income year".

In rejecting the taxpayer's appeal, Emmett J (Edmonds J agreeing) held that "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" (para [21]).

Interestingly, however, Edmonds J (contrary to the view expressed by Stone J) did not accept that any money had been included in the taxpayer's assessable income. His Honour said, at para [33], as follows:

"Equally, where as here, a taxpayer makes a capital gain from the disposal of an asset (CGT Event A1), it is not money that is included in his assessable income but an amount calculated by reference to the provisions of Part 3-1 of the 1997 Act starting with the capital proceeds from the disposal and the cost base of the asset. Money equal in amount to the amount of the capital proceeds may well be received by the taxpayer; indeed, in most cases, will be received, but that money is not included in the assessable income of the taxpayer. If that be right, then the money misappropriated on the facts of the present case, could never give rise to an allowable deduction under s 25-45."

Edmonds J concluded at para [34]:

"The point of these observations is that, in my view, s 25-45 has an extremely limited field of operation; it is limited to income derived by cash basis taxpayers by the receipt, actual or constructive, of money, in the sense referred to in [32] above, where the same money is lost in and through circumstances which trigger the application of the section."

Lean v FCT [2010] FCAFC 1 (Full Federal Court; Emmett, Edmonds and Perram JJ; 28 January 2010).


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