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[2010] FCAFC 1
respondent. Appeal dismissed. The primary judge's orders stood, including the setting aside of the Tribunal's decision and affirmation of the Commissioner's objection decision. The Commissioner did not ask...
3 cited instruments linked from this judgment.
The taxpayer lost money that he had transferred to a proposed investment arrangement, after a supposed investment manager misappropriated it. Although the funds originated from Microsoft share-sale proceeds included in the taxpayer's assessable income calculation, the Court held that the taxpayer had already applied the proceeds to investment and received their benefit. The funds later stolen were therefore not the same money included in assessable income for s 25-45. The appeal was dismissed. The judges also made observations about the provision's possible reach, but they did not all express those observations as necessary to the result.
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The appeal concerned whether a taxpayer could deduct money lost through the misappropriation of funds transferred to a purported investment arrangement. The statutory provision in issue was s 25-45 of the Income Tax Assessment Act 1997 (Cth) (the 1997 Act), which permits a deduction for certain losses of money caused by theft or misappropriation, provided the money was included in the taxpayer’s assessable income.
The taxpayer, David Lean, became interested in Mr Heffernan after attending a meeting for customers of Metashare International Pty Ltd. He was led to believe that Mr Heffernan was a successful securities trader and investment fund manager. In May 2001, Lean transferred $5,000 to a Hong Kong account nominated by Heffernan [9].
The larger transactions involved proceeds from the sale of Microsoft shares. Lean exercised options and sold the resulting shares through a United States stockbroker. On 11 July 2001, $517,416 of sale proceeds was transferred to a Hong Kong account. Lean later received an “E-ceipt” referring to an account in his wife’s name [10]-[11]. On 24 August 2001, Lean instructed his stockbroker to transfer a further $4,112,898.59 to Hong Kong, receiving E-ceipts referring to accounts in his own name and a “private client” account [13].
The evidence did not establish that Heffernan actually made investments or what precise mechanism he used to misappropriate the funds. The Tribunal found that the funds were held for Lean and could be applied for authorised investment purposes, but Heffernan had wide discretion over possible investments and no authority to use the funds for his own benefit [15]-[19]. The Tribunal also found that Heffernan misappropriated the money shortly after the August transfer, with an intention to do so from the outset [19].
Lean claimed deductions against his assessable income, including a deduction for the misappropriation. The Tribunal allowed a deduction of $2,315,157 under s 25-45. The Commissioner appealed on a question of law. The primary judge allowed the Commissioner’s appeal, set aside the Tribunal’s decision, and affirmed the Commissioner’s objection decision [3]-[4]. Lean then appealed to the Full Court. The Full Court dismissed his appeal [25].
The key question was whether the money misappropriated was “the money” included in Lean’s assessable income, as required by s 25-45. Emmett J explained that the provision requires the money lost to be capable of identification as the money included in assessable income [20]. It was not enough that the stolen funds could be traced back to the proceeds of the share sales.
The central point was what happened when Lean instructed his stockbroker to transfer the sale proceeds to Hong Kong. The transfers were made according to Lean’s instructions. After the transfers, the money was available for investment at Heffernan’s direction. Emmett J concluded that Lean had received the benefit of the sale proceeds because he had applied them to investment. The money had therefore “left the Taxpayer’s hands” before its later misappropriation [22].
Emmett J drew support from EHL Burgess Pty Ltd v Federal Commissioner of Taxation (1988) 80 ALR 639, where the court had addressed money used to pay a taxpayer’s debts. In Lean, the same basic reasoning applied to money used for investment: once the taxpayer applied the money in that way and received its benefit, a later misappropriation was not a misappropriation of the same assessable-income money [21]-[23]. The conclusion was that s 25-45 did not provide the claimed deduction.
The judgments also show why the identity question is difficult. Perram J noted that money can change form: cash deposited with a bank becomes a debt, and a cheque can give rise to further legal relationships [45]. He treated traceability as necessary but not necessarily sufficient to establish identity [46]-[47]. His proposed additional approach was to ask whether the use was interim. Money held temporarily by a broker pending instructions, or placed in the taxpayer’s own account while investment options were considered, might remain in interim use. Lean’s transfer to Heffernan for a new investment enterprise was different [50]-[51].
The judges also addressed the character of the original loss under the general deduction rules. The Tribunal had found that the taxpayer intended to derive profit, but regarded the loss as capital because the proposed activities were broad and the investment was not an income-producing enterprise carried on by Lean [38]-[40]. That issue made the alternative claim under s 25-45 important, but it did not alter the Court’s conclusion that the statutory identity requirement was not met.
The judgment explains s 25-45 as the successor to s 71 of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act). Section 71 had provided a deduction for certain losses caused by embezzlement, larceny, defalcation or misappropriation of money that was or had been included in the taxpayer’s assessable income [29]. Edmonds J considered the earlier provision and s 25-45 to require identity between the money misappropriated and the money included in assessable income [31].
EHL Burgess had already stated that money used to pay a taxpayer’s debts could no longer be the subject of a relevant misappropriation, because the benefit of the money had been received through reduction of the taxpayer’s liabilities. It also required the money lost to be traceable and identifiable as assessable-income money [27]-[28]. Lean applied that reasoning to money applied to investment [20]-[23].
The decision’s central contribution, on the supplied judgment, is its application of that identity requirement to funds transferred for investment. It distinguishes a later theft of money still held pending instructions from the later loss of money the taxpayer has already applied to a new investment arrangement [50]-[51]. The judgment does not establish that tracing is irrelevant; rather, it explains that tracing alone may not establish the required identity.
There are important limits to what can be said about the “after” state of the law from this source. The judgment provides no later decisions or statutory amendments. It therefore supports an account of the rule as stated and applied in 2010, but not a claim about how later courts have modified or applied it.
The judges also differed in the breadth of their observations. Edmonds J considered that s 25-45 had an extremely limited field of operation, potentially confined to cash-basis taxpayers who receive money and lose that same money [31]-[34]. Perram J considered that view had force but expressly hesitated to decide the broader question finally [53]. Those observations should not be treated as a single, unqualified holding that the section can only apply to cash-basis taxpayers.
At [20], Emmett J said that applying assessable-income money towards expenses or investment is sufficient to break the necessary connection with a subsequent misappropriation. In plain English, once the taxpayer has used the money for a purpose and obtained its benefit, the same money may no longer be treated as the money later stolen for the purposes of this deduction provision.
At [22], Emmett J applied that reasoning to Lean. The stockbroker transferred the sale proceeds according to Lean’s instructions, and the money became available for investment. Emmett J treated that as Lean receiving the benefit of the proceeds and the funds leaving his hands. The judgment does not depend on a finding that Lean personally handled physical cash.
At [31], Edmonds J described the statutory requirement as an “identity” between the money misappropriated and the money included in assessable income. He also explained that a taxpayer’s assessable income may include an amount or receivable, rather than the particular money later paid to discharge it. His observation was that such a later payment may not itself be money included in assessable income.
At [45]-[47], Perram J explained why identifying the “same” money is not a simple physical test. Money can take different forms, and different legal relationships can arise as it moves through banking and payment systems. Traceability helps establish identity, but Perram J did not regard traceability as invariably sufficient.
At [50]-[51], Perram J offered the idea of interim use as an analytical tool. A temporary holding of money while instructions or investment options are considered may be different from placing money into a new investment enterprise. He regarded Lean’s transfer to Heffernan as the latter. This reasoning is a separate explanation of the outcome, not a reason to overlook the majority reasoning in Emmett J’s judgment.
The decision is relevant where a taxpayer claims a deduction under s 25-45 for money allegedly stolen or misappropriated, and the claimed funds originated from amounts included in assessable income. The central inquiry is whether the lost money can be identified as the assessable-income money, not merely whether there is a traceable route from one to the other [20]-[23], [46]-[47].
The facts most directly addressed are where the taxpayer instructs an intermediary to transfer money for investment, the transfer is carried out as instructed, and a person involved in the investment arrangement later misappropriates the funds. In Lean, the taxpayer intended the money to be invested and made it available for investment at Heffernan’s direction [14]-[18], [22]. The Court treated this as more than temporary custody.
By contrast, Perram J’s discussion indicates a possible distinction where a broker temporarily holds sale proceeds pending the taxpayer’s instructions, or where a taxpayer holds funds in an account while choosing between investment alternatives [50]. These examples were part of his analysis, rather than findings about Lean’s circumstances.
The case also flags the importance of the legal and practical arrangements governing the funds. Relevant matters in the judgment included the instructions given to the stockbroker, the purpose of the transfer, the authority given to Heffernan, whether the funds were intended to be invested, and whether the taxpayer had received the benefit of applying the money [12]-[18], [22]. The judgment records that the precise mechanics of the misappropriation were not established [19]. It does not decide every possible situation involving an agent, a bank account, or pooled funds.
The supplied judgment does not cite any later cases or report how later courts treated Lean. Accordingly, no conclusion about later judicial treatment can be grounded in this source.
The judgment itself discusses two earlier authorities. Emmett J relied on EHL Burgess for the proposition that money used to pay debts has left the taxpayer’s hands, and extended the reasoning to money applied to investment [21]. Edmonds J said the earlier court’s reasoning was correct and treated it as supporting the identity requirement [27]-[31]. Perram J discussed EHL Burgess’s requirement of tracing, while adding that tracing may not always be sufficient to establish identity [46]-[47].
Perram J also referred to Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation (1956) 95 CLR 344 in discussing the distinction between a capital investment and an enterprise directed to producing assessable income [40]. The supplied judgment does not provide a detailed account of that authority’s reasoning or its later treatment.
The judgments leave open the precise reach of s 25-45 beyond the facts before the Court. Edmonds J considered the section’s operation to be extremely limited, particularly for accruals-basis taxpayers, where an amount may be included in assessable income before the later receipt of money [31]-[34]. Perram J considered that position persuasive in practical terms but expressly declined to close the question finally [53].
Another unresolved issue is how identity should be analysed where money changes form or passes through accounts and payment systems. Perram J explained that money may shift from cash to bank debt or a negotiable instrument, while still representing the same value in some sense [45]. He regarded traceability as necessary but possibly insufficient [46]-[47]. The judgment does not supply a complete test for every such transaction.
The boundary between interim custody and application to a new investment is also not comprehensively defined. Perram J’s examples at [50]-[51] help distinguish temporary holding from a new enterprise, but the judgment does not set out a comprehensive list of factors for deciding when a use is “other than interim”.
Finally, the statutory question concerning s 51AAA of the 1936 Act was not determined. The Commissioner raised it only as an alternative contention, and the Court found it unnecessary to address it after resolving the s 25-45 issue [24], [52]. The judgment therefore supplies no ruling on how that provision might affect a different claim involving misappropriated funds.
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INTRODUCTION 1 This appeal concerns the effect of s 25-45 of the Income Tax Assessment Act 1997 (Cth) (the 1997 Act) in relation to the misappropriation of a substantial sum of money belonging to the appellant, Mr David Lean (the Taxpayer). The money was misappropriated after the Taxpayer transferred it to a bank in Hong Kong. 2 The Taxpayer's assessable income for the year ended 30 June 2002 included a net capital gain. The Taxpayer claimed deductions totalling $4,972,671 from his assessable income. The deductions included the sum of $3,287,749 in respect of the misappropriation. The respondent, the Commissioner of Taxation (the Commissioner), disallowed the deductions and issued a notice of assessment to the Taxpayer dated 12 May 2006. The notice of assessment showed an outstanding tax liability of $1,309,196. The Taxpayer objected to the Commissioner's assessment, disputing the Commissioner's disallowance of the sum of $3,287,749. On 28 August 2006, the Commissioner made an objection decision affirming his decision to disallow that sum as a deduction. 3 The Taxpayer then commenced a proceeding in the Administrative Appeals Tribunal (the Tribunal), seeking review of the Commissioner's objection decision of 28 August 2006. On 20 June 2008, the Tribunal set aside the decision under review. The Tribunal ordered that the matter be remitted to the Commissioner for reconsideration, with the direction that the misappropriation loss claimed by the Taxpayer is, as to the amount of $2,315,157, a deduction allowed by s 25-45 of the 1997 Act. 4 The Commissioner then appealed to the Federal Court pursuant to s 44 of the Administrative Appeals Tribunal Act 1975 (Cth), which permits an appeal from a decision of the Tribunal on a question of law. On 14 May 2009, a judge of the Court ordered that the appeal be allowed, that the decision of the Tribunal be set aside and that the Commissioner's objection decision of 28 August 2006 be affirmed. The Taxpayer has now appealed to the Full Court from those orders.
THE RELEVANT STATUTORY PROVISIONS 5 Under s 6-1(1) of the 1997 Act, assessable income consists of ordinary income and statutory income. Section 6-5(1) provides that a taxpayer's assessable income includes income according to ordinary concepts, which is called ordinary income. Section 6-10(1) provides that a taxpayer's assessable income also includes some amounts that are not ordinary income. Amounts that are not ordinary income, but are included in a taxpayer's assessable income by provisions of the 1997 Act about assessable income, are called statutory income. Section 6-15(1) provides that, if an amount is not ordinary income and is not statutory income, it is not assessable income and a taxpayer does not have to pay income tax on that amount. 6 Section 102-5(1) of the 1997 Act provides that a taxpayer's assessable income includes the taxpayer's net capital gain, if any, for the relevant income year. Thus, net capital gain constitutes statutory income. Net capital gain is worked out as follows: Step 1 Reduce the capital gains made by the taxpayer during the income year by the capital losses, if any, made during the income year. Step 2 Apply any previously unapplied net capital losses from earlier income years to reduce the amounts, if any, remaining after the reduction of capital gains under Step 1. Step 3 Reduce by the discount percentage (in this case 50%) each amount of capital gain remaining after Step 2. Step 4 If any of the taxpayer's capital gains qualify for certain concessions, those concessions are applied to each capital gain. Step 5 The sum of the amounts of capital gains, if any, remaining after Step 4 is the taxpayer's net capital gain for the income year. 7 Division 8 of the 1997 Act deals with deductions. Under s 8-1(1), a taxpayer can deduct from the taxpayer's assessable income any loss or outgoing to the extent that:
THE MISAPPROPRIATION 9 In January 2001, the Taxpayer attended a meeting for customers of Metashare International Pty Ltd (Metashare), a company that provided research and a share trading system. At the meeting, a Metashare employee informed the Taxpayer of Mr Shayne Heffernan. The Taxpayer was led to believe that Mr Heffernan was a reputable and highly successful securities trader and investment fund manager. In May 2001, the Taxpayer transferred $5,000 to a Hong Kong account nominated by Mr Heffernan. The Taxpayer was impressed by Mr Heffernan and the apparent growth of the $5,000. 10 As at July 2001, the Taxpayer was the holder of options to acquire shares in Microsoft Inc in the United States. Encouraged by Mr Heffernan to increase his investment, the Taxpayer exercised the options and shares in Microsoft Inc were allotted to him as a consequence of the exercise. He then sold the shares through a United States stockbroker, who received the proceeds of sale. The Taxpayer instructed the US stockbroker to transfer the proceeds of sale of the Microsoft Inc shares to the Hong Kong bank account nominated by Mr Heffernan. 11 While the precise instructions to the US stockbroker are not clear, on 11 July 2001, a transfer of $AUS517,416 was made to the Hong Kong bank account from the proceeds of the sale of the Microsoft Inc shares. There is no evidence as to the Hong Kong bank to which that money was transferred. However, the Taxpayer received a document called an "E-ceipt". The E-ceipt stated that the money had been credited to a numbered account in the name of the Taxpayer's wife. The E-ceipt was issued in the name of Our World Exchange Limited. Our World Exchange Limited, which is incorporated in Vanuatu, was totally subservient to Mr Heffernan and operated merely at his whim. As such, it was merely Mr Heffernan's agent and did not act, in any sense, independently of Mr Heffernan. 12 In August 2001, the Taxpayer attended a seminar in the Philippines conducted by Mr Heffernan. During the course of that seminar, Mr Heffernan offered the Taxpayer a "partnership relationship" in relation to investment of funds and told him that a "private client account" arrangement would be established, which would be a "true partnership" in which all investment decisions would be made jointly. Mr Heffernan promised that such an account would be in the Taxpayer's own name and that he would be able to maintain full control of the account. It is unclear whether the Taxpayer had the same understanding as to his relationship with Mr Heffernan at the time he effected the transfer in July 2001. 13 On 24 August 2001, on the basis of the assurances given by Mr Heffernan at the seminar, the Taxpayer instructed his US stockbroker, to transfer $AUS4,112,898.59 to the Hong Kong bank account from the proceeds of a further sale of Microsoft Inc shares. The Taxpayer received two E-ceipts that stated that the money had been credited to two different numbered accounts in the Taxpayer's name and had been deposited to a "private client" account. 14 The Taxpayer regularly discussed with Mr Heffernan trading and other supposed investment activities involving the private client account. He requested documents confirming the details of the transactions, but none was provided and there was no documentary evidence to demonstrate, for example, that the Taxpayer incurred any trading losses in relation to the money he caused to be transferred to the Hong Kong bank account. The Taxpayer thought Mr Heffernan was trading as an agent for him or was in some business arrangement with him but did not ever have any clear understanding of the precise nature of his relationship with Mr Heffernan and Our World Exchange Limited. 15 The Tribunal found that the money sent by the US stockbroker was received in Hong Kong with general instructions that it be held on behalf of the Taxpayer and be applied for authorised investment purposes. However, the Taxpayer did not derive any investment income and could not show that any investment transactions actually occurred. 16 The Tribunal found, from the generality of the proposal discussed between the Taxpayer and Mr Heffernan, and the absence of clear evidence of more limited instructions from the Taxpayer to Mr Heffernan, that the private client account was a means of facilitating any kind of investment opportunity that presented itself and was recommended by Mr Heffernan to the Taxpayer. The Tribunal also found that it was not restricted to ordinary trading activities and was open to participation in capital investment opportunities. The Tribunal found further that the money transferred on 24 August 2001 was an amount that could be resorted to for any of a very wide range of possible investment activities, a range limited only by the subjectivity of Mr Heffernan's preferences and assessment of the potential profitability of individual proposals. 17 The Tribunal rejected the view that the transfer of the money to Hong Kong gave rise merely to a debtor and creditor relationship, either with Mr Heffernan or Our World Exchange Limited, that merely gave the Taxpayer a contractual entitlement to share in the growth of the investments that was supposed to be made. The Tribunal concluded that Mr Heffernan and Our World Exchange Limited held the money for the absolute benefit of the Taxpayer and subject to his instructions. The Tribunal concluded that they were, in relation to their custody and control of the Taxpayer's private client fund, his agents. 18 The Tribunal characterised the position of Our World Exchange Limited and Mr Heffernan as "custodial agents" in relation to the money, although it is not entirely clear what the Tribunal meant by custodial agent. However, whatever the relationship between the Taxpayer, on the one hand, and Mr Heffernan and Our World Exchange Limited, on the other, was, it is clear that Mr Heffernan had a very wide discretion as to the investments that he could make with the money. Nevertheless, he clearly had no authority to apply the money for his own benefit. 19 The Tribunal found that, as a result of misappropriation by Mr Heffernan, the Taxpayer lost the net balance of the money that the US stockbroker transferred to the Hong Kong bank account. The Tribunal concluded that the money was misappropriated when it was received and that the intention to do so existed from the outset, as did the intention to avoid the return of the money. The Tribunal found that the misappropriation and losses should be regarded as having occurred soon after the money was transferred in August 2001. However, there was no evidence and no finding as to the precise mechanism of the misappropriation by Mr Heffernan.
APPLICATION OF SECTION 25-45 20 The question in the appeal is whether the money in respect of which the Taxpayer has incurred a loss, being the money that was transferred to Hong Kong and misappropriated, was money that was included in the Taxpayer's assessable income. In order to satisfy s 25-45, the money that was misappropriated must be capable of being characterised as the same money that was included in the Taxpayer's assessable income. It must be possible to identify the misappropriated money with the money included in the Taxpayer's assessable income. The act of a taxpayer in applying money of the taxpayer towards expenses or investment is sufficient to break the necessary connection between money included in the taxpayer's assessable income and a subsequent misappropriation. By applying the money towards expenses or investment the taxpayer has received the benefit of the money that was assessable income. 21 Where money that was included in the assessable income of a taxpayer has left the taxpayer's hands, there can be no relevant misappropriation of, or in respect of, that money. Money will have left a taxpayer's hands where it has been used to pay off that taxpayer's debts (see EHL Burgess Pty Ltd v Federal Commissioner of Taxation (1988) 80 ALR 639 at 647). Similarly, 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. 22 In the present case, the proceeds of sale of the Microsoft Inc shares, which were received by the Taxpayer, through his US stockbroker, constituted money that was included in the assessable income of the Taxpayer by the operation of s 102-5 of the 1997 Act. While the precise details are not clear, the money was transferred to the Hong Kong bank account and was credited to an account or accounts with Our World Exchange Limited in the name of the Taxpayer. It is clear that the US stockbroker dealt with the proceeds of the sale of the Taxpayer's Microsoft Inc shares in accordance with the instructions of the Taxpayer. That is to say, the Taxpayer instructed the US stockbroker to transfer the proceeds to an account with a bank in Hong Kong and the US stockbroker acted in accordance with those instructions. While the particulars of that account are not known, the proceeds of sale were in fact dealt with and applied in accordance with the instructions of the Taxpayer. So far as the Taxpayer was concerned, the money was then available for investment at the direction of Mr Hefferman. The Taxpayer thus received the benefit of the proceeds of sale that constituted assessable income. That money left the Taxpayer's hands. 23 Accordingly, the money that was misappropriated from the account in the name of the Taxpayer with Our World Exchange Limited was not the money that had been included in assessable income of the Taxpayer. The primary judge did not err in concluding that the Taxpayer is not entitled to a deduction under s 25-45 in respect of the money that was misappropriated. 24 The Commissioner sought leave to raise, by notice of contention, the possible application of s 51AAA of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act). That question had not been ventilated before the Tribunal and had not been raised before the primary judge. The Taxpayer objected to the raising of the question on appeal on several bases. Since the Commissioner sought to raise that matter only if he failed in relation to the primary question of the application of s 25-45, it is unnecessary to deal with the matter.
CONCLUSION 25 The appeal should be dismissed. The Commissioner does not ask for his costs of the appeal.
EDMONDS J 26 I have had the advantage of reading a draft of the reasons for judgment of Emmett J. I agree with his Honour's conclusion that the appeal should be dismissed for the reasons his Honour gives. I merely want to add some observations of my own on the scope of s 25-45 of the Income Tax Assessment Act 1997 ('the 1997 Act') and its application to the facts of a case such as this. 27 His Honour's reasons and conclusion are predicated on what a Full Court of this Court said in EHL Burgess Pty Ltd v Federal Commissioner of Taxation (1988) 80 ALR 639 at 647: If income, when received, has been used to pay off the taxpayer's debts and so has left the taxpayer's hands, there can be no misappropriation of or in respect of that money. The benefit arising from the reduction in the liabilities of the taxpayer cannot be the subject of a relevant misappropriation. Likewise, 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 s 71 deduction. The section requires that the misappropriation be of or in respect of money that is or has been included in assessable income. That criterion must be established on the facts of the case. It should perhaps be added that the criterion may be established (as is demonstrated by the words "or has been") although the loss has occurred after the derivation of the income, provided the identity of the money lost as assessable income has not been obliterated. 28 What the Full Court said is undoubtedly correct. 29 The Court was there dealing with s 71 of the Income Tax Assessment Act 1936 ('the 1936 Act') which, at the relevant time, read: 71 Where a loss incurred by the taxpayer through embezzlement, larceny, defalcation or misappropriation by a person, including an agent, employed by the taxpayer, not being a person employed solely for private or domestic purposes, of, or in respect of, money that is or has been included in the assessable income of the taxpayer is ascertained in the year of income, that loss shall be an allowable deduction. 30 Section 25-45 of the 1997 Act now reads: You can deduct a loss in respect of money if: (a) you discover the loss in the income year; and (b) the loss was caused by theft, stealing, embezzlement, larceny, defalcation or misappropriation by your employee or *agent (other than an individual you employ solely for private purposes); and (c) the money was included in your assessable income for the income year, or for an earlier income year. Note: If you receive an amount as recoupment of the loss, the amount may be included in your assessable income: see Subdivision 20-A. 31 Clearly s 25-45, like its predecessor s 71, requires an identity between the money misappropriated and the money included in assessable income. On the other hand, in many cases, certainly for accruals basis taxpayers, it will not be money that is included in assessable income but the amount of a receivable. The subsequent discharge of that receivable by the payment of currency or the delivery of a bill of exchange is not included in the assessable income of such a taxpayer. In my view, there is no room for the operation of s 25-45 in such cases because the money that is misappropriated, whatever it is, cannot be money which has been included in the assessable income. 32 What is said in the preceding paragraph presupposes that, for the purposes of s 25-45, the term 'money' extends beyond currency and encompasses modern mediums of money exchange such as cheques and other negotiable instruments. In this day and age, I think that must be the preferable construction. 33 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. 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.
REASONS FOR JUDGMENT PERRAM J 35 The question in this appeal is whether the appellant taxpayer is entitled to claim a deduction for money lost following its investment in what turns out to have been a fraudulent scheme, probably of the Ponzi variety. The scheme, whose precise mechanics were not fully laid bare in the evidence, was conducted by a rogue, Mr Shane Heffernan. This evidence suggested that Mr Heffernan was a sophisticated criminal and that the taxpayer was far from being alone in being gulled by him. In July and August 2001 the taxpayer made two investments in Mr Heffernan's scheme which totalled approximately $4.63 million. This was done by means of two electronic fund transfers to nominated bank accounts in Hong Kong. 36 Before the Administrative Appeals Tribunal ("the Tribunal") there was considerable debate as to the nature of the taxpayer's "investment". The Tribunal found, and it is not disputed, that the taxpayer's purpose in transferring the funds and dealing with Mr Heffernan was to derive profit both from trading and capital investment as opportunities presented themselves to Mr Heffernan. The Tribunal concluded, and it is not in dispute, that Mr Heffernan misappropriated the taxpayer's money shortly after each of the two electronic transfers were made. 37 Section 8-1 of the Income Tax Assessment Act 1997 (Cth)("the Act") is the general deduction provision. It provides: (1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. (2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or (b) it is a loss or outgoing of a private or domestic nature; or (c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or (d) a provision of this Act prevents you from deducting it. For a summary list of provisions about deductions, see section 12-5. (3) A loss or outgoing that you can deduct under this section is called a general deduction. For the effect of the GST in working out deductions, see Division 27. (asterisks, notes and emphasis omitted) 38 Because the taxpayer's purpose in making the investments was the derivation of profit the Tribunal concluded that the first, positive, limb of s 8-1(1) of the Act was satisfied. However, it also concluded that the loss was of a capital nature with the consequence that it fell within the second, negative, limb of s 8-1(2)(a) and was, therefore, not available as a general deduction. 39 This conclusion flowed from the Tribunal's finding that the breadth and generality of the activities which Mr Heffernan portrayed to the taxpayer did not permit the taxpayer's deposit of $4.112 million to be characterised as a revenue item. 40 Essentially, so the Tribunal thought, the taxpayer's interest in the moneys advanced was in the nature of a capital investment and was not some kind of enterprise carried on in the course of gaining or producing assessable income by the taxpayer: cf. Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation (1956) 95 CLR 344 at 349-350. In an attempt to avoid the conclusion that the investment was capital in nature, the taxpayer had argued that he was carrying on business through or with Mr Heffernan, but the Tribunal was not persuaded that this was so. 41 The conclusion that the loss was capital in nature and not deductible under the general deduction provision then made relevant the taxpayer's alternate argument, with which this appeal is concerned, based on s 25-45 of the Act. It provides: You can deduct a loss in respect of money if: (a) you discover the loss in the income year; and (b) the loss was caused by theft, stealing, embezzlement, larceny, defalcation or misappropriation by your employee or agent (other than an individual you employ solely for private purposes); and (c) the money was included in your assessable income for the income year, or for an earlier income year. (asterisks and notes omitted) 42 The taxpayer's argument was straightforward. There was no debate that the requirements of subsection (a) and (b) were satisfied. Further, subsection (c) was satisfied because the taxpayer had included in his 2002 return an amount of $2,804.049 reflecting the exercise by the taxpayer of share options in the United States (which had netted a total of $5,608,099), and it was those proceeds of sale which had been electronically transferred to the accounts controlled by Mr Heffernan. In that sense the share sale profits were the money stolen by Mr Heffernan. 43 It is necessary then to turn to the language of s 25-45 itself. Because "assessable income" is a measure of money rather than money itself, it cannot literally be true that money is ever "included" in "assessable income" if the word is given its ordinary meaning of treating something as part of a whole. This suggests the presence of an ellipsis and a corresponding need to understand the expression "included in your assessable income" as meaning, in effect, returned as assessable income. 44 The Commissioner argued, and the trial judge accepted, that the money which was lost had to be the same as the money which was included in the assessable income. The contrary was not really argued before this Court. The question which arises is the highly artificial one of determining whether one sum of money is the same as another. To be clear, neither the word "same" nor the concept of "identity" appear in s 25-45 of the Act, but the need for an identity between the money lost and the money returned inevitably arises from the reference in subsection (c) to "the money" which, as a result of the definite article, can only refer to the word "money" when it first appears in the section. 45 The concept of two sums of money being the same is problematic. It is notorious that the meaning of "money" is mercurial both in law and economics. It extends from the simple concept of cash and coins through negotiable instruments and on to debts and other more obscure interests. Given that money is very often a medium of exchange it is particularly susceptible to changes in form. Cash, if placed by a depositor in a bank account becomes a debt; if a cheque is drawn the debt "becomes" a negotiable instrument and new debts and relationships arise. All of these, in some sense, represent the same money. 46 That observation ensures that the kind of "sameness" demanded by s 25-45 cannot be concerned only with the form that the money takes. This Court has previously determined that the section requires the money in question to be traceable. In EHL Burgess Pty Ltd v Federal Commissioner of Taxation (1988) 80 ALR 639 ("EHL Burgess") the Full Court, speaking of s 25-45's predecessor, s 71 of the Income Tax Assessment Act 1936 (Cth), said (at 647): The section requires that there be a tracing of moneys so that what has been misappropriated can be identified with that which has been or is included in the assessable income. There is no deduction for all losses arising from misappropriation. 47 Whilst I would agree that traceability is a necessary condition to establish the identity of two sums of money I do not think that it is always a sufficient one. I do not understand EHL Burgess to hold to the contrary. The difficulty in this case is to identify some stable criterion by which identity, in that sense, may be judged. 48 It is tempting, no doubt, to say that money must always maintain the same "nature". But that concept is itself somewhat elusive. The Tribunal found that both the investments and the loss were capital in nature and that capital quality might, it could be thought, be contrasted with the "nature" of the money immediately before its investment. The learned trial judge went down this path and characterised the money included in the return as income and the money invested with Mr Heffernan as capital. Having that different quality the money, though traceable, could not be the same money. With respect, however, the money never had the quality of being income. This was for two reasons. First, it was in truth a capital receipt resulting from the disposal of a capital asset, namely, the shares resulting from the exercise of the United States share options. Such a receipt was not income according to ordinary concepts. It was returned in the taxpayer's assessable income only because s 102-5(1) of the Act required net capital gains to be so returned. 49 Secondly, even if that were not so, money does not ever partake of the quality of being income which, in truth, is but a measure of an amount of money derived. As a quantity, it is conceptually distinct from the revenue it gauges; it is the difference between the measure and the measured, between the number and the thing. 50 It follows that an approach to identity which focuses on the capital or revenue nature of the money which has been lost is likely to prove difficult to apply. A better approach is, I think, to ask whether the money has been used in a way which is other than interim. Had the proceeds of sale of the stock been stolen from the taxpayer's broker's account whilst awaiting the taxpayer's instructions, the holding by the brokers would have been, in that sense, interim. If the taxpayer himself had placed the money in his own cheque account whilst choosing between different investment options then that too would have been an interim use. 51 The taxpayer, however, was not using his money in such a way when he placed it with Mr Heffernan. That investment was a wholly new enterprise. Whilst it was true that the investment was derived, in a traceable form, from the money realised on the sale of the stock it was not the same money. Perhaps another way of reaching the same conclusion is to observe that the taxpayer's decision to invest the proceeds of one investment in another denied the possibility that the same money was at both ends of the transaction. 52 It is not, in that circumstance, necessary to deal with the Commissioner's alternative contention based on s 51AAA of the Income Tax Assessment Act 1936 (Cth). 53 Edmonds J is of the view that s 25-45 of the Act is limited in its operation to income derived by cash basis taxpayers on the receipt of money understood as cash or other ready means of exchange. There is, with respect, much to be said for this view. It is difficult to see, in practice, how the provision could practicably operate outside those circumstances. However, I would hesitate to close the door finally on that issue; the concept of money is perpetually evolving as are the frauds perpetrated to obtain it, and the enterprises in which those frauds occur.
Lean
Commissioner of Taxation
Appeal dismissed. The primary judge's orders stood, including the setting aside of the Tribunal's decision and affirmation of the Commissioner's objection decision. The Commissioner did not ask for costs: [25].