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Decision Impact Statement

David Lean and Commissioner of Taxation

Venue: Full Federal Court
Venue Reference No: NSD 529 of 2009
Judge Name: Emmett, Edmonds & Perram JJ
Judgment date: 28 January 2010
Appeals on foot:
No.

Administrative Treatment (Implication on current Public Rulings and Determinations)

Relevant Rulings/Determinations:

Subject References:
Income Tax
Deductions
Misappropriation
Necessary connection
Money included in assessable income

Précis

Whether misappropriated money was included as assessable income; and whether the act of applying money towards expenses or investment was sufficient to break the necessary connection between the money included in the taxpayer's assessable income and a subsequent misappropriation.

Decision Outcome:

Appeal from the judgment of Stone J in the Federal Court dismissed.

Brief Summary of Facts

1. In January 2001 the taxpayer attended a meeting held by a company that provided a research and share trading system. At that meeting the taxpayer was provided with the name of a share trader, Mr Heffernan, who he was led to believe was "reputable and highly successful". In May 2001 the taxpayer transferred $5,000 to a Hong Kong account nominated by Mr Heffernan.

2. The taxpayer held options to acquire shares in Microsoft Inc in the United States. Mr Heffernan encouraged the taxpayer to increase his investment. The taxpayer exercised the options and sold the allocated shares through a US stockbroker. The taxpayer instructed the US stockbroker to transfer the proceeds of sale to the Hong Kong bank account nominated by Mr Heffernan.

3. On 11 July 2001 $AUS 517,416 was transferred to the Hong Kong Bank Account. The taxpayer received an E-ceipt issued in the name of Our World Exchange Limited. Our World Exchange Limited was incorporated in Vanuatu and was subservient to Mr Heffernan and operated at his whim. Therefore it was an agent of Mr Heffernan and did not act independently.

4. In August 2001 the taxpayer went to a seminar held by Mr Heffernan. At that seminar the taxpayer was offered an arrangement which would allegedly give the taxpayer more control over his money.

5. On 24 August 2001 the taxpayer instructed his US stockbroker to transfer an amount of $AUS 4,112,898.59 representing the proceeds of a further sale of Microsoft Inc shares to the Hong Kong Bank Account. The taxpayer received two E-ceipts that stated the funds had been credited to two different numbered accounts in the taxpayer's name.

6. The taxpayer could not provide evidence that he derived any investment income nor was he able to show that any investment transactions actually occurred.

Issues decided by the Court

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 and thus a deduction could be claimed under section 25-45 for the year ended 30 June 2002. In order to do this it must be found that the money that was misappropriated was capable of being characterised as the same money that was included in the taxpayer's assessable income.

The court found that where the money had left the taxpayer's hands - for instance for reinvestment - there can be no relevant misappropriation in respect of that money.

His Honour, Edmonds J, expressed the view that the section could only ever apply to cash basis taxpayers [paragraph 34]. Perram J agreed that he could not see how it could operate outside of cash basis accounting in practice. However, his Honour expressed the view that he was hesitant to "close the door finally" on that issue. [para 53]

Tax Office view of Decision

The decision concerned a deduction for a loss by theft, stealing, embezzlement, larceny, defalcation or misappropriation under section 25-45. It considered where the provision could be applied and where it could not. This case rejected an argument that tracing alone was sufficient to bring losses arising from the subsequent spending of funds into the operation of the provision on the basis that it was included in the taxpayer's assessable income.

It should be noted that section 116-60 of the Income Tax Assessment Act 1997 applies to amounts misappropriated in the 2007-08 income years and later income years. This provision allows for modifications to the capital proceeds of a CGT event in circumstances where an employee or agent misappropriates all or part of the capital proceeds.

Administrative Treatment

List of Rulings and Determinations Affected

n/a

Implications on current Public Rulings & Determinations and Law Administration Practice Statements

n/a

Your comments

We invite you to advise us if you feel this decision has consequences we have not identified, or if a precedential decision such as a Public Ruling or an ATO ID requires reconsideration or amendment. Please forward your comments to the contact officer by the due date.

Date Issued:	21 September 2010
Due Date:	16 November 2010
Contact officer:	Peter Chochula
Email address:	peter.chochula@ato.gov.au
Telephone:	(02) 9374 2607
Facsimile:	(02) 9374 8628
Address:	52 Goulburn Street Sydney, NSW 2000

Legislative References:
Income Tax Assessment Act 1936
51AAA
71

Income Tax Assessment Act 1997
6-1
6-5
6-10
6-15
8-1
25-45
102-5

Case References:
EHL Burgess Pty Ltd v. Federal Commissioner of Taxation
(1988) 80 ALR 639
88 ATC 4517
19 ATR 1407

Charles Moore & Co (WA) Pty Ltd v. Federal Commissioner of Taxation
(1956) 95 CLR 344
[1956] HCA 77