Although the monetary losses that result from fraud are usually tax deductible, provided there is a connection with a business or income-producing activity and the money has been included in assessable income, there are exceptions.
Common situations where tax deductions have been allowed include:
- Loss of business profits as a result of theft by an employee
- Loss of investment earnings as a result of theft by an agent
- Loss of cash takings prior to banking from a safe on the business premises as a result of theft by persons unknown
- Loss of cash takings as a result of theft while on the way to the bank
- Expenses, such as accounting fees, relating to the fraud or theft where they can be regarded as management of tax affairs or satisfying regulatory requirements
However, situations where tax deductions have not been available include:
- Loss of money given to an investment broker for purchasing shares, where the money was misappropriated by the broker and the shares never purchased
- Loss of business takings misappropriated by a sole trader’s spouse, where the spouse was not acting as an employee or agent of the taxpayer
- Legal and investigation fees incurred by a partnership relating to a fraud and misappropriation of funds by one of the partners.
There are three main factors in whether a tax deduction will be allowed in these situations.
The first is whether the loss or expense was an ordinary incident of the taxpayer’s business or income producing activity.
The second is whether the theft or fraud was undertaken by an employee or agent of the taxpayer.
Finally, there is whether the money lost had been included in the taxpayer’s assessable income.
This is why, for example, in the well-publicised recent case of the drug dealer claiming a loss for money stolen in the course of his drug dealing, the courts felt that they had no choice but to allow a tax deduction.
Although the activities were illegal, the taxpayer was engaging in a business activity and had been assessed on his proceeds from the business.