Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello MP)Chapter 6 - Denial of deductions for illegal activities
Outline of chapter
6.1 Schedule 3 to this Bill inserts section 26-54 into the Income Tax Assessment Act 1997 . The provision will deny deductions for losses and outgoings where they are incurred in the furtherance of, or directly in relation to, activities in respect of which the taxpayer has been convicted of an indictable offence.
6.2 Complementary amendments to the capital gains tax provisions will ensure such losses and outgoings are not included in cost base calculations.
Context of amendments
6.3 The income tax law allows deductions against a taxpayer's assessable income for any loss or outgoing incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. Generally, deductions will be allowed under these provisions if there is sufficient nexus or link between the loss or outgoing and the business or production of assessable income, and the amount is not of a private or capital nature.
6.4 On 5 June 2003, the Full Federal Court in Commissioner of Taxation v La Rosa confirmed earlier decisions to allow a tax deduction for $220,000 for money stolen from the taxpayer, as it was considered there was a sufficient link between the theft and the taxpayer earning his assessable income through illegal drug dealing.
6.5 The Full Federal Court found that the taxpayer being engaged in an illegal activity when the loss was sustained did not mean that the deduction should be denied.
6.6 On 27 October 2004 the High Court refused the Commissioner of Taxation's (Commissioner) special leave application to appeal the Full Federal Court's decision.
Summary of new law
6.7 These amendments will deny deductions for losses and outgoings whether they are of a revenue nature or capital nature to the extent that they are incurred in the furtherance of, or directly in relation to, activities in respect of which the taxpayer has been convicted of an indictable offence. Indictable offences are offences that are punishable by imprisonment for at least one year.
| New law | Current law |
|---|---|
| Where a taxpayer has been convicted of an indictable offence, deductions under the general deduction and capital gains tax provisions will be denied. | Income from illegal means is income according to the ordinary concept of income. Deductions against ordinary income are allowable under the general deduction provisions (section 8-1) or taken into account for the purposes of capital gains tax provisions. |
Detailed explanation of new law
Expenditure in relation to illegal activities
6.8 Subsection 26-54(1) will operate to deny deductions for losses and outgoings to the extent they are incurred in the furtherance of, or directly in relation to, activities in respect of which the taxpayer has been convicted of an offence which is punishable by imprisonment for at least 12 months. [Schedule 3, item 2, subsection 26-54(1)]
6.9 Relevant activities in relation to the offence are those that comprise the physical element of the offence, that is the conduct, result of conduct or circumstances in which conduct results or occurs. 'Physical element' has the same meaning as it appears in the Criminal Code Act 1995.
6.10 Deductions will be denied for all expenditure where the activities are wholly illegal such as drug dealing or people smuggling. For example, dealing in illegal drugs (buying and selling and associated activities) is an offence in its own right, not just acquiring illegal drugs, though that in itself is an offence.
6.11 On the other hand, there will be cases where a taxpayer is conducting a lawful business but is convicted of an illegal activity while carrying on that business. In these cases only the expenditure that is incurred directly or in the furtherance of the illegal activity will be denied. Expenditure that is incurred in undertaking the underlying lawful activity and that would have been incurred regardless of the illegal activity will continue to be deductible. This is because the expenditure cannot be said to further or be directly related to the illegal activity. The expenditure is too remote to the illegal activity.
Expenditure in relation to capital gains
6.12 Similarly, the capital gains tax provisions will be amended so that losses and outgoings incurred in relation to illegal activities in respect of which the taxpayer was convicted of an indictable offence do not form part of the cost base or reduced cost base for capital gains purposes. This will ensure that no capital loss or reduced capital gain can arise from such expenditure. [Schedule 3, items 3 and 4]
6.13 The Commissioner will have up to 4 years after the taxpayer is convicted of an indictable offence to issue an amended assessment. This will provide an appropriate amendment period where a taxpayer makes a claim for a deduction in an income tax return and is subsequently convicted of an indictable offence. [Schedule 3, item 2, subsection 26-54(2)]
Application and transitional provisions
6.14 These amendments will apply to losses and outgoings incurred after 29 April 2005. This is the date of announcement by the Treasurer. It is appropriate that amendments to deny inappropriate tax outcomes where criminal behaviour is involved apply from the date of announcement.