Hi there accounting fans!
Its been a while since we’ve talked about tax! Please note that any tax advice contained in this article is relevant to Aotearoa NZ. For more specific tax information, please consult with your local tax agent.
Is fraud tax deductible?
This is an interesting question.
The simple answer is: Yes, money lost to fraud is tax deductible.
BUT. There are a few criteria that need to be met for fraud to be tax deductible. Let’s take a look.
What is the definition of fraud for tax deductions?
Fraud, simply put is a ‘monetary loss that arises from an abuse of trust or misrepresentation in the course of operating a business’.
Let’s look at some examples:
Scenario 1: A fraudulent employee
Gino’s Motors employs Bibby as their accounts payable manager. Bibby is responsible for paying Gino’s Motors’ suppliers on time. However Gino’s Motors has been receiving overdue notices from their suppliers. Upon investigation, it turns out that Bibby has not been paying Gino’s suppliers. Bibby has been paying themselves instead.
This is fraud. An employee abuses the trust given by the employer. As a result of this abuse, the employer has now lost money. Then, the employee will likely be prosecuted. However the likelihood of recovery of the funds will be quite low. Hence Gino’s Motors can claim this loss as a tax deduction.
Scenario 2: A cheating agent
Finance GO is a finance company. They disburse their loans to customers via their sales agents. Sales agents hold the funds in trust, then pay it out to the customer or the customer’s supplier. They gave a loan disbursement of $30,000 to one of their Agents, Emma Crook. Emma did not pay out this amount to the customer or the supplier. Then Emma left the country without telling anyone.
This is also fraud. While the sales agent is not directly employed by Finance GO, they are still held in a position of trust by the company. Due to the abuse of this trust, Finance GO can claim the lost $30,000 as a tax deduction.
What about fraud from investment scams?
Here’s where things start to get tricky.
There are heaps of investment scams out there. Plenty of high risk investments (like crypto and NFTs) are fronts for investment scams.
From an ethical standpoint, yes, surely we should allow some relief for victims of investment scams. However from a practical standpoint, every investment carries risk. It is the responsibility of the investor to understand what those risks are. That risk includes losing all their investment.
The IRD isn’t going to give tax relief to every investor that lost their money in a bad investment. As an investor, this is something you have to prepare for yourself.
Exceptions to the rule
There are some exceptions to this rule. If your primary business is the trading of securities, then you can claim any losses on trades as a tax deductible expense. However, the flipside is that any gains you make on trades are taxable.
Furthermore, different types of investments have different tax treatments. Share sales get the capital gains treatment. Interest and dividend income are subject to withholding tax. So if you are unsure about how to treat your investment scam losses, its best to talk to a tax adviser.
Protect yourself from fraud!
By the end of the day, you don’t want to be defrauded in the first place! Ensure that your internal controls are working. Make sure that there are checks and balances in place. But if all that fails, you can rest easy knowing that at the very least, you can claim a tax deduction on any fraud losses.
Stay positive!