Commissioner of Taxation v La Rosa

The three-member Full Court of the Federal Court upheld the earlier rulings, finding that La Rosa was entitled to deduct the $220,000 in full.[6] The main issue considered by the court was the deductibility of expenses incurred by an illegal business.[5] The leading judgment in the case was given by Justice Peter Hely, who observed:

The purpose of the ITAA is to tax taxable income, not punish wrongdoing. [...] There should not be a higher burden of taxation imposed on those whose business activities are unlawful than that imposed in relation to lawful business activities. Punishment of those who engage in unlawful activities is imposed by the criminal law, and not by the laws in relation to income tax.[7]

The court first considered whether the sum had correctly been included in La Rosa's assessable income. It noted a substantial precedent that "the illegal nature of a receipt does not deny its taxability", as the ITAA made no distinction between income derived from legal and illegal activities. It therefore upheld the AAT's initial ruling that the $220,000 formed part of La Rosa's assessable income. The court observed that exempting illegally obtained revenue from taxation would "favour dishonest businesses over honest ones".[8] The court also ruled that La Rosa's operations, although illegal, nonetheless constituted a "business" within the ITAA definition.[9]

Section 51(1) of the ITAA allowed taxpayers to deduct losses "incurred in gaining or producing the assessable income", with some exceptions. Section 51(2) specifically allowed for the deduction of "expenditure incurred or deemed to have been incurred in the purchase of stock used by the taxpayer as trading stock".[10][lower-alpha 1] In ruling that the stolen money constituted a "loss", the court applied the 1956 High Court decision in Charles Moore (WA) Pty Ltd v Commissioner of Taxation, where a deduction was allowed for money that had been stolen from a business while being taken to a bank.[12] The cash was stolen from La Rosa "during operations to acquire trading stock" (specifically, a "substantial supply of prohibited drugs").[13] Because of this, the court upheld the AAT's original decision that the loss had a direct connection with the business operations and therefore fell under the general deduction provisions. As with income, the ITAA did not expressly prohibit deductions for expenses incurred in illegal activities.[2]

The ATO submitted that the court should adopt a "purposive" rather than a literal approach to interpreting the ITAA's deduction provisions, as the ITAA contained sections barring deductions for fines, penalties, and bribes.[5] It argued that, based on these existing "public-policy" exceptions, the unexpressed intent of the legislation was to prohibit deductions relating to illegal activities; the court should consequently read into the legislation an implied prohibition on claiming those deductions.[14] The court rejected this submission on the grounds that a non-literal interpretation of the deduction provisions would be inconsistent with other areas of the ITAA and would cause uncertainty among taxpayers. It stated that it was the role of the legislature to determine public-policy exceptions to the deduction provisions, not that of the courts.[15]