Investors duped by ponzi schemes now have one thing to be thankful for: the Tax Court of Canada (TCC) recently ruled that money returned to a victim as part of the fraud cannot be considered interest income and thus taxed by the Canada Revenue Agency (CRA). This decision, however, stands in sharp contrast to an earlier finding from the Federal Court of Appeal (FCA).
In Roszko v. The Queen, an investor received $156,000 in 2008 from TransCap Corp., a well-orchestrated Ponzi scheme allegedly trading commodities. The question before the TCC was whether this money was interest earned on an investment and thus taxable as income from a source under paragraph 12(1)(c) of the Income Tax Act or whether the monies were a return of part of the $800,000 the investor had given to TransCap over four years.
The TCC concluded that certain payments arising out of a Ponzi scheme could be taxable, but not in this case: “The court found as a fact that the taxpayer had been the victim of a fraud from start to finish.”
“Thus, the taxpayer was not receiving amounts from the Ponzi scheme,” says Timothy Fitzsimmons, a partner with the law firm Dentons Canada LLP in Toronto, “that were taxable in his hands.
“In this way,” he continues, “the Roszko case provides an example of the types of cases in which these Ponzi scheme payments will not be subject to taxes – [that is] because the payments are a return of the taxpayer’s original investment.”
In another case regarding Ponzi schemes, the FCA ruled in Johnson v. The Queen in 2012 that money paid out of a Ponzi scheme – in excess of the taxpayer’s original investment – was taxable as income.
One of the clear distinctions between the two cases is the nature of the agreement between the investor and the purported investment company.
In Johnson, the agreement was primarily oral, so it was difficult to ascertain the nature and extent of the fraud from the outset. In Roszko, there was a detailed arrangement that clearly – and fraudulently – spelled out how funds would be invested and which promised annual returns of 18%-22%.
“The distinction the Tax Court made here is that where something is a fraud from Day 1, it can’t give rise to income taxes,” says William Innes, a tax lawyer with Rueter Scargall Bennett LLP in Toronto.
In the TCC’s 15-page decision, Justice Campbell Miller concluded that the money returned in Roszko is not income until returns exceed the original investment: “It cannot be considered income from property, but rather a return of capital to the extent of the original amounts invested. Only excess returns might be considered income.
“This is quite different from Ms. Johnson’s situation,” the decision continued, “where there were excess returns, and the court found she entered into a contract, and her rights under that contract were respected. No fraud, as such, was found [in the Johnson case]: she got exactly what she contracted for.”
The TCC decision also states that there is a difference between income from fraudulent activity, which is taxable, and income from a contract that is itself a fraud, which is not.
The TCC left another question open, says Fitzsimmons: “What is unclear after the Roszko decision is how the taxpayer’s overall loss on the fraudulent scheme will be treated for tax purposes.”
The CRA’s efforts to collect tax payments from duped investors has raised eyebrows. Some tax experts believe this is an indication of the national tax agency’s increasingly aggressive approach. Says Innes: “They are not leaving any stone unturned.”
Innes also notes that if the CRA appeals the Roszko decision, as anticipated, and the FCA overturns it, this case could go to the Supreme Court of Canada.
Says Innes: “On its face, it’s not an ideal situation to try to tax a taxpayer who has been defrauded.”
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