1. Skip to navigation
  2. Skip to content
  3. Skip to sidebar

Tax Court Rules Amounts Paid Out of Ponzi Scheme Not Taxable

The tax treatment of amounts paid out of failed Ponzi schemes is once again in the news. In Roszko v. The Queen (2014 TCC 59), the Tax Court of Canada allowed the taxpayer’s appeal and held that amounts paid out of a fraudulent scheme were not taxable as interest income.

Roszko follows two recent decision on this issue. In Johnson v. The Queen (2012 FCA 253), the Federal Court of Appeal held that amounts paid out of a Ponzi scheme in excess of the duped taxpayer’s original investment were taxable as income. And in Orman v. Marnat (2012 ONSC 549), the Ontario Superior Court of Justice held that amounts received out of a Ponzi scheme were not investment income (see also this article on the court’s consideration of whether it could rectify certain corporate documents of two companies that had invested in the fraud).

In Roszko, the taxpayer was induced to invest in TransCap Corporation, which was allegedly trading commodities, on the basis that the investment would return 18% to 22% annually. In 2006, the taxpayer made an initial investment of $100,000, which was structured as a loan.  In 2006 and 2007, the taxpayer loaned a total of $800,000 to TransCap. From 2006 to 2009, TransCap paid to the taxpayer a total of $408,000 as follows: $22,500 in 2006, $81,000 in 2007, $156,000 in 2008, and $148,500 in 2009.

In December 2009, the taxpayer became suspicious of the activities of TransCap, which lead to an investigation by the Alberta Securities Commission, which eventually determined that TransCap had perpetrated a fraud on investors.

The issue before the Tax Court was whether the $156,000 received by the taxpayer in 2008 was interest income under paragraph 12(1)(c) of the Income Tax Act.

The Tax Court cited the Federal Court of Appeal’s decision in Johnson for the proposition that there can indeed be a source of income in a Ponzi scheme. However, the Tax Court held that the facts in the Johnson case – wherein the Federal Court of Appeal held that the $1.3 million received by the taxpayer out of the Ponzi scheme was taxable – were different from the facts of the present case. Specifically, in Roszko, the taxpayer’s agreement with TransCap stipulated how the funds were to be invested, the taxpayer was lead to believe the funds would be so invested, the funds were not invested in that manner (i.e., the taxpayer’s contractual rights were not respected), it was agreed that TransCap perpetrated a fraud, and the fraud was described in a decision of the Alberta Securities Commission.

The Tax Court held that the facts of Roszko were more like those in the case of Hammill v. The Queen, in which the Federal Court of Appeal held that a fraudulent scheme from beginning to end cannot give rise to a source of income from the victim’s point of view and hence cannot be considered as a business under any definition.

The Tax Court noted that, in Roszko, the Crown had argued that the income was property income in the form of interest. However, the Tax Court held the amount received by the taxpayer was not income from property, but rather a return of capital to the extent of the original amounts invested. The Tax Court noted that excess returns might be considered income. The Tax Court allowed the appeal .

This is a victory for the taxpayer for the 2008 tax year, but the unanswered question that looms in the background is how the taxpayer’s overall loss ($392,000) on the Ponzi scheme investment will be treated for tax purposes.

, , , ,

Tax Court Rules Amounts Paid Out of Ponzi Scheme Not Taxable

CRA Considers Tax Treatment of Crowdfunding

Hot on the heels of the CRA’s recent publication of a “fact sheet” on its views on the tax treatment of Bitcoin currency (which has been in the news recently – see articles here and here), the CRA has published two technical interpretations on the tax treatment of “crowdfunding“.

In CRA Document No. 2013-0508971E5 (October 25, 2013) and CRA Document No. 2013-0509101E5 ”Crowdfunding” (October 29, 2013) the CRA was asked about the tax treatment of amounts received by taxpayers through a crowdfunding arrangement.

The CRA stated that it understood crowdfunding to be a way of raising funds for a broad range of purposes, using the internet, where conventional forms of fundraising funds might not be possible (and which may or may not involve the issuance of securities).

The CRA stated that, depending on the specific circumstances, crowdfunding amounts received by the taxpayer could represent a loan, capital contribution, gift, income or a combination thereof. The CRA noted its position described in Interpretation Bulletin IT-334R2 “Miscellaneous Receipts” (February 21, 1992) that voluntary payments received by virtue of a taxpayer’s profession or carrying on of a business are considered taxable receipts. The CRA also noted that, on the other hand, a non-taxable windfall may exist where the taxpayer made no organized effort to receive the payment and neither sought nor solicited the payment. The CRA’s view is that a business has commenced where the taxpayer has started some significant activity that is a regular part of the business or that is necessary to get the business going (see Interpretation Bulletin IT-364 “Commencement of Business Operations” (March 14, 1977)). Conversely, a gift may exist where the donor transfers property with no right, privilege, material benefit or advantage conferred in return.

These two recent technical interpretations follow an earlier publication (CRA Document No. 2013-0484941E5 “Crowdfunding” (August 13, 2013)), in which the CRA stated that amounts received by a taxpayer from crowdfunding activities would generally be included in the taxpayer’s income pursuant to subsection 9(1) of the Income Tax Act as income from carrying on a business (and that certain expenses may be deductible).

These views from the CRA are helpful guidance for those who have undertaken or are considering crowdfunding. We agree that a taxpayer’s specific circumstances will be determinative of the tax treatment of the crowdfunded amounts (i.e., on a case-by-case basis). However, because of the various activities for which crowdfunding may be sought, and the ease with which crowdfunding may be accessed, it is less clear when a taxpayer’s activities (including seeking crowdfunding and any other associated activities) will result in the conclusion that a taxpayer has commenced carrying on business.

Accordingly, taxpayers who seek and obtain crowdfunding (for business and non-business purposes) should be aware of the potential tax implications, particularly in light of fact-specific results and the CRA’s evolving views on the subject.

, , ,

CRA Considers Tax Treatment of Crowdfunding

The Tax Court of Canada and the World of Opera

Moliere once said, “Of all the noises known to man, opera is the most expensive.”

In Knapik-Sztramko v. The Queen (2013-799(IT)I, October 17, 2013), the Tax Court of Canada managed to reduce some of that cost, at least for one opera performer.

The taxpayer was an opera singer. In 1997, she entered a vocal competition organized by the Gerda Lissner Foundation. The taxpayer won the competition and from 1997 to 2006 she received monies for the payment of singing coaches, stage training, accommodation and travel expenses. The CRA reassessed the taxpayer to include in her income the amounts received from the Foundation.

Under paragraph 56(1)(n), a taxpayer must include in his/her income any amount received as or on account of a prize other than a “prescribed prize”. Section 7700 of the Income Tax Regulations states,

7700. For the purposes of subparagraph 56(1)(n)(i) of the Act, a prescribed prize is any prize that is recognized by the public and that is awarded for meritorious achievement in the arts, the sciences or service to the public but does not include any amount that can reasonably be regarded as having been received as compensation for services rendered or to be rendered.

In this case, the Crown conceded that the prize was recognized by the public and was for meritorious achievement in the arts. However, the Crown argued, the prize was paid as compensation for services. In the Crown’s view, the taxpayer had undertaken certain activities (coaching, training, career development, etc.) for, and provided services to, the Foundation in exchange for the money.

The Tax Court found that the taxpayer had provided no services to the Foundation, and that the activities undertaken by the taxpayer were consistently comprised of training, support and education to enhance her performance abilities:

The identification of the appellant as someone worthy of specialized study and training was the basis for awarding the prize from the Foundation’s perspective. This prize was not a relationship of, or in substitution for, employment, but a prize awarded on merit with reasonable conditions attached in order to ensure that the burgeoning talent identified was further refined by the benefactor.

The Tax Court allowed the taxpayer’s appeal.

The tax treatment of prizes is a nuanced area, dovetailing as it does with the taxation of scholarships, bursaries, fellowships and employment income. The issue seems to garner public attention every four years when the CRA responds to queries as to whether Olympic medal-winning athletes are subject to tax in Canada on their prizes (answer: Canadian athletes, yes (see CRA Document No. 2004-0098691E5 “Prizes paid to amateur athletes” (January 21, 2005), CRA Document No. 2008-0300071M4 “Olympic medals” (June 26, 2009) and CRA Document No. 2012-0458181M4 “Olympic performance awards” (September 18, 2012)); non-resident athletes, no (see subsection 115(2.3) of the Income Tax Act)).

The Tax Court’s decision in Knapik-Sztramko is a helpful case in a limited body of jurisprudence on what qualifies as a non-taxable prize under paragraph 56(1)(n) and Regulation 7700.

, , , ,

The Tax Court of Canada and the World of Opera

Daishowa-Marubeni: A Tree Fell in the Forest and the SCC Caught it!

In Daishowa-Marubeni International Ltd. v. The Queen, 2013 SCC 29, Justice Rothstein marries tax philosophy and tax practice by asking and answering the question:

If a tree falls in the forest and you are not around to replant it, how does it affect your taxes?

The Court analyzes the difference for tax purposes between liabilities and embedded obligations, considers the law of contingent liabilities, the role of tax symmetry in the Income Tax Act (Canada) (the “Act”), the role of the agreement between the parties and the role of accounting treatment in reaching the conclusion that embedded obligations are not liabilities that form part of proceeds of disposition.

For a full analysis of the decision, click here.

Daishowa-Marubeni: A Tree Fell in the Forest and the SCC Caught it!

Provincial Income Allocation: Salaries and Wages to Include All Taxable Benefits

In the Provincial Income Allocation Newsletter No. 4 (March 2013), the Canada Revenue Agency notes that the Allocation Review Committee (“ARC”) has changed its position on amounts previously excluded in calculating “salary and wages paid in the year” for provincial income allocation purposes:

Effective for the 2013 tax year, the amount of salaries and wages paid in the year for the purpose of provincial income allocation calculations will include all taxable benefits that are to be included in the employees’ income in the year. This includes deemed amounts such as stock option benefits under section 7 of the Income Tax Act (Canada), regardless of whether these benefits are deductible in calculating the employer’s income.

Corporations having a permanent establishment in more than one province will need to consider the ARC’s change in position when preparing their next income tax return.  Applying the previous year’s method of calculation salaries and wages may fail to include all of the amounts now required to be included in the calculation.

, ,

Provincial Income Allocation: Salaries and Wages to Include All Taxable Benefits

Supreme Court dismisses leave application in Johnson v. The Queen

On March 21, 2013, the Supreme Court of Canada dismissed (with costs) the application for leave to appeal in the case of Donna M. Johnson v. Her Majesty The Queen.

The issue in Johnson was the tax treatment of receipts from a Ponzi scheme. The Tax Court (2011 TCC 540) allowed the taxpayer’s appeal and held that the receipts were not income from a source for the purpose of paragraph 3(a) of the Income Tax Act. The Federal Court of Appeal (2012 FCA 253) reversed the lower court’s decision, allowing the Crown’s appeal.

I commented on the decisions of the Tax Court and the Federal Court of Appeal in the March 2013 Ontario Bar Association Tax Section newsletter.

,

Supreme Court dismisses leave application in Johnson v. The Queen

Canada Revenue Agency Toronto Centre Tax Services Office Describes Current Audit Issues

At today’s Canada Revenue Agency Toronto Centre Tax Professionals Group Breakfast Seminar (November 14, 2012), the CRA provided an update on a number of current audit issues.

The CRA was represented by Sal Tringali, Regional Technical Advisor of Aggressive Tax Planning, and James McNamara, Manager of International Taxation and Aggressive Tax Planning Audit Division from the Toronto Centre Tax Services Office. The discussion was moderated by Jacques Bernier (Baker McKenzie LLP) and Rachel Gervais (BDO Canada LLP).

The audit issues highlighted by the panel included the following:

GST/HST

  1. Recapture input tax credit
  2. ITC allocation % – mixed supplies
  3. Financial services
  4. Imported supplies
  5. Reinsurance/loading
  6. Loyalty reward points
  7. VDP – Related parties

Income Tax

  1. Artificial capital losses
  2. Loss trading
  3. Surplus strips
  4. Offshore bank accounts held by individuals
  5. Donation arrangements
  6. International transactions
  7. S. 85 rollovers
  8. RRSP appropriations
  9. Tax-free savings accounts (TFSA)

Additionally, the CRA made the following comments:

    • The CRA’s access to/requests for accountants’ working papers remains a “hot topic”. Generally speaking, the CRA will first ask the taxpayer for information/documents, after which the CRA may request information/documents from the taxpayer’s accountants. The CRA’s objective is to perform high-quality audits, and access to complete information is required to do so.
    • The CRA reminded taxpayers of its recent announcement that the CRA will not assess a taxpayer’s return where the taxpayer has claimed a charitable donation and the alleged gift is made as part of a donation arrangement. The delay in assessing the return could be two years or more (see Jamie Golombek’s recent article on the subject).
    • The CRA has appealed the Tax Court’s decision in Guindon v. The Queen to the Federal Court of Appeal. In light of the Tax Court’s decision, the CRA is currently considering its options in respect of the assessment of third party penalties.
    • The CRA has considered the application of third party penalties in 185 cases. In 71 of those cases the penalty was applied, resulting in the imposition of $79 million of penalties. In 50 cases the penalty was not applied, and 64 cases are ongoing.
    • The CRA will continue to revoke e-file privileges where a tax preparer is subject to a penalty, even where a penalty against a single tax preparer may result in the revocation for his or her entire firm.
    • The CRA referred to the recent Supreme Court decision in GlaxoSmithKline v. The Queen and stated that it intends to follow the new OECD guidelines on transfer pricing and the hierarchy of pricing methods. The CRA said that it did not expect to release any formal communication to the public on this issue, but Information Circular IC 87-2R “International Transfer Pricing” may be updated to reflect this position.

UPDATE: After the seminar, the CRA informed us that it intends to follow the guidance in the recently updated OECD Guidelines and will be issuing a Transfer Pricing Memoranda (TPM) on the matter to the public. This TPM will reflect a recently released internal Communique on the same subject and will be made available in the near future.

    • The CRA clarified that Tax Earned By Audit (“TEBA”) remains a metric for measuring ”tax at risk”, but it is not used to measure the performance of an auditor. Rather, the CRA measures the performance of auditors based on six major elements: (i) planning the audit, (ii) conducting the audit, (iii) applying the appropriate legislation/policy, (iv) the end product of the audit, (v) professionalism in the audit, and (vi) timeliness of completion of the audit.
    • The CRA plans to convene face-to-face meetings with approximately 160 large businesses (i.e., annual sales over $250 million) as part of the CRA’s large business audit project. The CRA will continue to risk-assess all large businesses/entities annually.
    • The CRA intends to clear a backlog of approximately 1,300 audit files so that it may assess the most recent taxation year and the immediately preceding taxation year for most businesses by 2015-16.
    • The CRA reiterated that issues that arise during the audit process should be raised with the auditor, after which it may be appropriate to involve the auditor’s team leader. If the issue cannot be resolved at that level, it would be appropriate to raise the issue with the auditor’s manager or the assistant director of audit at the particular TSO.

, , ,

Canada Revenue Agency Toronto Centre Tax Services Office Describes Current Audit Issues

No Medal for CRA’s Questionable Treatment of Canadian Olympic Medalists

On August 13 I came across this article in the Globe and Mail outlining how CRA treated prizes received by Canadian Olympic Medalists.

Gold medalists receive a $20,000 prize from the Canadian Olympic Committee, Silver medalists $15,000 and Bronze medalists $10,000. The CRA asserts that those amounts are taxable. The CRA’s position is based on what can only be described as a questionable interpretation of Income Tax Regulation 7700:

7700. For the purposes of subparagraph 56(1)(n)(i) of the Act, a prescribed prize is any prize that is recognized by the general public and that is awarded for meritorious achievement in the arts, the sciences or service to the public but does not include any amount that can reasonably be regarded as having been received as compensation for services rendered or to be rendered.

This regulation is directly related to the Nobel Prize in Chemistry awarded in 1986 to Dr. John C. Polanyi of the University of Toronto. There was considerable public sentiment that Dr. Polanyi not be subject to income tax on this prize. As a result the Income Tax Act was amended to introduce the concept of a tax exempt “prescribed” prize. It is one of the most straightforward provisions in Canadian tax law. All that is required is:

    1. recognition of the prize by the general public; and
    2. that the prize is awarded for meritorious achievement in the arts, the sciences or service to the public (I am intentionally omitting the irrelevant language about compensation for services).

Surprisingly, the CRA has concluded that Canada’s Olympic medalists were not being awarded for “service to the public”:

I must clarify that the media reports you refer to dealt not with the value of the medals themselves but with the prize money the Canadian athletes who won medals at the Games. Paragraph 56(1)(n) of the Income Tax Act states that the total of all amounts received in the year as, or on account of a prize for achievement in a field of endeavour that the taxpayer ordinarily carries on should be included in the taxpayer’s income. This provision of the Act would not normally apply to your example of a lottery winner; however, paragraph 56(1)(n) is sufficiently broad as to apply to a prize awarded to an athlete for winning an Olympic medal.

I note that the Act provides an exception to this rule for a prescribed prize. For purposes of this exception, section 7700 of the Income Tax Regulations defines a “prescribed prize” as any prize that is recognized by the general public and that is awarded for meritorious achievement in the arts, the sciences, or in service to the public. Although winning an Olympic medal may be an internationally recognized achievement and could indirectly promote a sense of nationalism, such a prize is not awarded in recognition of service to the public and therefore would not be a prescribed prize and would not fall within the exception.

CRA Document 2008-0300071M4 “Olympic medals” (26 June 2009)

Since it first participated in the games of 1900, Canada has won 278 medals in the Summer Games (an average of 11 per Games) and 145 in the Winter Games (an average of 7 per Games). It is astonishing that the CRA and the Department of Finance would regard the taxation of these awards as material. To suggest that these young men and women who spend years of their lives training for the chance once every four years to put the Canadian flag and anthem on display for the entire world to see and hear are not engaged in service to the Canadian public is not only unsupportable in light of the text, context and purpose of the provision, but serves to undermine the federal government’s own financial support of amateur athletics and best and brightest of Canada’s Olympic athletes. It is hoped that the CRA sees the light sooner rather than later and changes its position accordingly.

, , , ,

No Medal for CRA’s Questionable Treatment of Canadian Olympic Medalists