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IRS: Bitcoin Not a Currency for Tax Purposes

As expected, the U.S. Internal Revenue Service has provided some guidance on the U.S. tax treatment of Bitcoin.

In Notice 2014-21 (March 25, 2014), the IRS stated that Bitcoin is property and not currency for tax purposes.  According to the Notice, “general tax principles applicable to property transactions apply to transactions using virtual currency.”  Some of the U.S. tax implications of Bitcoin include the following: (1) taxpayers receiving Bitcoins as payment for goods or services must include in their gross income the fair market value of the Bitcoins; (2) taxpayers will have a gain or loss upon the exchange of Bitcoins for other property; and (3) taxpayers who “mine” Bitcoins must include the fair market value of the Bitcoins in their gross incomes.  The IRS also confirmed in its statement that employment wages paid in Bitcoins are taxable.

This guidance from the IRS accords with the positions taken by tax authorities in other jurisdictions.

Commentators have considered the tax implications of Bitcoin in Canada both before and after the CRA released its most recent guidance in CRA Document No. 2013-0514701I7 “Bitcoins” (December 23, 2013).

The Canadian government has taken the position that Bitcoin is not legal tender. The Canada Revenue Agency has stated that, when addressing the Canadian tax treatment of Bitcoin, taxpayers must look to the rules surrounding barter transactions and must consider whether income or capital treatment arises on Bitcoin trading (i.e., speculating on the changes in the value of Bitcoins).

While Bitcoin currency exchanges encounter uncertainty (or fail entirely), and Bitcoin prices continue to fluctuate, the global tax implications of Bitcoin are becoming clearer.

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IRS: Bitcoin Not a Currency for Tax Purposes

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.

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Tax Court Rules Amounts Paid Out of Ponzi Scheme Not Taxable

Tax Court of Canada Limits Shopping for Expert Witnesses: Aecon Construction Group Inc. v. The Queen

In his recent decision in Aecon Construction Group Inc. v. The Queen, Justice Angers of the Tax Court of Canada adopted a practical and sensible approach to the problem of an expert witness potentially being conflicted out of a tax appeal because of having been approached by one of the parties which then decides not to commission a report from that expert.

In Aecon, the disputed turned on the fair market value of mining properties in 1993.  The taxpayer contended that the value was $32 million while the Crown contended that the value was $3 million.  The taxpayer relied on two expert reports.  The Crown originally relied upon one expert report.  Prior to trial Crown counsel approached two other experts, Mr. F and Mr. R, both of whom had already been approached by the taxpayer.  The Crown wrote counsel for the taxpayer taking the position that the taxpayer’s limited contact with Mr. F should not disqualify him from acting for the Crown in the tax appeal.  The taxpayer’s counsel took the position that both Mr. F and Mr. R were disqualified and the Crown took this motion in the Tax Court to have the status of Mr. F determined in advance of trial.

Justice Angers quoted the famous statement of Lord Denning in Harmony Shipping Co SA v. Davis et al. as reproduced by Justice O’Keefe of the Federal Court in Abbott Laboratories v. Canada (Minister of Health), 2006 F.C. 340.

[20] Accordingly, the principles require that the Court balance the interests of the party seeking to retain an expert witness and the party seeking to protect its confidential information. In that regard, counsel for Pharmascience raises the danger of expert witnesses being contacted simply to deprive an opposing party of their expertise. This danger was eloquently described by Lord Denning in Harmony Shipping Co SA v. Davis et al, [1979] 3 All ER 177 (C.A.):

If an expert could have his hands tied by being instructed by one side, it would be very easy for a rich client to consult each of the acknowledged experts in the field. Each expert might give an opinion adverse to the rich man, yet the rich man could say to each, “Your mouth is closed and you cannot give evidence in court against me” ….. Does that mean that the other side is debarred from getting the help of any expert evidence because all the experts have been taken up by the other side? The answer is clearly No …. There is no property in an expert witness as to the fact he has observed and his own independent opinion of them. There being no such property in a witness, it is the duty of a witness to come to court and give his evidence in so far as he is directed by the judge to do so.

Justice Angers concluded that the limited contact between the taxpayer and Mr. F was not sufficient to support a disqualification:

[23] Neither party in this motion, has been able to clarify the nature of the confidential information that may or may not have been communicated. Mr. F’s affidavit does not disclose if he has, in fact, received any and the appellant did not cross-examine Mr. F on his affidavit. It is therefore unclear as to the risk associated with disclosing said information or if, it will cause a prejudice to the appellant. No evidence was put forward that allowing the respondent to retain Mr. F. would prejudice the appellant.

[24] In the light of the evidence presented, one cannot conclude that Mr. F and the appellant shared sufficient information for either one to expect that whatever that information may be would be kept in confidence or is privileged. Mr. F was never retained, no retainer agreement or confidentiality agreement was signed and there is no evidence that the appellant would have requested Mr. F not to discuss the matter with others. Mr. F did not open a file, did not invoice the appellant nor received any payment, nor was he asked to perform any services. It appears to me that the discussions Mr F had with the appellant in 2001 were of an informal nature and nothing more than an attempt to see if Mr. F shared their point of view. In his affidavit, Mr. F did not recall discussing specific legal strategy other than the fact that he refused to be “creative” in responding to CRA’s position. He cannot recall the documents he reviewed nor did he retain any documents. He also said that early on, he communicated to the appellant that, on the basis of previous experience with Watts, it was unlikely that the appellant would agree with his firm’s method of valuation. That is hardly the foundation necessary for the appellant to shield Mr. F from being retained by the opposing party and provide his opinion.  [Emphasis added]

What is clear from this decision is that a limited contact with a potential expert witness will not normally be sufficient to disqualify that witness.  There must be real concerns about confidential information shared with that potential expert and the taxpayer must be able to prove those concerns to the satisfaction of a judge if the potential disqualification is raised before the court.

Tax Court of Canada Limits Shopping for Expert Witnesses: Aecon Construction Group Inc. v. The Queen