The Tax Court of Canada has recently confirmed the tax treatment of Ponzi scheme victims as I feared they would in the very first issue of The Tax Issue.
In a Ponzi scheme, taxpayers unwittingly entrust funds to a promoter, who, rather than investing them, uses them to make payments to other investors. The flow of funds continues this way until enough people finally ask for their money back, at which point, the fraud is exposed.
The taxpayer in the case of Johnson (2011 TCC 540) was a winner because the court ruled that in a Ponzi scheme, there is no investment and thus no source of income. The good news for this taxpayer, a victim of Andrew Lech, was that she was one of the few who cashed in her capital after a few years of receiving what she thought was a great return on her investment. The “income” she dutifully reported over the years was held not to be “income from a source” and thus not subject to income tax.The court stated that “the net receipts were nothing more than the shuffle of money among innocent participants.”
The bad news for those who have lost their investment, however, is that there is no tax relief available for the loss of their capital. In a normal investment, the loss would be considered a capital loss, 50% of which can be used to offset capital gains. For these victims of fraud, since no income source existed, no tax deduction is available on the loss of the investment.
The only consolation is for taxpayers who reported income in past years to amend their returns and request refunds on the tax they paid on the payments received from fraudulent schemes.
Update: The CRA has decided to appeal this decision….To be continued…..