Are losses due to fraud deductible from your taxes?

The facts of Ruff v The Queen (2012) are unusual, to say the least. Charles Ruff, a lawyer in Calgary whom you would expect to be more skeptical than most, was a victim of fraud. But the issue is not the fraud, but whether in computing income from his legal practice, Ruff could deduct the amount lost to the fraud.

Ruff's troubles began in April 2005 when he received an email from Purity Adams asking for his help. Purity's father, "a wealthy cocoa and gold merchant in South Africa,î had been assassinated, she told Ruff, but not before he had left US $8.5 million in a container with a security company in Abidjan, CÙte d'Ivoire, during a business trip. The remaining members of the Adams family needed financial assistance to obtain the release of that container and Purity was soliciting Ruff's help.

Most people who receive emails from people in far-off lands asking for money simply delete them. Ruff, however, was convinced this was genuine ó notwithstanding some rather embarrassing observations made by the court during the hearing.

The court took note of the purported security company's website: "One obvious observation in looking at the page in colour is that of the five pictures at the top of the page, two of the pictures are clearly taken in an area where there is snow. One picture is of a house with snow in the driveway and snow on the roof and another is of a dog standing on a roadway that is snow-covered. The security company was supposedly located in Abidjan, CÙte d'Ivoire, which is very close to the equator. Given the proximity of Abidjan, CÙte d'Ivoire, to the equator, one would have expected that the climate would be a tropical climate and not one where one would find snow-covered houses or roads. The Appellant stated that he had not noticed this until it was brought to his attention during argument following the hearing.î

There were other troubling aspects that should have alerted Ruff to the suspicious nature of the request. After Ruff had paid numerous charges to have the container released and shipped, Aeroground Diplomatic Courier Services notified Ruff that the container had arrived in London but the freight had not been paid and additional funds were required.

According to this letter: "During the random checks, we discovered the delivery charge has not been paid from the origin (Cote d'Ivoire). Please see the reverse side of your Airway bill shipment document. It was stated that on no account we should not deliver any diplomatic consignment to any customer on credit. This is part of our company policy.î

The double negative in "on no account we should not deliver,î should have alerted Ruff the lawyer. But it did not and Ruff continued to slide further into the trap ó divesting himself of even more money in the pursuit of the elusive container.

In total, Ruff spent $398,995, which he then wanted to deduct from his law practice income as a business expense. The Canada Revenue Agency (CRA) took issue with this and the matter ended up in the Tax Court of Canada.

The CRA claimed that since this was fraud there was no source of income. Ruff counterclaimed that his law practice was his source of income and he was pursuing profit through those means. This argument became futile when the court decided that all of the expenses were unreasonable and that the CRA had properly disallowed the expenses under Section 67 of the Income Tax Act.

What makes this decision doubly interesting is that the tenor of the court seemed to imply that if the losses to fraud had been reasonable, the losses could have been deducted from Ruff's income. The fact that every aspect of Ruff's transaction would seem unreasonable to almost any observer denied him any prospect of deducting these losses against his income.

As the judge remarked: "It seems to me that there are simply too many inconsistencies and too many questions about the story for the appellant to have a reasonable belief that the container existed.î

This case reveals that losses to fraud may be deductible if they are lost from a "sourceî of income (business, investment, etc.) and they are reasonable.