Do Ponzi Schemes Generate Taxable Income?

In Roszco v. The Queen (2014) TCC 59, a recently released decision from the Tax Court of Canada, the issue at hand was whether interest generated from fraudulent schemes was taxable within the meaning of section 12(1)(c) of the Income Tax Act (the Act).

In 2007 and 2008, Mr. Roszco invested $800,000 with TransCap Corporation. Although he received $156,000 of this principal amount back in a series of payments in 2008, the TransCap investments turned out to be a Ponzi scheme. Despite the fact that it became clear that no other payments were forthcoming, the Canada Revenue Agency (CRA) reassessed Mr. Roszco’s 2008 taxation year on the basis that the $156,000 received in 2008 was interest income under section 12(1)(c) of the Act.

Mr. Roszco had lots of reasons to defend his 2008 tax return: rescission of contract, the concept of resulting trust, and that the impact of an ongoing breach of a contract which negated the amounts paid as being properly considered interest.

The CRA relied on the multiple contracts that were signed to argue that the $156,000 was an interest payment and that fraud does not negate a finding of interest from a source. In effect, the CRA relied on the contract and the Appellant did not.

Honourable Justice Campbell J. Miller held that since the purported interest payments were derived from what was in fact a fraud from the outset, they could not be considered income from property, but rather a return of capital. Good for the taxpayer!

The analysis of the case law revealed that Ponzi schemes could constitute sources of income in certain circumstances, such as when the contractual arrangements between the parties are completely respected.

But what was important in this case was that only excess returns might be considered income under the Act.

This is indeed a welcome finding by Justice Miller, who has clarified the law surrounding interest income derived from investments that turn out to be fraudulent schemes.

Greer Jacks is updating jurisprudence in EverGreen Explanatory Notes, an online research library of assistance to tax and financial professionals in working with their clients.