When Is a Fraud a Business? Never, Apparently

Traditionally, if a business venture was a fraud from beginning to end, the courts have held it is not possible for a business to exist and therefore can be no source of income from which expenses could be deducted for tax purposes.

However, the appellants in a recent Tax Court of Canada case – Garber vs. The Queen (2014) TCC 1 – argued, unsuccessfully it turns out, that a business and a fraud could co-exist.

Mr. Bellfield, the so-called mastermind of an elaborate business scheme, traded favours with friends and friends of friends who were lawyers, accountants, promoters, and other prominent persons.

He created and aggressively promoted a “yacht scheme.” This venture was to create large tax losses in its first few years, as massive capital outlays and expenses would be incurred in establishing the ‘business.’   

Key to the outcome in court was determining whether the taxpayer’s contractual rights were respected in the scheme and whether the taxpayer got what they bargained for. 

Justice Rossiter found, in fact, that the investor’s contractual rights were not respected and the investment scheme was fraudulent from day one. He concluded that there was no source from which to deduct losses from income.  

Garber is a reinforcement of the common law rule that has developed regarding fraudulently run businesses and the deductibility of the associated losses. If the taxpayer’s contractual rights are respected throughout the scheme then there may be a source of income to deduct losses from, but this is not possible when contractual rights are disrespected and the scheme has been perpetuated by fraud and misrepresentations from the very beginning.

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.