Recently the Canada Revenue Agency (CRA) provided some written
guidance on the income tax treatment for taxpayers that unknowingly
make an investment in a fraudulent investment scheme, including
Ponzi or Ponzi-like schemes (See CRA Technical Interpretation
Document No. 2014-0531171M6 dated July 3, 2014).The rules will
apply to taxpayers who had what reasonably appeared to be
legitimate investments for income tax purposes. These guidelines
will not apply to taxpayers who knowingly participated in a scheme
for tax avoidance purposes, including the non-reporting of
potential investment income.
According to the CRA guidelines, any funds received by a
taxpayer that are considered returns on investment should be
included in their taxable income. The fact the funds were not
invested in a legitimate investment does not alter the taxable
income treatment to the taxpayer. 1
A taxpayer may claim a deduction for a bad debt expense,
pursuant to paragraph 20(1)(p) of the Income Tax Act (ITA) to the
extent the investment income purportedly earned from a scheme, that
was not considered to have been received or withdrawn by the
taxpayer, was previously included in the taxpayer's taxable
income. The bad debt can be claimed in the year the fraud is
discovered or at such earlier time the debt is established to have
The nature of any losses needs to be reviewed to determine
whether the losses are a business loss or a capital loss, and if a
capital loss, whether the loss is a "business investment
Capital Loss – The taxpayer may
be able to claim a capital loss pursuant to paragraph 39(1)(b) of
the ITA to the extent they lost money on their initial investment
in the scheme. A net capital loss may only be applied against a
taxable capital gain. A taxpayer may carry back three years or
carry forward indefinitely any net capital loss.
Business Investment Loss – A
taxpayer may claim a deduction for a business investment loss that
is a capital loss from a disposition of a share of a corporation
that is a small business corporation (SBC) or a debt owing to the
taxpayer of a Canadian Controlled Private Corporation (CCPC) that
was a SBC. Therefore, a business investment loss is only available
if the investment was shares or debt of a CCPC that was a SBC. In
general terms, a SBC is a CCPC that meets specific criteria
relating to the use of its assets. Ponzi schemes generally relate
to debt, not shares. One half of a business investment loss
qualifies as an allowable business investment loss (ABIL), which
may be deducted against all sources of income, not just capital
Where tax deductions have been claimed and funds have
subsequently been recovered by a taxpayer from an investment
scheme, through a legal settlement or otherwise, the recovered
amounts will be treated as taxable as a recovery of previously
deducted bad debt expenses, recovery as a previously deducted
capital loss or recovery as a previously deducted allowable
business investment loss.
Taxpayer Relief Provisions
Where individual taxpayers have invested in fraudulent
investment schemes and are seeking tax relief, there may be
situations where a request for 'Taxpayer Relief' under
certain provisions of the ITA may be available to adjust prior year
income tax returns for missed deductions. These situations are
generally dealt with by CRA on a "case-by-case"
The CRA's guidance relating to the taxable treatment of
funds received from fraudulent investment schemes can be challenged
since it is not supported by recent case law. However, specific tax
deductions available to taxpayers who unknowingly have made a bad
investment in a so-called fraudulent investment scheme (which are
similar to the income tax deductions available on making bad
investments in legitimate investments) is welcome tax relief from
the CRA. Despite the tax deductions that may be available, as
always, investors must choose their investments wisely, as the
potential tax savings from any tax deduction will only recover a
portion of their actual investment losses incurred.
1. Note the CRA guideline for income inclusion is
inconsistent with the income tax treatment decided on in a recent
tax case Roskzo v. The Queen (2014 TCC 69) in which the Tax Court
found "income" from a fraudulent investment
"scheme" was really a return of the investor's own
money and not taxable.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
To print this article, all you need is to be registered on Mondaq.com.
Click to Login as an existing user or Register so you can print this article.
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).