Tax treatment of Ponzi scheme investments

CRA: Tax treatment of Ponzi scheme investments
Posted on Jul 10th, 2014 By Timothy Fitzsimmons

We have previously written about court decisions on the tax results arising from taxpayers’ (failed) investments in Ponzi schemes (see our posts on Roszko v. The Queen (2014 TCC 59), Johnson v. The Queen (2011 TCC 54) and (2012 FCA 253), Hammill v. The Queen (2005 FCA 252) and Orman v. Marnat (2012 ONSC 549)).

These decisions raise questions as to how the CRA may assess all aspects of the income earned and losses suffered by the duped investors. For example, while the cases focused on whether the taxpayer was required to report some of the returned funds as income, the tax treatment of losses after the collapse of the fraudulent scheme has not been considered.

The CRA has now provided some guidance on how it will administer the Income Tax Act (Canada) in respect of the income and losses arising from Ponzi schemes. In CRA Document No. 2014-0531171M6 “Fraudulent Investment Schemes” (July 3, 2014), the CRA stated:

Income inclusion – Amounts paid to a taxpayer that are returns on their investment should be included in the taxpayer’s income. The fact that the funds were not invested on behalf of the taxpayer does not change the nature of the transaction for the taxpayer.
Bad debt – If the investment was a fraudulent scheme, the taxpayer may be able to claim a bad debt under paragraph 20(1)(p) of the Act in respect of the lost investment funds. The amount of the bad debt claim will be subject to certain adjustments. The bad debt should be claimed in the year the fraud is discovered (i.e., the year in which fraud charges are laid by the Crown against the perpetrator, or at such earlier time as the debt is established to have become bad).
Losses – The taxpayer may be able to claim a capital loss or business investment loss:
Capital loss – The taxpayer may be able to claim a capital loss under paragraph 39(1)(b) of the Act, which may be carried back three years or forward indefinitely. A net capital loss may only be applied against a taxable capital gain.
Business investment loss – Under paragraph 39(1)(c), a business investment loss is a capital loss from a disposition of a share of a small business corporation or a debt owing to the taxpayer by a Canadian-controlled private corporation that was a small business corporation. Under paragraph 38(c) of the Act, one-half of a business investment loss is an allowable business investment loss, which may be deducted against all sources of income.
Other deductions – The taxpayer may be able to claim interest expenses or other carrying charges not previously claimed by filing a T1 Adjustment Request form.
Recovered amounts – Where the taxpayer recovers funds from a scheme (i.e., through a legal settlement or otherwise), these recovered amounts may be taxable as recovery of a previously deducted bad debt, recovery of a previously deducted business loss, or recovery of a previously deducted capital loss.
Taxpayer relief – The CRA will consider requests for taxpayer relief on a case-by-case basis.
This guidance is helpful, but there are many technical requirements for the operation of these provisions, and further it is not clear how the CRA’s administrative views accord with the case law. For example, at least two cases (Roszko, Orman) have held that amounts paid out a fraudulent scheme are not income to the duped investor. A third case (Hammill) held that a fraudulent scheme cannot give rise to a source of income. In future cases, we expect the courts will continue to clarify the tax treatment of income and losses arising from failed Ponzi schemes.

An Auditor’s Standard Of Care

An Auditor’s Standard Of Care
Article by John G. Bassindale and Jack Millar
Millar Kreklewetz LLP
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For years it was an open question as to whether or not a Canada Revenue Agency (“CRA”) auditor owed a duty of care to a taxpayer under audit. In the recent case of Leroux (2014 BCSC 720) the Supreme Court of British Columbia (BCSC) concluded that, on the facts, the CRA auditors owed a duty of care to the taxpayer. But what is the appropriate standard of care a CRA auditor must meet to avoid a finding of negligence?

Briefly, Leroux was the case of a taxpayer who was assessed by the CRA, had the majority of his assessment overturned, and then brought a civil action for damages against the CRA. The BCSC determined that a duty of care was owed to the taxpayer based on recent SCC cases about when a public official owes duty of care. Paralleling the standard imposed on police officers in Hill v. Hamilton-Wentworth Regional Police Services Board (2007 SCC 41), the BCSC stated that the standard of care which was owed to the taxpayer was “that of a reasonably competent tax auditor in similar circumstances”.

Such a standard should not be a surprise to the CRA because one would presume that the CRA would expect that all of its auditors would meet the threshold of a “reasonably competent tax auditor”. The CRA often speaks of the high quality of its auditors, and how few of their audits are overturned on objection or appeal. This also accords with the Taxpayer’s Bill of Rights which includes a “Right to expect the CRA to be accountable” and a “Right to be treated professionally, courteously, and fairly”.

The BCSC found that the CRA auditor met the standard of the “reasonably competent auditor in similar circumstances” in the GST audit and in the characterization of the receipts (income versus capital) for income tax purposes; however, the BCSC also held that the standard was not met with respect to the imposition of penalties and the assessing of statute barred years – two areas which often arise in tax audits.

The BCSC found three specific areas of negligence.

First, the CRA auditor was found to have applied the wrong standard for imposing penalties. A penalty was imposed under section 163(2), which requires the taxpayer either made a false statement “knowingly” or “under circumstances amounting to gross negligence”. However, the auditor’s Penalty Recommendation Report said the taxpayer “ought to have known” – which he BCSC held was insufficient foundation for a section 163(2) penalty. Accordingly, the CRA auditor did not meet the standard of care of a reasonably competent auditor on this issue.

Secondly, the CRA auditors applied penalties to all taxes assessed in all years. The BCSC noted that this was inappropriate because the penalty should only apply to the issue where the CRA auditor felt the taxpayer had been grossly negligent – not on the entirety of the tax assessed. In other words, penalties should be considered by CRA auditors and imposed on an “issue by issue” basis rather than being applied “holus-bolus”. After noting the CRA auditor “thought this did not matter” when imposing penalties, the BCSC found the CRA auditor did not meet the standard of care of a reasonably competent auditor on this issue.

Lastly, the BCSC held that it was unacceptable that the taxpayer was threatened with “gross negligence” penalties if he did not sign a statute barred waiver for 1993. The BCSC found the auditor did not meet the standard of care of a reasonably competent auditor and should “not have threatened the taxpayer with a punitive quid pro quo.” Additionally, the BCSC noted that because the tests for gross negligence requires higher threshold than for opening up of statue barred years, the auditor should not have equated the two tests.

We are particularly hopeful that the CRA will take note of the BCSC’s comments regarding the conduct of its auditors when dealing with penalties and requests for waivers. We understand from speaking to other practitioners that the approach taken by the CRA auditors in Leroux is not uncommon. In our experience, auditors typically apply a penalty to the entire assessment, rather than on an “issue by issue” basis. Likewise, we have seen a CRA auditor on a recent file threaten and ultimately impose gross negligence penalties when the waivers offered were not to their liking. It is a breath of fresh air to see that a judge has found these common audit actions to be in appropriate.

If such situations arise in the future, practitioners should consider raising the BCSC’s standard of care comments with the auditor and/or with senior CRA officials as may be required. Irrespective of whether a duty of care is owed to all taxpayers in all circumstances, we would expect the CRA’s position to be that all of its auditors must meet the standards of a reasonably competent auditor in all audits conducted and assessments issued.

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.

What You Need To Know About Personal Income Tax Instalments

What You Need To Know About Personal Income Tax Instalments
Article by Ali Toyserkani
Crowe Soberman LLP
When we first meet with young health professionals, many are surprised when we inform them that they will owe personal income taxes come the following April. They are even more shocked when they learn that they are obligated to make quarterly income tax installments on a go-forward basis. Let’s explain why self-employed health professionals are required to make quarterly income tax installments.

Medical residents and part-time workers are generally considered employees. The remuneration received is paid by an employer, who is legally obligated to withhold payroll source deductions (i.e. Employment Insurance premiums and Canada Pension Plan premiums) and personal income tax from the amounts paid. This is why your gross income may be, for example, $1,000 per week but you only receive $750 deposited into your bank account. When you receive your annual T4 slip it shows the total gross amount of income you earned in the prior year and the taxes and other deductions that were withheld at source. The deductions that your employer has withheld throughout the year have been remitted to the Canada Revenue Agency (CRA) as a prepayment of your personal taxes. As a result, when you prepare your personal income tax return, your personal tax liability is, more often than not, covered and you may be entitled to a refund (especially if you made RRSP contributions or have tuition, education or other tax credits available).

When you transition to practicing your health profession after graduating or after finishing your medical residency, you will likely be self-employed. In other words, you will be billing fee-for-service, receiving some form of compensation through an Alternative Funding Plan or will be an associate in a practice. As a self-employed practitioner, there is no employer that deducts payroll source deductions and personal income taxes from the remuneration you receive throughout the calendar year. This is why, after the first full year of being a self-employed health professional, there is usually a significant personal income tax liability owing by the following April.

An obligation to prepay the majority of your personal income tax by quarterly installments for the following year will arise if your net tax owing is more than $3,000 in the current year and in either the prior year or the year prior to last year. For example, you can expect to have a quarterly income tax installment obligation in 2015 if you had more than $3,000 in net tax owing both in 2014 and either in 2013 or 2012.

Installment payments for a particular year are due on March 15, June 15, September 15, and December 15. Often the CRA will mail you a remittance form, which can be used to pay the installments at your financial institution or by mailing a cheque to them. You can also make your personal income tax installments online via the CRA’s website or through online banking.

There are three methods for calculating the installment amounts that are owed. An individual may choose the method which results in the smallest installment obligation:

Option 1

Calculating based on an average of the amount of taxes owed in the prior two years. This is the CRA default option and will be the amount that shows up on the installment reminders they send you.

Option 2

Calculating based on the amount of taxes owed in the prior year. This option will result in the lowest installment obligation if your current year income will be greater than your prior year’s amount, but lower than the amount in the year prior to last; or

Option 3

Calculating based on what you estimate will be your current year taxes owed. This option will result in the lowest installment obligation if your current year income will be lower than those in the last two years. However, if you miscalculate the amount of expected taxes owed and you have remitted an amount which is less than the actual amount of taxes that are owed for the current year or an amount which is less than what your instalment obligation would have been under the lesser of Option 1 and Option 2, you will be subject to interest and possibly penalties for the insufficient instalments remitted.

Failing to remit installments on time can be costly. The CRA charges interest on the deficient amounts at a prescribed rate (currently five per cent). If this interest charge adds up to more than $1,000, an additional penalty is added.

Transitioning to becoming a practicing health professional and launching your career is an exciting time in your life. As your life circumstances and finances change, it is important that you remain aware of your new tax obligations. The Crowe Soberman Health Care Group can guide you through calculating the correct amount of personal income tax installments for the upcoming year and can help you plan for these payment obligations.

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.

 

MANAGE YOUR MONEY-Last minute RRSP tips – save on taxes, save more for retirement

The deadline looms for making your 2014 contribution to investments held in your Registered Retirement Savings Program (RRSP). But you’ve still got a few days and a few choices to make that will save on taxes and save more for your retirement. Here are your last-minute RRSP tips.

RRSP deadline details

• March 2, 2015 at 11:59 PM is the deadline for contributing to investments in your RRSP for the 2014 tax year.
• You may make a maximum contribution of up to $24,270, depending on your earned income in 2014 (and minus your pension adjustment if applicable).
• You’ll find your personal maximum allowable contribution on your most recent notice of assessment from the Canada Revenue Agency (on line (A) of the  RRSP Deduction Limit Statement).
• You can carry forward unused contribution room from prior years.
• You can fill your unused contribution room in a single year or over a number of years until the end of the year in which you reach age 71(or the end of the  year your spouse/common-law partner turns 71).

RRSP tax-saving, tax-deferring, income-building tips

• Maximize this year’s RRSP contribution. This is the best strategy for tax savings and maximizing potential long-term growth.
• Maximize last year’s RRSP contribution. For additional tax savings and enhanced long term growth, catch up on your unused contribution room as quickly as possible.
• Borrow to gain. You could maximize this year’s contribution or catch up on past contribution room with an RRSP loan. The money you borrow will generate a tax break and add to your tax-deferred RRSP growth potential. The key is to get a loan at a low interest rate and pay it back quickly. Use your extra tax savings to help pay off the loan.
• Split to gain. If your spouse’s income will be lower than yours over the next few years or in retirement, a spousal RRSP can generate retirement income that is subject to less tax. The plan is in your spouse’s name but you contribute to it. Your total can’t exceed your personal yearly contribution room but your spouse’s limit is unaffected by your contribution.

“Nil Consideration” Election For Members Of A Closely Related Group – New Filing Requirement And Other Changes

Canada: “Nil Consideration” Election For Members Of A Closely Related Group – New Filing Requirement And Other Changes
Last Updated: February 6 2015
Article by D’Arcy Schieman, Marlene Legare, Alain Fournier, Sean Aylward and Blake Murray
Osler, Hoskin & Harcourt LLP
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Group Relief Election: Canadian corporations and partnerships that are members of the same closely related group can, in certain circumstances, make an election under section 156 of the Excise Tax Act (Canada) (ETA) to treat certain taxable supplies made between the members as being made for nil consideration. As a result, transactions covered by the election are not subject to the goods and services tax/harmonized sales tax (GST/HST). In the past, the election form did not have to be filed with the Canada Revenue Agency (CRA), but had to be maintained in the parties’ records for audit purposes. As a result of recent amendments to the ETA, the election form for new elections that take effect on or after January 1, 2015, and for previously-made elections that remained in effect on that date, will have to be filed with the CRA (or with Revenu Québec (RQ), in the case of Québec-based registrants). If, prior to 2015, any election form for a continuing election had been filed with the CRA or RQ, the election will have to be re-filed using the new prescribed form. The filing deadlines and other changes relating to the election are discussed below.

Filing Deadline:

Elections that become effective on or after January 1, 2015 – The specified filing deadline is the earliest date that any of the electing parties is required to file a GST/HST return for the reporting period in which the election becomes effective – i.e., February 28, 2015 should be the earliest possible filing deadline.
Elections that became effective before January 1, 2015 and remained in effect on that date – These elections will not be effective for supplies made after 2014 unless they are filed (or re-filed) in the new prescribed form after 2014. The specified filing deadline is December 31, 2015.
Under the amended election provision, the CRA (or RQ, where applicable) has discretion to accept late-filed elections.
New Prescribed Form: The election is now made using CRA Form RC4616 entitled, “Election or Revocation of an Election for Closely Related Corporations and/or Canadian Partnerships to Treat Certain Taxable Supplies as Having Been Made for Nil Consideration for GST/HST Purposes.” Form RC4616 replaces Form GST25.

Consolidated Election: New CRA Form RC4616 permits a group of closely related entities making the election to consolidate their election in a single form.

Joint and Several Liability: The amended election provisions provide that parties to this group relief election (or persons that conduct themselves as if such election were in effect) are subject to a joint and several (or solidary) liability provision with respect to the GST/HST liability that may arise in relation to supplies made between the parties on or after January 1, 2015.

Québec Sales Tax (QST) Election: A similar group relief election exists under the QST legislation. The February 20, 2014 Québec Budget announced that changes will be made to the QST election rules to parallel the ETA changes.

Changes Regarding Newly-Established Members: The recent amendments to the election provisions included changes (generally applicable to supplies made after 2014) affecting the eligibility of certain entities to make the election, particularly in the case of newly-established members of the closely related group. Relative to the pre-amended rules, the revised eligibility conditions could be more difficult to meet in some cases, and less restrictive in other cases.

Various Factors to Consider: In preparing new elections, and before choosing to file pre-2015 elections to maintain them in force, the following factors should be carefully examined:

whether the various conditions for the election are clearly met;
whether or not it remains beneficial to have the election in place for all electing members;
whether transactions that occurred after the chosen effective date of the election have been treated in accordance with the election;
whether any of the special rules for financial institutions apply; and
whether any changes to ownership structures and supplies made by members of the group may affect the group’s ability to use the election.
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.