Fraud victims can catch a break from the tax man

National Post

2009-08-15


Just 10 days after Montreal financial advisor Earl Jones was charged with fraud and theft in connection with the loss of between $30-million and $50-million from his clients, a similar scheme has come to light in British Columbia.

Earlier this month, a B.C. Securities Commission panel found that four B.C. residents perpetrated a "deliberate and well-organized" scheme that resulted in the loss of more than US$10-million by about 800 investors.

The scheme began as an investment club. Investors were encouraged to put their money with "experienced traders who had a long history of producing double-digit monthly returns through foreign-currency trading," said the B.C. Securities Commission in a statement.

Bizarrely, the scheme used a vehicle called a "private common law spiritual trust," which seems to have been invented by one of the promoters.

The panel concluded it was a Ponzi scheme and that the trust structure was a "sham."

For investors who lost money, there may be some relief through the tax system.

With respect to clients of Earl Jones, late last month, Jean-Pierre Blackburn, Minister of National Revenue, issued a statement encouraging affected investors who may be having trouble meeting their current tax bills to contact the Canada Revenue Agency directly.

The CRA, under the "fairness" provisions, has the discretion to waive or cancel all or part of any penalties or interest charged if taxpayers can't make required tax payments on time due to "extraordinary circumstances."

While this may help affected investors with their immediate cash-flow problems, two more significant tax issues remain. First, what relief is there for taxes paid on phantom income reported in prior years? And second, can an investor write off a loss for tax purposes?

The answer to the first question seems relatively straightforward. If investors have been reporting interest income, for example, in prior years' returns, if the investments were non-existent, then the "income" received was fictional and shouldn't have been taxable.

Although the CRA hasn't yet made a formal announcement on how investors should proceed, current law suggests investors could request adjustments going back up to 10 years to recoup taxes paid on such phantom income.

The tax treatment of the investment loss may be more problematic.

Last March, Bernie Madoff investors facing similar tax issues were given generous tax relief by the Internal Revenue Service. The IRS announced that the amount of any Ponzi-related losses could be claimed as a "theft loss" as opposed to a capital loss and therefore be deductible against all sources of income. The loss could also be carried back up to five years and carried forward for up to 20 years.

To date, the CRA has not commented on the Canadian tax treatment of such losses.