When it comes to investing, the old adage "if it sounds too good to be true, it probably is" has protected many an investor from various schemes or frauds.
But the downside of participating in something that seems just a bit too tempting is twofold: first, you risk losing your money but secondly, you could also be in for a long, drawn out battle with the tax man who may try to collect tax on your investment "returns" regardless of the fact that you may have lost some or even all of your money.
While it sounds hard to believe that the Canada Revenue Agency would go after an investor for tax on fictitious earnings, that's exactly what happened in a case decided earlier this year.
An Alberta investor found himself in Tax Court fighting a tax bill for 2008 on $156,000 of "interest income" from an investment that turned out to be part of the TransCap Ponzi scheme, which ultimately took in $52-million from unsuspecting investors.
The Alberta taxpayer sold the family farm in 2006 and initially invested his portion of the proceeds with a reputable Alberta financial firm. Seeking a way to reduce the taxes owing on the sale of the farm, he attended a presentation in Edmonton put on by TransCap. At the presentation, however, instead of getting tax advice, he was convinced by a representative of TransCap that "he could achieve significant returns on his investments in the range of 18% to 22%."
After a subsequent meeting, he decided to try investing with an initial $100,000, set up in the form of a loan. It was his understanding that TransCap was buying and selling commodities at considerable profit in order to achieve the high returns promised to investors.
Ultimately, the taxpayer ended up investing a total of $800,000 with Transcap and received monthly payments, as promised. In 2009, things began to unravel when, after the death of his son, he approached TransCap for a return of some his money to cover the funeral expenses. His request was denied "in a manner which caused [him] some suspicion." He dug deeper and ultimately his inquiries led to an Alberta Securities Commission investigation which found that TransCap had perpetrated a Ponzi Scheme.
As the ASC wrote, "Alberta investors (believed) that their money would be applied in bond trading and bridge financing that would fund interest payments and principal payments on (Transcap's)... securities, whereas in fact payments to investors in this Ponzi scheme were funded from their own and their fellow investors subscription money - something sustainable only for so long as investment subscriptions covered the payments out."
In 2008, the taxpayer received $156,000 in payments from TransCap which he reported on his tax return as "interest income" and he paid tax on this amount. Since it subsequently turned out that the entire amount received was really a return of his own money that he loaned to Transcap, he felt he should not have had to pay the tax on this $156,000.
Fortunately, the judge agreed, writing that the taxpayer "was misled to believe interest would be funded by TransCap. It was not. The funding of those payments, described as interest, was from...investors' own money. That is not what was contracted for: it is not interest."