2019-0805221E5 Fraudulent investment scheme

Principal Issues: How are various losses incurred by a taxpayer as a result of their investment in a fraudulent investment scheme treated for income tax purposes?

Position: See response.

Reasons: Question of fact and the legislation.

Author: Sigouin, Renée
Section: 12(1)(c); 20(1)(p); 39(1)

XXXXXXXXXX                                                                          2019-080522
                                                                                                  Renee Sigouin
                                                                                                  (613) 670-8903
October 22, 2019

Dear XXXXXXXXXX:

I am writing in response to your correspondence to Mr. Geoff Trueman, Assistant Commissioner, Legislative Policy and Regulatory Affairs Branch, concerning the income tax implications of participating in a fraudulent investment scheme. Mr. Trueman has asked me to respond on his behalf. Thank you for your understanding regarding the delay of this response.

You have asked whether losses you incurred from a fraudulent investment scheme may be claimed as an allowable business investment loss. You have also asked whether the investment income you had previously included in your income that was later discovered to be part of the fraudulent scheme may be treated as a return of capital. I understand that Mr. Trueman’s earlier correspondence to you dated February 12, 2019, responded to your prior related question of whether the Canada Revenue Agency (CRA) could refund the taxes you had paid on this investment income.

This technical interpretation provides general comments about the provisions of the Income Tax Act and related legislation (where referenced).  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination.  The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R9, Advance Income Tax Rulings and Technical Interpretations.

Each of the publications referenced below are available on the CRA website at canada.ca/cra-forms-publications.

Investment income

Amounts paid to taxpayers that are a return on their investment should be included in the taxpayer’s income. This was confirmed by the Federal Court of Appeal in The Queen v. Johnson, 2012 FCA 253, 2013 DTC 5004.

However, a taxpayer may claim a deduction for a bad debt under paragraph 20(1)(p) of the Act in the year a fraudulent investment scheme is discovered to the extent that the investment income supposedly earned from the scheme, that was not considered to have been received or withdrawn by the taxpayer, was previously included in the taxpayer's income. Generally, the year the fraud is discovered is considered to be the year during which the Crown lays charges against the perpetrator of the fraud. Any amounts received by the taxpayer or paid to a third party for the benefit of the taxpayer cannot be claimed as a bad debt deduction.

Capital losses and allowable business investment losses (ABIL)

Income Tax Folio S3-F9-C1, Lottery Winnings, Miscellaneous Receipts, and Income (and Losses) from Crime, explains in paragraph 1.44 that the nature of any losses incurred as a result of a fraudulent investment scheme needs to be established in order to determine the correct tax treatment. Specifically, it will need to be determined whether the loss was as a result of carrying on a business or from the disposition of an investment that was being held on capital account. For assistance in determining whether an investment is being held on income or capital account, see paragraphs 9 to 13 of Interpretation Bulletin IT-479R, Transactions in Securities.

If a loss is incurred on the disposition of an investment that was being held on capital account, a taxpayer may be entitled to a capital loss pursuant to paragraph 39(1)(b) of the Act to the extent that the taxpayer is unable to recover the amount of their initial investment. Ordinary allowable capital losses for a tax year may be deducted only from taxable capital gains realized in the year. If the allowable capital losses exceed the taxable capital gains, the difference is a net capital loss which may be carried back three years and forward indefinitely to be deducted only against taxable capital gains. More information on capital losses and how to apply an allowable capital loss is available in the T4037 Capital Gains guide.

Unlike ordinary allowable capital losses, an ABIL for a tax year may be deducted from all sources of income for that year. An ABIL is one-half of a business investment loss determined under paragraph 39(1)(c) of the Act. An ABIL can be carried back up to three years and forward up to ten years and deducted in calculating the taxable income of such other years, following which it becomes a net capital loss. Information on what constitutes a business investment loss and how to determine a taxpayer’s ABIL for a tax year, is outlined in Income Tax Folio S4-F8-C1, Business Investment Losses. A taxpayer’s loss that does not qualify as a business investment loss may still qualify as a capital loss under paragraph 39(1)(b) of the Act.

The CRA is responsible for administering and enforcing the Act and the Department of Finance Canada is responsible for developing tax policy and changing the Act. As you have requested special tax treatment not found in the current tax legislation for investors impacted by fraudulent investment schemes, I am sending a copy of our correspondence to the Honourable Bill Morneau, Minister of Finance for his consideration.

I trust these comments will be of assistance.

Yours truly

Lita Krantz, CPA, CA
Manager, Tax Credits and Ministerial Issues
Business and Employment Division
Income Tax Rulings Directorate

c.c.:
      The Honourable Bill Morneau, P.C., M.P.
      Minister of Finance
      House of Commons
      Ottawa ON  K1A 0A6

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2020

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2020