Tax Treatment and Ponzi Schemes

 

A question accountants still struggle to answer is the tax treatment of Ponzi schemes. Are losses deductible and are moneys earned taxable?

A Ponzi scheme is a fraudulent investment scheme where investors are paid interest from the capital of other investors.  No real commerce is going on and no new money is being generated.  Ponzi schemes are illegal in Canada but many people get caught up in such scams due to the promise of high returns over short time periods. However even when not shut down by the authorities, as investment slows the schemes fall apart and many are left out of pocket. 

The question that has plagued accountants for years is what is the tax status of money earned and lost through a Ponzi scheme?  It is an important question to answer because the amounts involved are usually large enough to attract CRA interest.

The answer however is still unclear, despite many court cases.  In Roszko v. The Queen [2014], the most recent case in this area the court stated that certain payments out of a Ponzi scheme would be taxable, but others would not.

From previous cases it is clear that the level of knowledge the investor possessed as to the nature of the scheme is important.  If you are fully aware that there is no investment occurring, and that you are partaking in an illegal scheme, then any profits are taxable.  However if you were duped from beginning to end, then it cannot be said that you entered into a legitimate business venture, and losses incurred are not deductible.

When considering the tax status of money received, how the payment is characterized is also important.  In Roszko Justice Miller stated “only excess returns might be considered income”.  This means that only profits (interest on capital invested) would be taxable.; return of capital would not be.

So as it stands there is no black and white rule for whether money in and out of Ponzi schemes are subject to tax.  Each case will likely attract the CRA and often end up in court where a judge will decided on a case by case basis by weighing various factors. However if you enter into an illegal scheme with full knowledge, don’t expect the courts to be sympathetic, and if an investment looks too good to be true, it probably is.

For more information on fraudulent investment schemes visit https://www.antifraudcentre-centreantifraude.ca

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