The following article appeared in a recent edition of the Hamilton Law Association Law Journal.
The police execute a search at your client’s house. They find pot plants and a large amount of cash. They seize the cash and charge your client with trafficking, and he is later convicted of that crime.The police want to ensure that the fisc is protect, and so they inform the CRA about finding the cash. The CRA conducts an audit. Unfortunately (but understandably), your client reported little or no income for tax purposes while carrying on his trafficking business, and so the CRA reassesses on the basis that your client’s increased “net worth”—represented by the cash—is the result of unreported income from that business.
Leave aside the tricky issues associated with net worth assessments. And take it as given that the CRA is only too happy to collect taxes on profits derived from illegal and immoral businesses and that the tax courts have endorsed the collection of taxes in such circumstances. Your client might ask how the CRA can include in his taxable income cash that has been seized. Why should he have to pay tax on amounts that have been taken from him?
In Chan v. The Queen, 2010 TCC 3, the taxpayer argued that he should be entitled to a deduction for the seizure of the funds. The Court, however, pointed out that the taxpayer never ceased to own the funds that had been seized. The funds were seized, but they were not forfeited because the taxpayer made a successful application for the funds to be used to pay his legal bills. Seizure as such does not give rise to a deduction.
What if the funds are forfeited? In Brizzi v. The Queen, 2007 TCC 226 (an informal procedure appeal), the taxpayer was convicted of trafficking and as a result portfolio securities that he owned that had been purchased with the profits from his business were seized and forfeited as proceeds of crime. The taxpayer argued that trafficking is a business, that the forfeiture of assets is an everyday risk or incidental expense associated with the business and that therefore he should be entitled to deduct the amount forfeited in computing income from the business.
The Court responded:
It is important to mention that the tax authorities are not concerned with the legality of an activity (see Canada (M.N.R.) v. Eldridge, [1965] 1 Ex. C.R. 758 (QL), at par. 25, and 65302 British Columbia Ltd. v. Canada, 1999 CanLII 639 (S.C.C.), [1999] 3 S.C.R. 804, at par. 56). It is accepted that if a taxpayer’s income from an illegal business is taxable, that taxpayer should be allowed the benefits of the Income Tax Act (the “Act”) in terms of deductions. It is also important to mention that this Court is only concerned with determining the validity of an assessment after considering all relevant facts and with ascertaining whether the assessment is in compliance with the Act. Equitable considerations are not within our jurisdiction.
The Court, however, denied a deduction because, in the Court’s view, the forfeiture was a consequence of carrying on an illegal activity, not an amount incurred to earn the income from that activity. The Court distinguished the ratio in 65302 British Columbia Ltd. in which the Supreme Court permitted the deduction of penalties paid for the illegal production of eggs over quota. The Tax Court in Brizzi characterized the penalties paid in 65302 British Columbia Ltd. as amounts directly related to the earning of additional income from the (illegal) over-production of eggs. According to the Court in Brizzi, the amounts Mr. Brizzi forfeited had no such income earning purpose. The Tax Court arrived at a similar conclusion in Anjaria v. The Queen, 2007 TCC 746, another informal procedure appeal.
These decisions seem to take a rather narrow view of what constitutes a tax deductible expense. To be deductible, an expense need not be causally related to income, and a taxpayer is not required to show that an expense is linked with the production of a particular item of income before the expense is deductible. Rather, a deductible expense need only be reasonably related to the income-earning process. This point is well illustrated in Imperial Oil Ltd. v. Minister of National Revenue, [1947] Ex. C.R. 527. In that case, the taxpayer operated a tanker that collided with another ship. The taxpayer compensated the ship’s owner and deducted the compensation paid in computing income for tax purposes. The Minister attempted to deny the deduction of the damages, but the Court held they were ‘deductible on the grounds that collisions were an “ordinary risk of the marine operations part of the appellant’s business and really incidental to it”.’[1]
Even if one accepts, however, that the Tax Court in Brizzi and Anjaria took too narrow a view of what constitutes a deductible expense, query whether the cases would be decided differently in respect of cash forfeited after March 22, 2004. Parliament amended the Income Tax Act (Canada) to overrule 65302 British Columbia Ltd. by adding section 67.6, which prohibits the deduction of fines or penalties. It would seem that, even if a taxpayer could convince a judge that a forfeiture was a valid business expense, the deductiblity of the expense might be denied because of the rule in section 67.6. In Toth v. The Queen, 2006 TCC 116, the Court considered the taxation of amounts taken from an RRSP pursuant to an order issued under the Criminal Code. The Court seemed to regard the amount forfeited from the RRSP as akin to a fine or penalty imposed under the Code, which would suggest that an amount so forfeited could not be deducted for income tax purposes.
In Toth, the CRA added insult to injury by including the amount forfeited from the taxpayer’s RRSP in his income for tax purposes. In court, the taxpayer initially argued that the amount should not be included in his income because he did not receive it, to which the Court responded (at ¶11): “I have no hesitation in finding that the Order of the Quebec Court was a legal obligation placed on the Appellant requiring the transfer of his RRSPs to the Procureur General du Quebec. Also, I find that the Appellant had constructive receipt of the RRSP funds.”
Section 67.6 prohibits the deduction of fines and penalties. Will the section apply if the amount forfeited is taken under a provincial civil forfeiture statute such as the Civil Remedies Act, 2001 (Ontario)?[2] Ontario’s Ministry of the Attorney General describes the Act in the following terms:
Civil asset forfeiture focuses solely on the connection between property and unlawful activity, and is not based on any criminal conviction. By contrast, criminal asset forfeiture permits forfeiture of assets obtained by or used in the commission of an offence following the conviction of an individual.[3]
It would seem that an individual whose assets are forfeited under the Civil Remedies Act and who is reassessed by the CRA in respect of the assets could argue that the forfeiture did not constitute a fine or penalty because the forfeiture did not relate to the individual’s conduct. The seizure was in rem, not against the person. As a result, the individual could argue, based on Imperial Oil and 65302 British Columbia Ltd., that he or she should be entitled to deduct the amount seized.
The individual might have a technical argument, but he or she will also need to overcome the reluctance of the tax courts to permit the deduction of amounts in computing income from an illegal business, 65302 British Columbia Ltd. notwithstanding. In many respects, their squeamishness is understandable. Consider the position where a drug dealer attempts to deduct amounts paid for having a customer who isn’t paying his bills “roughed up”. Should a tax court permit the deduction of such amounts if the drug dealer can produce receipts? Not if public policy has anything to do with it, which it will, inevitably.
On the other hand, if judges will pretend that drug dealing, for example, is a business like any other for tax purposes, then they must also allow for the deduction of reasonable expenses incurred in carrying on that business.
[1] 65302 British Columbia Ltd., at ¶31. Interestingly enough, the Supreme Court in 65302 British Columbia Ltd. distinguished Imperial Oil on the grounds that its test for deductibility was too narrow (at ¶45).
[2] S.O. 2001, c. 28.
[3] Ministry of the Attorney General, Backgrounder, August 1, 2006, retrieved from tinyurl.com/y9psc68 on February 13, 2010.
