Some tax issues for criminal lawyers

This article originally appeared in the Hamilton Law Association Journal.

A client facing criminal charges would seem to have enough on his or her plate—like the possibility of serving a jail sentence—without having to worry about tax issues. The CRA, however, will be only too happy to pile on where it thinks the accused has earned income that should be subject to tax.

Proceeds of Crime Are Subject to Tax

Income earned from a business is subject to tax even if the business is illegal. In No. 275 v MNR, 55 DTC 439, a taxpayer tried to argue that the government shouldn’t make itself a partner in an illegal and immoral business (prostitution) by trying to collect tax on the income from the business. The Tax Appeal Board responded as follows:

It is clear from the above decisions that, when the question in issue is whether profits arising from illegal sources are liable to taxation or not, the courts are not concerned, either with the source of the taxpayer’s income, or by the means taken by him to earn it, but merely with the question as to whether or not the said income is liable to tax under the provisions of the taxing statute. Once the courts are satisfied that the income is liable to tax, it is immaterial that it comes from a legal or an illegal business, or a business which is malum in se or malum prohibitum.

Similarly, the courts have had little difficulty concluding that income derived from the sale of drugs, the sale of stolen goods or fraudulent activity is subject to income tax. In Molenaar v R, 2003 TCC 468, aff’d 2004 FCA 349, the court held that the sale of illegal drugs constituted a taxable supply that was subject to GST.

CRA Follow-up

The CRA claims that it regularly scans local papers for news about criminal charges that have been laid and then follows up with the accused if it thinks the alleged criminal activity might have generated income that should be subject to tax. One wonders whether the communication between the police and the CRA isn’t more direct than that (or why the CRA would be so coy about the communication), but, in any case, where the CRA learns about income-generating criminal activity, it might well contact the taxpayer to make inquiries about his or her income and/or net worth.

The CRA, as part of its audit, might issue a requirement to the taxpayer to produce books and records. Generally speaking, a taxpayer must respond to these requirements relating to civil liability for taxes even though the answers provided might touch on facts and evidence that are at the very heart of the criminal charges (see, for example, Breau v Canada (National Revenue), 2012 FC 1207, which is under appeal, and Patry v. Canada (Attorney General), 2011 FC 1032). Of course, whether the evidence thus obtained can be used in the criminal proceedings is another matter entirely. The fact that criminal charges are pending, however, does not by itself stop the CRA from gathering evidence for a civil reassessment.

 As a practical matter, the CRA, perhaps understandably, will often not require the filing of, or rely on, “financial statements” for the illegal business and will instead conduct its audit using the net worth method. The CRA, using bank records and other records relating to the assets and liabilities of the accused (eg title documents respecting the ownership of real property and cars), will look for evidence of an increase in the net worth of the accused that cannot be explained by his or her reported income. The CRA will usually reassess as taxable income any unexplained increase in the accused’s net worth. The CRA might also assess the accused for net GST in respect of the increase, depending on the nature of the illegal activity.

File That Objection!

If the CRA does reassess the accused, it is essential that he or she follow the procedures set out in the Income Tax Act and Excise Tax Act for contesting reassessments. In Cameron v R, 2006 TCC 588, the taxpayer had been charged with theft from his employer. The CRA reassessed the taxpayer to include in his income the amounts supposedly stolen. The taxpayer did not file notices of objection, on the advice of his counsel, he claimed, and supposedly with assurances from the CRA to the effect that it would not maintain the reassessments if he were acquitted. In the event, the Crown dropped the criminal charges, but the CRA did not vary the reassessments. By then, the taxpayer could not file objections—he was out of time—and so he tried to file an appeal to the Tax Court. The Tax Court, however, quashed his appeal because it was (and is) a condition precedent to a Tax Court appeal that an appellant has previously filed a valid objection.

Mr Cameron’s criminal defence counsel, if he gave the advice attributed to him by the taxpayer, was wrong to give it. The taxpayer must file an objection to any and all reassessments in order to vary them. The taxpayer should have filed an objection that simply stated that he objected to the reassessments issued. The objection as filed initially would not have included detailed facts and reasons for the objection. The objection would have requested that the CRA hold its consideration of the objection in abeyance pending the resolution of the criminal charges. Even though the Income Tax Act requires an objection to contain the facts and reasons on which the taxpayer relies, the CRA routinely accepts objections of this kind, and, perhaps because of the caseload of its appeals branch, seems only too happy to postpone consideration of an objection until any related criminal charges have been resolved.

Res judicata

A taxpayer should also not accept advice to the effect that, if criminal charges against the taxpayer are dropped or the taxpayer pleads to a lesser offence, then the CRA will reduce or reverse its reassessment. It is very unlikely that the CRA will consider itself bound by any particular resolution of criminal charges. The Crown might not be able discharge the onus on it to prove the elements of a criminal offence beyond a reasonable doubt. The CRA does not face the same burden. The standard of proof in the Tax Court is a balance of probabilities, and the onus is on the taxpayer to “demolish” the CRA’s assumptions about the facts underlying its reassessment. The CRA is entitled to make assumptions about the taxpayer’s income, and then the taxpayer must prove the assumptions wrong on a balance of probabilities. The Crown might fail to prove that a taxpayer stole $30,000 from his employer, perhaps because some crucial evidence is excluded under the Charter. The CRA, however, can generally still use that evidence—a reassessment under the Income Tax Act does not engage Charter protections—and then it is up to the taxpayer to prove that he did not earn that $30,000 as income for the purposes of the Income Tax Act. Or the accused who was charged with stealing the $30,000 might plead guilty to theft under $5,000. Again, the CRA might very well maintain a reassessment that assumes the amount taken (or “earned”) was $30,000 even though the taxpayer “admitted” taking only $5,000 in the criminal law process. In short, the CRA need not reduce or reverse a reassessment merely because the related criminal charges are dropped or the accused pleads guilty to a lesser offence.

On the other hand, a criminal conviction might preclude a taxpayer from contesting civil reassessments. In Cranston v R, 2011 FCA 5, aff’g 2010 TCC 414, the taxpayer’s tried to contest reassessments based on a net worth assessment that included gross negligence penalties. The tax courts dismissed his appeal because he had been convicted on criminal charges based on the same net worth assessment that formed the basis of the reassessments. The Federal Court of Appeal also affirmed that the gross negligence penalties did not constitute another punishment for the same offence because the penalties are civil in nature.

 In light of the foregoing, defence counsel, when negotiating a guilty plea, must take care to ensure, to the extent possible, that any agreed statement of facts does not unnecessarily admit facts that can be used by the CRA in upholding a reassessment. An admission in an ASF to the effect that the taxpayer earned a certain amount by engaging in illegal activity—for example, an admission that cash seized from premises under the control of the taxpayer were generated through the sale of drugs—will make it difficult or impossible to argue that the amount should not be included in income for tax purposes.

 Of course, defence counsel can only do so much to protect the accused from a civil tax reassessment. Any ASF or other form of resolution is likely evidence that the CRA will be able to use against the accused as part of the civil tax process. Defence counsel can limit the damage—for example, by attempting to exclude statements to the effect that cash seized was proceeds of crime—but if the police seized large amounts of cash as part of the investigation and that fact is admitted in an ASF, then the taxpayer will likely be left having to explain the source of that cash for civil purposes.

Conclusion

Sometimes a client who has been convicted of an offence under a plea, and who is now facing a CRA reassessment stemming from the underlying charges, will complain that he or she did not understand the tax implications of the charges or the plea. One suspects that the implications were explained or that criminal defence counsel recommended consulting with a tax adviser, and the client either forgot the explanation or did not follow-up with an adviser. Moreover, given the consequences of a criminal conviction, the client might well have had no choice but to accept a particular resolution of the charges regardless of the tax consequences. In any case, defence counsel will need to advise the accused that certain kinds of charges have tax implications, as outlined above, and that, if defence counsel is not able to address the tax issues, the accused will need to consult with someone who can.

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The author thanks Jeff Manishen for his comments on a draft of this article. Any errors remain those of the author.