A rogue convinces you to “invest” in a “business” and you lose the money you invest because the business really consists of stealing your money. Will you be entitled to a deduction in respect of the money you have lost? The Federal Court of Appeal, in Hammill v. The Queen, 2005 FCA 252, said no.
The unfortunate Mr Hammill began purchasing gems in the late 1980s for the purposes of re-sale. By 1993, he had acquired an “inventory” of gems supposedly worth over $500,000, and he decided that he wanted to sell them. He began dealing with a Toronto company that offered to help him with the sale. The Toronto company purported to present an offer from a third party that would deliver a handsome profit but that required Mr Hammill to pay large up-front fees and other charges to facilitate the sale. The transaction did not close, however, and Mr Hammill’s up-front fees and charges were not refunded. Instead, the Toronto company presented another offer and Mr Hammill again paid large amounts up-front to ensure that the deal would close. The deal did not close. This process was repeated five times in all so that by 1996, when Mr Hammill finally reported the matter to the Mounties, he had paid over $1.6 million for various purposes supposedly related to the sale of his gems, and he had received nothing in return. To add insult to injury, when the Mounties moved in on the Toronto company, its principals fled and took Mr Hammill’s gems with them.
Mr Hammill, in computing his income for tax purposes, tried to deduct the value of his lost inventory and the fees and expenses he had paid. The Minister allowed the former but not the latter expenses. The Minister admitted that Mr Hammill had engaged in an adventure in the nature of trade so that he was entitled to deduct the cost of his inventory. The Minister took the position, however, that the fees were not laid out for the purposes of earning income and that, in any case, they were not reasonable because Mr Hammill had not acted in a reasonable manner when he paid them.
Both the Tax Court (see 2004 TCC 595) and the Federal Court of Appeal agreed with the Minister. The Tax Court seemed even to question whether Mr Hammill should have been entitled to deduct his inventory costs. The Court, despite the Minister’s admissions, found that Mr Hammill was not in business; rather, the Court found he was a victim of a fraud from beginning to end. In those circumstances, Mr Hammill could not have had a source of income, and so he was not entitled to a deduction for the fees and other expenses he had paid.
The Federal Court of Appeal, at ¶39, agreed:
In my view, it was open to the Tax Court Judge to hold, on the basis of this evidence, that the appellant was the victim of a fraud from beginning to end. This finding, which the appellant has not confronted, precludes the existence of a business under the Act, regardless of any other consideration. The Tax Court Judge needed to go no further to support his conclusion that the claimed expenses were not incurred to earn income from a business pursuant to paragraph 18(1)(a).
The Court wrote earlier in its judgment, at ¶27, that
This is not a case where the Court must have regard to the taxpayer’s state of mind, or the extent of a personal element in order to determine whether a certain activity gives rise to a source of income under the Act (Stewart, supra, Tonn v. The Queen, 96 DTC 6001 etc.). Nor is this a defalcation case of the type described in Parkland Operations, supra; Cassidy’s Limited, supra; Agnew, supra; and IT-185R, where a business is defrauded by an employee or a third party, and the issue becomes whether the resulting loss is reasonably incidental to the income-earning activities.
What is the moral of the story? According to the Federal Court of Appeal, if you are running a business, and an employee steals from you, you might be entitled to deduct the money you lose. If, however, you are in a business that is really a fraud from “start to finish”, and you lose money, you will be in no better position than if a thief steals the money in your wallet: you will not be entitled to a tax deduction for what you have lost in either case.
