Citation: 2014 TCC 59
Date: 20140221
Docket: 2012-793(IT)G
BETWEEN:
LEONARD ROSZKO,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
C. Miller J.
[1]
In 2008 Mr. Roszko
received $156,000 from TransCap Corporation ("TransCap"). Unbeknownst
to Mr. Roszko, TransCap ran a well-orchestrated Ponzi scheme. The issue before
me is whether the $156,000 was interest received by Mr. Roszko duly taxable as
income from a source, or whether the $156,000 was a return of part of the
$800,000 Mr. Roszko believed he had loaned to TransCap.
[2]
The Parties provided me
with an Agreed Statement of Facts as follows:
1. At all material times, the Appellant was an individual
resident in Canada and Alberta for the purposes of the Income Tax Act.
2. From February 2006 to December 2007 the Appellant
provided TransCap Corporation with a series of four amounts which totalled
$800,000.
3. With each amount provided to TransCap Corporation, the
Appellant received documents as follows:
(a)
Exhibit 1 – Copies of TransCap Corporation
Schedule A – Lenders Document, Schedule B – Promissory Note and Wire Payment
Services confirmation report respecting the $100,000 February/March 2006 funds;
(b)
Exhibit 2 – Copies of TransCap Corporation
Schedule A – Lenders Document, Schedule B – Promissory Note and Wire Payment
Services confirmation report respecting the $100,000 May/June 2006 funds;
(c)
Exhibit 3 – Copies of TransCap Corporation
Schedule A – Lenders Document, Schedule B – Promissory Note and Wire Payment
Services confirmation report respecting the $300,000 January 2007 funds; and
(d)
Exhibit 4 – Copies of TransCap Corporation
Schedule A – Lenders Document, Schedule B – Promissory Note and Wire Payment Services
confirmation report respecting the $300,000 October 2007 funds;
4. Each of the Schedule A – Lenders Documents and Schedule B
– Promissory Notes found at Exhibits 1 through 4 were issued according to the
T.C.C. Master Loan Agreement. A copy of the T.C.C. Master Loan Agreement is
attached as Exhibit 5.
5. In 2008, the Appellant received a total of $156,000 from
TransCap Corporation, broken down as follows:
(i)
$7,500 monthly, by way of cheque or direct
deposit; and
(ii)
A $66,000 annual sum by way of cheque.
Copies
of the cheques for the period May 2008 through December 2008 are attached as
Exhibit 6.
6. The Appellant reported the $156,000 received from
TransCap Corporation in his 2008 T1 personal income tax return as interest
income and paid both federal and provincial income taxes on this amount.
7. TransCap Corporation did not ever issue the Appellant any
T5 Statement of Investment Income slips for any funds received from TransCap
Corporation.
8. TransCap Corporation perpetrated a fraud on Alberta investors, including the Appellant, contrary to the Securities Act (Alberta), RSA 2000 c. S-4. A copy of the Alberta Securities Commission decisions Re
TransCap Corporation, 2013 ABASC 201, and Re TransCap Corporation,
2013 ABASC 326 are attached as collectively at Exhibit 7.
9. In total, TransCap Corporation provided $408,000 to the
Appellant between 2006 and 2009, inclusive, as follows:
2006: $22,500
2007: $81,000
2008: $156,000
2009: $148,500
The
annual amounts were received by the Appellant by way of monthly cheques or
direct deposits and, in 2008 and 2009, one larger lump sum in the amount of
$66,000. The Appellant has not received any additional funds from TransCap
Corporation.
10. On December 6, 2012, the Appellant sent correspondence to
TransCap Corporation declaring all funds received from TransCap Corporation to
be a return of capital. A copy of the December 6, 2012 correspondence is
attached as Exhibit 8.
[3]
Rather than attach all
the exhibits referred to in the Agreed Statement of Facts, I have attached the
following:
Appendix A Promissory
Note for $100,000 dated the 1st day of March, 2006; (the second Promissory Note
for $100,000 is similar)
Appendix B Promissory
Note for $300,000 dated January 18, 2007; (the second Promissory Note for
$300,000 is similar)
Appendix C Excerpts
from Master Loan Agreement.
[4]
Mr. Roszko testified,
flushing out in greater detail some of the above facts. He had sold the family
farm in 2006 and invested his portion of the proceeds with a reputable Alberta financial enterprise. However, as he was concerned about taxes arising from the
sale of the farm, he attended a presentation by TransCap in Edmonton, hoping
that he may receive some advice to assist with his tax position. Instead, with
promises from Blair Carmichael of TransCap that he could achieve significant
returns on his investments in the range of 18% to 22%, and following a
subsequent meeting with Mr. Carmichael, Mr. Roszko decided to try an initial
$100,000 investment. As is clear from the schedules attached this was set up in
the form of a loan. Mr. Roszko was led to believe TransCap bought and sold
commodities at considerable profit to achieve the high returns.
[5]
Having received the monthly
payments promised on the first $100,000, he proceeded to make an additional
$100,000 investment and again received the promised monthly payments. He then
made the two additional $300,000 investments, receiving payments from TransCap
as set out in paragraph 9 of the Agreed Statement of Facts.
[6]
In December 2009, after
the accidental death of his son, Mr. Roszko approached TransCap for a return of
some funds to cover funeral expenses. His request was denied in a manner which
caused Mr. Roszko some suspicion. He made enquiries which eventually led to an
Alberta Securities Commission investigation, and a finding by the Alberta
Securities Commission that TransCap perpetrated a fraud on investors. The
Alberta Securities Commission
indicated in their decision of May 9, 2013 that:
143 The "prohibited act" asserted by Staff was, essentially,
the misrepresentations to Alberta investors that their money would be applied
in bond trading and bridge financing that would fund interest payments and
principal payments on TCC and STC securities, whereas in fact payments to
investors in this Ponzi scheme were funded from their own and their fellow
investors subscription money – something sustainable only for so long as
investment subscriptions covered the payments out.
Issue
[7]
Is the $156,000
received by Mr. Roszko in 2008 from TransCap interest income within the meaning
of paragraph 12(1)(c) of the Income Tax Act (the "Act")
or does it represent the return of capital?
Analysis
[8]
The Appellant’s
position is that the sum of $156,000 received by the Appellant is a return of
the principal loan to TransCap and is not includable in his income, for the
following two reasons:
a) First, the Appellant
entered into the lending arrangement having relied on fraudulent
misrepresentations. As the innocent party, the Appellant has rescinded the
lending arrangement, rendering the contract void ab initio and of
no effect with respect to any payment of interest. In the alternative, the
Appellant argues that the transfer of funds by him to TransCap in circumstances
where there is no enforceable agreement, and no consideration payable by
TransCap, creates a resulting trust. The beneficial ownership of the funds
advanced by Mr. Roszko therefore always remained with him. The only
possible characterization of the payment to the Appellant is the transfer to
him of legal title to funds that were beneficially already owned by him.
b) Second, the lending
arrangement itself provides that any misrepresentation or breach of the
agreement would result in all principal and interest becoming due and payable,
without demand. As such, it is reasonable for the Appellant to characterize the
amount received as return of principal.
[9]
The Respondent relies
on the four contracts along with the Master Loan Agreement to argue that the
$156,000 clearly falls into interest within the meaning of paragraph 12(1)(c)
of the Act, and the fact of fraud does not negate a finding of interest
from a source. The Respondent considered the factors cited in the case of R v
Cranswick
and also relied on the Federal Court of Appeal’s decision in Johnson v R to reach
this conclusion. The Respondent also identified three requirements, based on
the Federal Court of Appeal decisions of Perini v R. and
Sherway Centre Ltd. v R,
that, if met, would render an amount interest:
a) the amount was compensation for
the borrower’s use of the money;
b) the amount was ascertainable on a
daily basis;
c) the amount was related to the
outstanding principal sum.
[10]
The basic distinction
between the Respondent’s approach and the Appellant’s first reason is that the
Appellant maintains that, legally, Mr. Roszko could rescind the contract and
render it void ab initio (which he did by letter of December 6,
2012), whereas the Respondent maintains one has to look to the terms of the
contract, which are enforceable, and they evidence Mr. Roszko’s right to
interest income. In effect, the Respondent relies on the contract and the Appellant
does not.
[11]
The Parties raise these
rather technical arguments addressing contract law, creditor-debtor law and tax
law. I am not convinced the situation needs to be as technically dissected. In
the Johnson case, which also involved a Ponzi scheme, the Federal Court
of Appeal concluded there can indeed be a source of income in a Ponzi scheme.
It confirmed that, where, as in that case, the investor ultimately receives
back more than she invested, applying the factors in the Cranswick case,
there is indeed income from a source.
[12]
However, in Johnson,
the situation was quite different from the situation before me. In Johnson,
the Federal Court of Appeal found that the contract was simply Ms. Johnson
agreeing to invest money on the basis she would receive the money she invested
"with a return in instalments in the amounts and on the dates indicated by
the post-dated cheques he gave her in exchange". The Federal Court of
Appeal went on to say:
39. Ms. Johnson may well have believed that Mr. Lech was going
to use the money to earn profits by option trading, because that is what he
told her he would do. However, the record discloses no evidence upon which
the judge could reasonably conclude that Mr. Lech was under a contractual
obligation to Ms. Johnson to generate profits in that manner, or in any
particular manner.
…
43. … Hypothetically, if Ms. Johnson had made her payments to
Mr. Lech knowing that he would use the money to operate a Ponzi scheme, she
would have profited exactly as she did in the years in issue in this case …
…
49. However, the principle on which Mr. Hammill was precluded
from claiming tax relief for his losses is not applicable to Ms. Johnson. Their
circumstances are entirely different, not because she profited from her
transactions with Mr. Lech, but because her contractual rights were
respected. As a matter of law, the fact that Mr. Lech used the proceeds of
his unlawful Ponzi scheme to fund the profits he was contractually obliged to
pay to Ms. Johnson is not relevant in determining the income tax consequences
to Ms. Johnson of her transactions with Mr. Lech.
[emphasis added]
[13]
There are significant
differences between Ms. Johnson’s situation and Mr. Roszko’s:
a) Mr. Roszko’s agreement with
TransCap stipulated how the funds were to be invested;
b) Mr. Roszko was led to believe the
funds would be so invested;
c) the funds were not so
invested: Mr. Roszko’s contractual rights were not respected; although he got a
$156,000 payment, it was not derived as contracted;
d) it was agreed as a
fact TransCap perpetrated a fraud;
e) the fraud was as described
by the Alberta Securities Commission in paragraph 143 of their decision quoted
earlier.
[14]
The Respondent argued
that I could not rely on facts raised in the Alberta Securities Commission
decision, not proven in the trial before me. While I accept such a general
proposition, I am of the view that the description of the fraud as set out in
the above quote from paragraph 143 is the Alberta Securities Commission’s
finding of law. It is unnecessary for Mr. Roszko to have to subpoena the
individuals who perpetrated the fraud on behalf of TransCap to describe the
fraud. The Alberta Securities Commission has done so, and I am prepared to rely
on that finding.
[15]
Mr. Roszko was misled
to believe interest would be funded by TransCap. It was not. The funding of
those payments, described as interest, was from Mr. Roszko and other
investors’ own money. That is not what was contracted for: it is not interest.
[16]
Putting this analysis
in terms of the Respondent’s argument, I find that of the requirements to find
interest, there is one missing element; that is, that TransCap did not use Mr.
Roszko’s money as it had contracted to do so – the payment of $156,000 cannot
be seen as a payment for the use of the money. Indeed, it is even questionable
that TransCap could be considered a "borrower" if it simply took from
Peter to pay Paul: that is not interest, that is a return of capital, and only
if, as in Ms. Johnson’s case, the investor receives more than a return of
capital can we ask whether such profit is business income from a source.
[17]
Further, in the Johnson
decision, the Federal Court of Appeal went on to distinguish the case before it
from the Hammill v R
case. The Federal Court of Appeal in addressing the Hammill decision
stated:
48. … It was determined at trial, however, that Mr. Hammill
was the victim of a fraud that commenced when he was contacted about the profits
to be made from buying and selling gems, and continued with the purported
efforts of the perpetrators to sell the gems. This Court confirmed that his
expenditures were not deductible because they were not connected to any source
of income – or in other words, there was in fact no business even though Mr.
Hammill honestly believed that there was. Justice Noël, writing for the Court, summarized
this conclusion as follows at paragraph 28 of the reasons:
A
fraudulent scheme from beginning to end or a sting operation, if that be the
case, cannot give rise to a source of income from the victim’s point of view
and hence cannot be considered as a business under any definition.
[18]
Mr. Roszko’s situation
of having a fraud perpetrated upon him from the outset is more similar to the
situation Mr. Hammill found himself in, and, as Justice Noël confirmed, this
cannot give rise to a source of business income. Granted, in the case before
me, the Respondent is not suggesting there is a source of business income, but a
source of property income in the form of interest. The principle I would
suggest is the same: the purported interest is a fraud from the outset. It
cannot be considered income from property, but rather a return of capital to
the extent of the original amounts invested: only excess returns might be
considered income. This is quite different from Ms. Johnson’s situation where there
were excess returns, and the court found she entered into a contract and her
rights under that contract were respected. No fraud, as such, was found: she
got exactly what she contracted for.
[19]
Having reached this
conclusion, I find it unnecessary to tackle the thorny issues raised by the
Appellant of the effect of rescission on a contract, the concept of a resulting
trust, or the impact of an ongoing breach of a contract. I see the matter in
simpler terms. Mr. Roszko was defrauded – that has been agreed. He trusted
TransCap to wisely invest his $800,000 to yield a significant return. TransCap
did not do that. In effect, TransCap just gave Mr. Roszko his own money back
or that of other duped investors. There is a distinction, I would suggest,
between earning income based on a fraudulent act or illegal activity versus a
finding that the contract itself is a fraud. In the former situation there can
be a source of income which can be taxable. In the latter situation there
cannot.
[20]
I allow the Appeal and
refer the matter back for reconsideration and reassessment on the basis that
Mr. Roszko did not earn interest income of $156,000 in 2008.
Signed at Ottawa, Canada, this 21st day of February 2014.
"Campbell J. Miller"
Appendix B
APPENDIX C
1.1 The Lender shall be
those parties who from time to time lend funds to the Borrower.
1.2 The Indebtedness of the
Borrower to the Lender shall, from time time, be equal to the aggregate amount
outstanding at any time of all loans and advances made or which mat be made by
the Lender to the Borrower pursuant to this Agreement and any interest/capital
gain thereon (the "Indebtedness").
…
2.2 The Loan(s) amount plus
all accrued and unpaid interest/capital gain, and such other amounts which may
be due and payable to the Lender from the Borrower, shall become due and
payable in any event on the various Loan Maturity Date(s) as agreed between the
particular Lender and the Borrower. Notwithstanding anything herein contained,
and in addition to any payment deadlines or accelerated provisions herein
contained, all Indebtedness shall become due and payable, without demand, in
the event an interest/capital gain payment is not made in a timely manner or
upon a Default occurring.
…
3.3 Under Irrevocable
Representation and Warranty made with various organizations and institutions
and under specific arrangements the loaned funds can only be utilized for
"Qualified Transactions" which are defined as the acquisitions of
assets only where TransCap has first acquired "Forward Commitment
Contracts" with organizations or institutions with the financial strength
to provide guaranteed purchases of those assets at a predetermined price and
date, which will allow TransCap to make a profit in the transaction. Further
conditions of the TransCap Corporation ESCROW is that the original loaned funds
can only be returned to the Lender and the original co-ordinates unless
notification of change is received from the Lender.
…
5.1.2 Keep the loaned funds in
"TransCap Corporation ESCROW" and be managed according to the
conditions as stated in Article 3.3. herein.
5.1.3 Continue to be liable
for any Indebtedness remaining outstanding should the funds for any reason not
be recovered from the "TransCap Corporation ESCROW", and in the event
of Default, to satisfy all the Indebtedness, and the Lender shall be entitled to
pursue full payment thereof.
…
7.1.2 If the Borrower neglects
to carry out or observe any covenant or condition under this Agreement;
…
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