Citation: 2012 FCA 253
HER MAJESTY THE QUEEN
DONNA M. JOHNSON
REASONS FOR JUDGMENT
respondent Donna M. Johnson appealed successfully to the Tax Court of Canada
for an order vacating reassessments under the Income Tax Act, R.S.C.
1985, c. 1 (5th Supp.) for 2002 and
2003 (2011 TCC 540). The Crown has appealed to this Court to restore the
main issue in the appeal is whether Ms. Johnson is required to pay income tax
on certain payments she received in 2002 and 2003 (net of related outlays) from
Andrew Lech. When Ms. Johnson received the payments, she believed that they
represented her share of the after-tax profit derived from option trading
transactions engaged in by a trust managed by Mr. Lech. In fact, and unknown to
Ms. Johnson, Mr. Lech was paying her from money he had obtained fraudulently
from the victims of a Ponzi scheme he was operating. Ms. Johnson argued
successfully in the Tax Court that the payments were not taxable in her hands
because the Ponzi scheme could not be a source of income to her. For the
reasons that follow, I have concluded that Ms. Johnson’s argument is wrong in
the payments in issue were properly included in Ms. Johnson’s income for 2002
and 2003, an issue arises as to whether the reassessments are invalid because
they were made outside the “normal reassessment period”, defined in the Income
Tax Act as three years after the date of initial assessment. The judge held
that the reassessment for 2003 was valid, but not the reassessment for 2002.
The Crown argues that the judge misapplied the applicable legal test for 2002
but not 2003. Ms. Johnson argues the contrary. For the reasons that follow, I
agree with the Crown that the reassessments for both years were valid.
facts as found by the judge are not in dispute. Ms. Johnson worked as a
registered nurse until the 1990s. She assisted her husband with a church they
began in Peterborough in 1974, and from 1982 worked with him in a travelling
ministry. Although Ms. Johnson has no formal training in business or finance,
the judge found her to be astute in business matters. In connection with the
transactions that are the subject of this case, Ms. Johnson drafted two
documents that the judge characterized as “relatively sophisticated” (see
paragraph 59 of the judge’s reasons; the two documents are described in the
the late 1990s, Ms. Johnson was introduced to Andrew Lech by her friend Liz
Wakeford. Ms. Wakeford is a bookkeeper who also files income tax returns and
has some real estate experience. She told Ms. Johnson that she had invested
successfully with Mr. Lech.
approximately 1997 until April of 2003, Ms. Johnson entered into numerous
transactions with Mr. Lech, at first through Ms. Wakeford as an intermediary,
and later directly with Mr. Lech. In each transaction, Ms. Johnson would give
Mr. Lech a cheque and at the same time, he would give her a number of cheques,
postdated to provide her with payments over eight to ten weeks in amounts that
in total exceeded her payment to him. Typically, the last postdated cheque for
each transaction represented the excess, or profit. It is not clear how many of
these transactions occurred, but Ms. Johnson testified that there were
approximately 70 in 2002 and 2003.
Lech told Ms. Johnson that he was combining her money with money held in a
family trust that he managed, and that he was using the money in option trading
to generate profits. He assured her that she had no risk of loss. He also
assured her that the family trust paid tax on the profits, and that the money
he paid to Ms. Johnson was “after tax profits” that she was not obliged to
report in her income tax returns. Ms. Johnson believed everything Mr. Lech told
Johnson did not seek professional investment or tax advice before entering into
the transactions with Mr. Lech, or at any time. Her own research consisted of
seeking and obtaining an assurance from her banker that large profits could be
made from option trading by someone who knew what they were doing. As to the
tax consequences of her investments, she consulted only her friend Ms.
Wakeford, who as indicated above was also an investor with Mr. Lech. Ms. Wakeford
did not testify in the Tax Court. Ms. Johnson testified that Ms. Wakeford
assured her that the amounts received from Mr. Lech should not be reported as
income because the tax on the profits was paid by the trust.
transactions between Ms. Johnson and Mr. Lech were not fully documented. Ms.
Johnson kept her own notes of the transactions. She also drafted two documents
that she asked Mr. Lech to sign. He did so in March of 2000. Those two
documents read as follows:
AGREEMENT BETWEEN ANDREW LECH & DONNA M. JOHNSON FOR INVESTMENT FUNDS AND INCOME TAX PURPOSES
I, Andrew Lech, declare and certify that
all taxes payable for income tax purposes, for all the investments funded by
Donna M. Johnson, have and are being paid through the Lech family trust
account over which I am the financial manager. It is not necessary for Donna
M. Johnson or her immediate family to report and declare investment income
to be taxed again.
AGREEMENT BETWEEN ANDREW LECH & DONNA JOHNSON FOR INVESTMENTS
I, Andrew Lech, am acting as a trustee of
investment funds for Donna M. Johnson, [………………..address
omitted………..……]. All cheques, whether current or post-dated payable to Mrs.
Donna Johnson and bearing my signature are to be honoured from the proceeds
of my estate in the event of my death.
Johnson testified that she did not require any documentation of the
transactions with Mr. Lech because she believed and trusted him. She also
testified that she believed it would be unreasonable of her to request
disclosure of what she assumed would be private information relating to Mr.
Lech’s family trust. The first document quoted above was intended only to
provide documentary evidence in the event of enquiries from the tax
authorities, and the second was intended to protect the position of Ms. Johnson
in the event of the death of Mr. Lech.
last transaction between Ms. Johnson and Mr. Lech occurred in April of 2003. In
that month Ms. Johnson gave Mr. Lech what would prove to be her last cheque to
him, which was cashed. However, Mr. Lech’s bank accounts were frozen shortly
afterward, and she could no longer cash his cheques. At about this time, a
class action was commenced against Mr. Lech by others who had invested with
him, and Ms. Johnson joined them. She testified that she did so in order to
recover the money represented by the cheques that she was unable to cash. She
was interviewed by the lawyer for the class action in December of 2003.
freezing of Mr. Lech’s bank account was part of or led to a police
investigation that lasted approximately three years. Ms. Johnson was
interviewed by the police in 2005. She testified that it was only at this point
that she began to have doubts about the trustworthiness of Mr. Lech. Criminal
charges were brought and Mr. Lech was convicted in 2007, receiving a sentence
of imprisonment for six years.
2003, Ms. Johnson embarked on a strategy of option trading on her own account
because she believed that she had learned enough from Mr. Lech to do so
successfully. She was initially successful, but the success did not last. By
2008, Ms. Johnson’s savings were gone.
of what Mr. Lech told Ms. Johnson was true. In fact, Mr. Lech and some other
individuals were operating a Ponzi scheme. Ms. Johnson was not being paid a
share of the profits from investments or option trading. Rather, unknown to
her, she was being paid from money that Mr. Lech had received from other people
through the operation of his Ponzi scheme.
the Ponzi scheme operated by Mr. Lech collapsed in 2003, many people in Canada and the United States lost significant sums of money. The Canada Revenue Agency audited 132
of the participants, and concluded that 32 of them had profited from their
dealings with Mr. Lech. Ms. Johnson was one of them. Although she lost the
value of the last cheque she gave him in 2003, she received $614,000 in 2002
and $702,000 in 2003 in excess of the amounts she paid to him.
judge commented at paragraph 28 of her reasons that those who lost money on Mr.
Lech’s Ponzi scheme may have been able to assert a claim against Ms. Johnson
for restitution (Re Titan Investments Ltd. Partnership, 2005 ABQB 637; Den
Haag Capital, LLC v. Correia, 2010 ONSC 5339). However, as of the date of
the Tax Court hearing in 2011, no such claim had been made.
Johnson prepared her own income tax return for 2002, and had an accountant
prepare her income tax return for 2003 because she did not know how to report
the result of her own option trading. None of the payments received from Mr.
Lech were included in her income for either year. Ms. Johnson testified that
she believed Mr. Lech when he said that these payments were not taxable in her
hands because the tax had been paid by the family trust, and for that reason
she did not report the payments as income when she filed her income tax return
for 2002, and did not disclose her transactions with Mr. Lech to the accountant
who filed her income tax return for 2003.
Johnson’s income tax returns for 2002 and 2003 were reassessed on November 20,
2007 to include in her income the net amounts she received in those years,
$614,000 and $702,000 respectively. Ms. Johnson objected to the reassessments
and then appealed to the Tax Court of Canada, on the basis that the 2007
reassessments were time barred, and alternatively that the amounts included in
income were not taxable.
judge agreed with Ms. Johnson that the amounts included in her income were not
taxable, and allowed her appeal from the reassessments on that basis.
judge went on to consider, in the alternative, the merits of Ms. Johnson’s
argument that the reassessments were invalid because they were time barred. The
judge held that the
misrepresentations in Ms. Johnson’s 2002 income tax return were not
attributable to any neglect, carelessness, wilful default, or fraud on her part
because when she filed her 2002 return, she had no reason to doubt the truth of
what Mr. Lech had been telling her. However, by the time Ms. Johnson filed her
2003 return, she had knowledge of facts that should have put her on notice that
he had been misleading her, and her failure to inform her accountant about the
transactions was careless. On that basis, the judge concluded that the
reassessment for 2002 was time barred, but the reassessment for 2003 was not.
question in this appeal is whether Ms. Johnson’s net receipts in 2002 and 2003
from her transactions with Mr. Lech were income from a source. If the answer is
no, the Crown’s appeal cannot succeed.
If the answer
is yes, it will be necessary to consider whether the Minister had the legal
authority to reassess Ms. Johnson after the normal reassessment period for 2002
Minister relies on section 3 of the Income Tax Act, and in particular
paragraph 3(a), to justify the income inclusions in the reassessments
under appeal. Section 3 sets out the rules for determining a taxpayer’s
“income” for a taxation year for income tax purposes. The first component of
the computation, as set out in paragraph 3(a), is the total of all
income from all sources. By virtue of the computational steps in the remainder
of section 3, the amount determined under paragraph 3(a) is included in
income for income tax purposes. Section 3 reads as follows (my emphasis):
3. The income of a
taxpayer for a taxation year for the purposes of this
is the taxpayer’s income for the year determined by the following rules:
3. Pour déterminer le revenu d’un contribuable pour une année
d’imposition, pour l’application de la présente partie, les calculs
suivants sont à effectuer :
the total of all amounts each of which is the taxpayer’s income for the
year (other than a taxable capital gain from the disposition of a
property) from a source inside or outside Canada, including, without
restricting the generality of the foregoing, the taxpayer’s income for the
year from each office, employment, business and property,
a) le calcul du total des sommes qui constituent chacune le
revenu du contribuable pour l’année (autre qu’un gain en capital
imposable résultant de la disposition d’un bien) dont la source se situe
au Canada ou à l’étranger, y compris, sans que soit limitée la portée
générale de ce qui précède, le revenu tiré de chaque charge, emploi,
entreprise et bien;
the amount, if any, by which
of the taxpayer’s taxable capital gains for the year from dispositions of
property other than listed personal property, and
taxpayer’s taxable net gain for the year from dispositions of listed personal
amount, if any, by which the taxpayer’s allowable capital losses for the year
from dispositions of property other than listed personal property exceed the
taxpayer’s allowable business investment losses for the year,
b) le calcul de l’excédent éventuel du montant visé au
sous-alinéa (i) sur le montant visé au sous-alinéa (ii):
(i) le total des
montants suivants :
(A) ses gains en
capital imposables pour l’année tirés de la disposition de biens, autres que
des biens meubles déterminés,
(B) son gain net
imposable pour l’année tiré de la disposition de biens meubles déterminés,
(ii) l’excédent éventuel de ses pertes en capital déductibles
pour l’année, résultant de la disposition de biens autres que des biens
meubles déterminés sur les pertes déductibles au titre d’un placement
d’entreprise pour l’année, subies par le contribuable;
the amount, if any, by which the total determined under paragraph (a)
plus the amount determined under paragraph (b) exceeds the total of
the deductions permitted by subdivision e in computing the taxpayer’s income
for the year (except to the extent that those deductions, if any, have been
taken into account in determining the total referred to in paragraph (a),
c) le calcul de l’excédent éventuel du total établi selon
l’alinéa a) plus le
montant établi selon l’alinéa b) sur le total des déductions permises par la sous-section e dans
le calcul du revenu du contribuable pour l’année (sauf dans la mesure où il a
été tenu compte de ces déductions dans le calcul du total visé à l’alinéa a));
the amount, if any, by which the amount determined under paragraph (c)
exceeds the total of all amounts each of which is the taxpayer’s loss for the
year from an office, employment, business or property or the taxpayer’s
allowable business investment loss for the year,
d) le calcul de l’excédent éventuel
de l’excédent calculé selon l’alinéa c) sur le total des pertes subies par le contribuable pour l’année
qui résultent d’une charge, d’un emploi, d’une entreprise ou d’un bien et des
pertes déductibles au titre d’un placement d’entreprise subies par le
contribuable pour l’année;
and for the purposes of this
Pour l’application de la présente partie, les règles suivantes
an amount is determined under paragraph (d) for the year in respect of
the taxpayer, the taxpayer’s income for the year is the amount so determined,
e) si un montant est
calculé selon l’alinéa d) à l’égard du contribuable pour l’année, le
revenu du contribuable pour l’année correspond à ce montant;
(f) in any other
case, the taxpayer shall be deemed to have income for the year in an amount
equal to zero.
f) sinon, le
revenu du contribuable pour l’année est réputé égal à zéro.
provisions in the Income Tax Act, including paragraph 3(a), use
the word “source” in phrases such as “source of income” and “income from a
source”. These words and phrases are not defined in the Income Tax Act.
However, their meaning is sufficiently clear from the context in which they are
used. Paragraph 3(a) lists four sources of income – office, employment,
property and business. The use of the word “including” in paragraph 3(a)
indicates that there may be sources of income apart from those listed. Section
56 of the Income Tax Act, for example, lists other amounts that are
treated as income for income tax purposes, including pension payments, and
various kinds of government and other benefits. (Section 56 is part of
subdivision d (entitled “Other Sources of Income”) of division B (entitled
“Computation of Income”) of Part I of the Income Tax Act
(entitled “Income Tax”); Part I of the Income Tax Act includes
sections 3 and 56).
is an open question whether any source of income exists that is not listed in
paragraph 3(a) or section 56. However, it is not necessary to answer
that question in this case. Indeed, it may never be necessary to determine that
question because the words “business” and “property” are so broadly defined for
income tax purposes that they may capture anything from which income is or may
be derived (other than an office or employment). Those definitions appear in
subsection 248(1) of the Income Tax Act and read as follows (my
includes a profession, calling, trade, manufacture or undertaking of any
kind whatever and, except for the purposes of paragraph 18(2)(c),
section 54.2, subsection 95(1) and paragraph 110.6(14)(f), an
adventure or concern in the nature of trade but does not include an office or
« entreprise » Sont compris parmi les entreprises
les professions, métiers, commerces, industries ou activités de quelque
genre que ce soit et, sauf pour l’application de l’alinéa 18(2)c),
de l’article 54.2, du paragraphe 95(1) et de l’alinéa 110.6(14)f), les
projets comportant un risque ou les affaires de caractère commercial, à
l’exclusion toutefois d’une charge ou d’un emploi.
“property” means property of
any kind whatever whether real or personal or corporeal or incorporeal
and, without restricting the generality of the foregoing, includes
right of any kind whatever, a share or a chose in action,
a contrary intention is evident, money,
timber resource property, and
work in progress of a business that is a profession;
« biens » Biens de toute
nature, meubles ou immeubles, corporels ou incorporels, y compris, sans
préjudice de la portée générale de ce qui précède :
a) les droits de
quelque nature qu’ils soient, les actions ou parts;
b) à moins d’une
intention contraire évidente, l’argent;
c) les avoirs forestiers;
d) les travaux en cours
d’une entreprise qui est une profession libérale.
other statutory provision cited by the Crown is subsection 9(1), which reads as
9. (1) Subject to this
Part, a taxpayer’s income for a taxation year from a business or property is
the taxpayer’s profit from that business or property for the year.
9. (1) Sous réserve des
autres dispositions de la présente partie, le revenu qu’un contribuable tire
d’une entreprise ou d’un bien pour une année d’imposition est le bénéfice
qu’il en tire pour cette année.
controversy arises in this case in connection with subsection 9(1). It equates
the profit from a business or property with the income from that
business or property for income tax purposes, subject to numerous positive and
negative adjustments required or permitted by other provisions in Part I of the
Income Tax Act, none of which are relevant in this case. Ms. Johnson
does not dispute that if her net receipts from her transactions with Mr. Lech
are income from property as the Crown contends, then the amount of the income
for 2002 is $614,000 and for 2003 is $702,000.
summarize as follows the reasoning behind the Crown’s position that Ms.
Johnson’s net receipts are taxable in her hands. Over several years, including
2002 and 2003, Ms. Johnson entered into a number of similar transactions with
Mr. Lech under which she invested money with Mr. Lech in consideration of
payments to be received in the amounts and on the dates evidenced by the
postdated cheques that Mr. Lech gave her at the time of each investment. Each
contract between Ms. Johnson and Mr. Lech was performed except the last one. A
right under a contract is a chose in action, which is “property” according to
the statutory definition quoted above. It follows that Ms. Johnson’s profit
from the contracts falls within the scope of paragraph 3(a) as income
from a source. The fact that Mr. Lech lied to Ms. Johnson about the manner in
which the profits were derived does not detract from the conclusion that she
received what she bargained for, which was a profit on her investment.
support of its position, the Crown cites the decision of the Supreme Court of
Canada in Stewart v. Canada, 2002 SCC 46. That case involved a challenge
to reassessments that disallowed rental losses on the basis that he had no
reasonable expectation of profit from the rental properties in issue. The main
proposition determined in Stewart is captured in paragraph 4 of the
reasons written by Justice Iacobucci and Justice Bastarache:
In our view, the reasonable expectation of profit
analysis cannot be maintained as an independent source test. To do so
would run contrary to the principle that courts should avoid judicial
innovation and rule-making in tax law. Although the phrase “reasonable
expectation of profit” is found in the Income Tax Act, S.C.
1970-71-72, c. 63 (the “Act”), its statutory use does not support the broad
judicial application to which the phrase has been subjected. In
addition, the reasonable expectation of profit test is imprecise, causing an
unfortunate degree of uncertainty for taxpayers. As well, the nature of
the test has encouraged a hindsight assessment of the business judgment of
taxpayers in order to deny losses incurred in bona fide, albeit
unsuccessful, commercial ventures.
50 of Stewart explains how to determine whether a source of business or
property income exists:
is clear that in order to apply s. 9, the taxpayer must first determine
whether he or she has a source of either business or property income.
As has been pointed out, a commercial activity which falls short of being a
business, may nevertheless be a source of property income. As well, it
is clear that some taxpayer endeavours are neither businesses, nor sources of
property income, but are mere personal activities. As such, the
following two-stage approach with respect to the source question can be
Is the activity of the taxpayer undertaken in pursuit of profit, or is it a
If it is not a personal endeavour, is the source of the income a business or
first stage of the test assesses the general question of whether or not a
source of income exists; the second stage categorizes the source as either
business or property.
Stewart approach to the identification of a source of income was
developed in a factual context quite unlike this case. In Stewart, the
question was whether Mr. Stewart’s investment in rental properties could be
considered a source of income even though the objective evidence indicated no
reasonable expectation of profit for the years under appeal. The answer was
yes, because Mr. Stewart’s investment in the rental properties was essentially
commercial in nature and there was no personal element. Looking no further than
Stewart, it would appear that the Crown is entitled to succeed in this
it is necessary to go further and consider the position of Ms. Johnson, which
is that the net receipts of her arrangements with Mr. Lech are not taxable
because, unknown to her, the money came from an unlawful Ponzi scheme rather
than the lawful option trading that she believed Mr. Lech would undertake on
most frequently cited case in which an amount was found not to be income from a
source is R. v. Cranswick,  1 F.C. 813 (C.A.). In that case, an
amount paid to a minority shareholder of a corporation by the majority
shareholder was held not to be taxable. The majority shareholder had arranged
for the sale of the corporation’s assets for less than their book value. In the
hope of avoiding controversy and potential litigation, the majority shareholder
offered to purchase the shares of all minority shareholders for an amount
exceeding their fair market value. A minority shareholder could choose instead
to receive a cash payment, which is what Mr. Cranswick chose.
Crown took the position that the payment was taxable to Mr. Cranswick, because
it was income from property (the shares). Justice Le Dain, writing for the
Federal Court of Appeal, disagreed. He referred to the following list of
factors, derived in part from Federal Farms Ltd. v. Minister of National
Revenue,  Ex. C.R. 91, to assist in determining whether a particular
amount is income from a source or a non-taxable receipt (sometimes referred to
in tax cases as a “windfall”):
recipient had no enforceable claim to the payment.
was no organized effort on the part of the recipient to receive the payment.
payment was not sought after or solicited by the recipient in any manner.
payment was not expected by the recipient, either specifically or
payment had no foreseeable element of recurrence.
payer was not a customary source of income to the recipient.
The payment was not
in consideration for or in recognition of property, services or anything else
provided or to be provided by the recipient; it was not earned by the
recipient, either as a result of any activity or pursuit of gain carried on
by the recipient.
Cranswick factors have proved to be a useful analytical framework in
many cases where it is alleged that an amount received by a taxpayer is not
income from a source.
this case, the judge considered the Cranswick factors. While she
acknowledged that Ms. Johnson’s net receipts have some characteristics of
income from a source, in that she provided capital to Mr. Lech and received
something in return, the judge found very little factual connection between Ms.
Johnson’s capital and the payments she received. The judge noted that there was
no evidence that Mr. Lech actually used Ms. Johnson’s money to obtain the
amounts he paid her, and concluded that the payments were not in satisfaction
of her agreement with Lech. It was essentially on that basis that the judge
held that the Cranswick factors favoured the position of Ms. Johnson.
judge’s analysis flows from a particular construction of the agreement between
Ms. Johnson and Mr. Lech, as set out in paragraph 39 of the judge’s reasons.
Essentially, the judge concluded that Mr. Lech was obliged to invest the money
Ms. Johnson paid him and to pay her the earnings from that investment activity.
I respectfully disagree with that construction of the agreement.
agreement between Ms. Johnson and Mr. Lech was never reduced to writing and is
evidenced only by Ms. Johnson’s testimony about what she was told by Mr. Lech,
and her subjective belief that he was telling the truth. In my view, her
evidence establishes no more than the existence of an agreement that Mr. Lech
would repay Ms. Johnson any money she gave him, with a return, in instalments
in the amounts and on the dates indicated by the postdated cheques he gave her
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.
Crown suggested an apt analogy. A person who deposits money with a bank in an
interest bearing account is entitled to receive interest from the bank in
accordance with terms governing the deposit, and is subject to income tax on
the interest received. The depositor may be told, or may reasonably assume,
that the bank will generate the money required to pay interest on the deposit
by conducting a lawful banking business. But the depositor is not relieved of
the obligation to pay tax on the interest on the deposit merely because the
bank, unknown to the depositor, generates the required funds through unlawful
my respectful view, the judge’s overly narrow construction of the agreement
between Ms. Johnson and Mr. Lech led to incorrect conclusions in respect of the
Cranswick factors. If those factors are considered in light of what I
have concluded is the correct construction of the agreement, the Cranswick factors
favour the position of the Crown:
Did Ms. Johnson have an enforceable claim to the
payments in issue?
Yes. Ms. Johnson entered into an agreement with Mr. Lech under which she
would receive payments in the amounts and on the dates indicated by the
postdated cheques she received from Mr. Lech when she invested her money with
him. There is no basis for concluding that the agreement was unenforceable as
a matter of law.
Was there an organized effort by Ms. Johnson to
receive the payments?
Yes. Ms. Johnson engaged in a consistent pattern of investments in which she
received postdated cheques simultaneously with each investment.
Did Ms. Johnson seek
or solicit the payments? Yes.
Were the payments expected
by Ms. Johnson, either specifically or customarily? Yes.
Did the payments have
a foreseeable element of recurrence? Yes.
Did the payments in issue come from a customary
source of income? Yes.
The general nature of the agreement between Ms. Johnson and Mr. Lech – a
contract of investment – is a common commercial transaction, and Mr. Lech
became a customary source of income to Ms. Johnson.
Were the payments in
consideration for something provided by Ms. Johnson? Yes. Each series of
payments, represented by the postdated cheques, was consideration for a payment
made by Ms. Johnson to Mr. Lech.
is submitted for Ms. Johnson (and here I quote from paragraph 23 of her
memorandum of fact and law) that “A Ponzi scheme cannot be considered to be a
source of income for innocent participants because it only involves the
reshuffling of money, not the creation of new wealth, and Ponzi schemes are, by
their very nature, doomed to collapse.”
do not quarrel with the proposition that a Ponzi scheme involves the shuffling
of money and that it will collapse at some point. However, for income tax
purposes, income is calculated on an annual basis, not over the entire life of
an enterprise. A Ponzi scheme may well be a source of income for some
participants during some part of its existence. This case suggests how that could
be so. 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, 2002 and 2003.
Johnson relied on some evidence from a tax official to the effect that those
who lost money because of the Ponzi scheme in this case were reassessed to
disallow the losses on the basis that the Ponzi scheme was not and could not be
a source of income to them. There is a document on the record that indicates
that at least one tax official believed that this would be a valid basis for
disallowing the deduction of losses suffered by victims of Mr. Lech’s Ponzi
scheme although the record contains no specific information about any such
reassessments. The Crown pointed out, correctly in my view, that the tax
official’s belief is not binding on the Crown and does not reflect the Crown’s
position in this case.
Ms. Johnson relies on this document as the basis for her argument if a Ponzi
scheme cannot be a source of income to a victim who loses money, it must follow
that it cannot be a source of income to an innocent participant who happens to
profit from it. Ms. Johnson also argues that there is a substantial injustice in
taxing persons who innocently profit from a Ponzi scheme while denying the
losses incurred by innocent victims of the same scheme.
are two difficulties with Ms. Johnson’s position. The first difficulty is that
it is based on a mischaracterization of the basis upon which Ms. Johnson is
being taxed. She is not being taxed because she profited innocently from a
Ponzi scheme. She is being taxed because she entered into a series of
agreements with Mr. Lech to receive a profit on her investments with him, and
she received what she bargained for. The fact that Mr. Lech funded her payments
with the proceeds of a Ponzi scheme is irrelevant.
second difficulty with Ms. Johnson’s argument is that it is based on an
incorrect understanding of the statutory scheme for determining income for
income tax purposes. The question as to whether a Ponzi scheme is a source of
income to a particular person, whether innocent or not, is a question that must
be answered on the basis of the facts relating to that person. In principle, a
person who participates in a Ponzi scheme, either as the main operator or in
association with others, may be engaged in an undertaking that would be
recognized for income tax purposes as a business, even if the business is
unlawful. Such a person is taxable on any profits derived from the Ponzi scheme
and, depending upon the specific circumstances, may be permitted to deduct any
may well be that a victim of a Ponzi scheme is unable to claim any tax relief
for the resulting loss. That would be the case if, for example, the
circumstances are analogous to those in Hammill v. Canada, 2005 FCA 252.
Mr. Hammill was induced to purchase gems for eventual resale, and accumulated a
significant inventory. When he decided it was time to sell the gems, he paid a
substantial sum of money to a person who promised to facilitate the sale. The
promises were never kept, and the gems were stolen. Mr. Hammill claimed a
deduction for the amounts paid to facilitate the sale, on the basis that the purpose
of the expenditures had been to sell his gems at a profit. 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.
the principle upon 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
Time limitations for
concluded that Ms. Johnson was required by paragraph 3(a) of the Income
Tax Act to report her net receipts from Mr. Lech in 2002 and 2003 in her
income tax returns for those years, it is necessary to consider whether the
reassessments that included those amounts in her income for those years were made
within the statutory time limits.
individuals, the normal reassessment period is three years from the date of
initial assessment. The Minister has the legal authority to reassess at any
time within that three year period. However, the reassessments in issue in this
case were made after that three year period. The Crown argues that the Minister
had the legal authority to make the late reassessments because of subparagraph
152(4)(a)(i), which reads as follows:
152. (4) The Minister
may at any time make an assessment, reassessment or additional assessment of
tax for a taxation year, interest or penalties, if any, payable under this
Part by a taxpayer or notify in writing any person by whom a return of income
for a taxation year has been filed that no tax is payable for the year,
except that an assessment, reassessment or additional assessment may be made
after the taxpayer’s normal reassessment period in respect of the year only
152. (4) Le ministre
peut établir une cotisation, une nouvelle cotisation ou une cotisation
supplémentaire concernant l’impôt pour une année d’imposition, ainsi que les
intérêts ou les pénalités, qui sont payables par un contribuable en vertu de
la présente partie ou donner avis par écrit qu’aucun impôt n’est payable pour
l’année à toute personne qui a produit une déclaration de revenu pour une
année d’imposition. Pareille cotisation ne peut être établie après
l’expiration de la période normale de nouvelle cotisation
au contribuable pour l’année que dans les cas suivants :
taxpayer or person filing the return
a) le contribuable
ou la personne produisant la déclaration :
made any misrepresentation that is attributable to neglect, carelessness or
wilful default or has committed any fraud in filing the return or in
supplying any information under this Act …
(i) soit a fait une
présentation erronée des faits, par négligence, inattention ou omission
volontaire, ou a commis quelque fraude en produisant la déclaration ou en
fournissant quelque renseignement sous le régime de la présente loi […]
an income tax return that omits income from a particular source contains a
misrepresentation. If such a misrepresentation is attributable to neglect,
carelessness, wilful default, or any fraud by the person filing the return or
supplying any information under the Income Tax Act, paragraph 152(4)(a)(i)
authorizes the Minister to reassess the return outside the normal reassessment
this case the key question is whether Ms. Johnson was careless in failing to
include in her 2002 and 2003 income tax returns the payments she received from
Mr. Lech in those years. The judge reasoned that the key factual question was
whether Ms. Johnson was careless in relying on Mr. Lech’s assurances that tax
had been paid on the profits and that she was not required to include them in
judge held that, because Mr. Lech’s bank accounts had not been frozen by the
time Ms. Johnson’s 2002 income tax return was due, it was reasonable for her to
continue to rely on his assurances, combined with those of her fellow investors
who all believed the same thing. However, by the time Ms. Johnson’s 2003 income
tax return was due, the fact that Mr. Lech’s bank accounts were frozen and the
class action commenced should have alerted her to the need to investigate
further the truth of what he had told her, and her failure to do so was
careless. On that basis, the judge concluded that the reassessments for 2002
were statute barred, but the reassessments for 2003 were not.
Crown argues that in respect of 2002, the judge erred in failing to consider
whether Ms. Johnson met the requisite standard of care – that of a wise and
prudent person who has considered the matter thoughtfully, deliberately and
carefully. That legal test is based on the following passage from the decision
of Justice Addy in Regina Shoppers Mall Ltd. v. Canada (1990), 90 D.T.C.
6427 (F.C.T.D.), adopted by Justice MacGuigan, writing for this Court in Regina
Shoppers Mall Ltd. v. Canada (1991), 91 D.T.C. 5101, at page 5013:
Where a taxpayer thoughtfully, deliberately and carefully
assesses the situation and files on what he believes bona fide to be
the proper method there can be no misrepresentation as contemplated by
section 152 [1056 Enterprises Ltd v. The Queen,  2 C.T.C. 1]. In
Joseph Levy v. The Queen,  C.T.C. 151 at 176, Teitelbaum J.
quotes with approval the following statement by Muldoon J. in the above case:
Subsection 152(4) protects such conduct, and perhaps only
such conduct, where the taxpayer thoughtfully, deliberately and carefully
assesses the situation as being one in which the law does not exact the
reporting of that which the taxpayer bona fide believes does not
It has also been established that the care exercised must
be that of a wise and prudent person and that the report must be made in a
manner that the taxpayer truly believes to be correct. In another decision by
Mr. Justice Muldoon, namely Iris M. Reilly, Executrix and Trustee of the
Estate of Cleo E. Reilly,  C.T.C. 21, in which he dealt again with
the subject, we find the following statement at p. 38:
In order to make any determination of making "any
misrepresentation that is attributable to neglect, carelessness or wilful
default . . . in filing the return or in supplying any information under the
Act" it is necessary to have direct evidence of the state of mind and
intention of "the taxpayer or person filing the return" or other
evidence upon which reasonable inferences can be drawn in regard to the
taxpayer's or other person's state of mind and intention.
And at p. 40:
The issue is not whether Mr. Tetz, in forming his opinion
at the material time was wrong, but whether his not reporting the disposition
was attributable to neglect, carelessness or wilful default.
Finally, at p. 42:
So, when it is now said that the standard of care is that
of a wise and prudent person, it must be understood that wisdom is not
infallibility and prudence is not perfection.
Crown argues that for 2002, Ms. Johnson did not meet the standard of a wise and
prudent person, nor did she consider the matter thoughtfully, deliberately and
carefully, when she accepted the assurances of Mr. Lech that the payments she
received were free of tax. Her carelessness is proved by the fact that she
failed to consult a knowledgeable adviser, simply taking comfort in the beliefs
of others who had entered into similar arrangements with Mr. Lech.
Johnson does not take issue with the authority of Regina Shoppers Mall,
but argues that she acted reasonably in relying on Mr. Lech’s assurances, since
he would have had no motivation to mislead her about the tax treatment of the
payments, and other people that she knew and trusted had also relied on him.
am unable to accept the submissions of Ms. Johnson on this point. In early 2003
when Ms. Johnson would have been preparing to file her 2002 income tax return,
she would have known that her net receipts from Mr. Lech for 2002 were
substantial – over $600,000. She had Mr. Lech’s assurance that the net receipts
were not taxable in her hands. However, she had no factual basis for assessing
the reliability of those assurances, and she failed to do what any reasonable
person in her position would have done, which was to seek independent advice
(and here I agree with the Crown that seeking assurances from a fellow
investor, even one who is a bookkeeper, is not the kind of independent advice
that would demonstrate reasonable care). Having failed to take that obvious and
simple step, she cannot claim to have considered the matter thoughtfully,
deliberately and carefully as a wise and prudent person would have done. I
agree with the Crown that the only reasonable conclusion on the evidence is
that Ms. Johnson was careless in omitting to include the payments in her income
the time Ms. Johnson’s 2003 income tax return was due, it was even more
apparent that the reliability of Mr. Lech’s assurances were seriously in doubt.
In respect of 2003, I agree with the judge that Ms. Johnson was careless in omitting
to inform the accountant who prepared her 2003 return about the payments from
Johnson argues that even if she had sought independent advice about the
taxability of the payments from Mr. Lech in 2003, any investigation by an
adviser at that time would have disclosed the fraud, and the adviser probably
would have advised Ms. Johnson that she had a reasonable basis for excluding
the payments from her income for 2003. This argument is interesting but
entirely speculative. The fact is that Ms. Johnson chose not to seek
independent advice, and there is nothing in the record from which it is
possible to determine what an independent adviser would have discovered or
advised at the time Ms. Johnson’s 2003 income tax return was due. The Crown has
the onus of justifying a late reassessment by proving that the conditions in
subparagraph 152(4)(a)(i) are met, but that does not require the Court
to give weight to arguments made by the taxpayer that have no evidentiary
these reasons I would allow the appeal, set aside the judgment of the Tax Court
of Canada, and dismiss Ms. Johnson’s income tax appeal for 2002 and 2003. The
Crown is entitled to its costs in this Court and in the Tax Court.
Pierre Blais, Chief Justice”
Johanne Trudel J.A.”