REASONS
FOR JUDGMENT
Graham J.
[1]
Roberta Mazo participated in a pyramid scheme
promoted by a company called Business In Motion International Corporation (“BIMIC”). Ms.
Mazo was one of the fortunate individuals who actually profited from the
scheme. The Minister of National Revenue reassessed Ms. Mazo to include what
the Minister asserts was unreported income from that scheme in Ms. Mazo’s
income in her 2007, 2008 and 2009 tax years. The Minister also assessed gross
negligence penalties.
[2]
While there are a number of issues in this
Appeal, the primary issues are what the nature of the scheme was and how the amounts
earned under the scheme should be taxed.
I. Nature of the Scheme
[3]
The BIMIC pyramid scheme involved multiple
different pyramids. Each pyramid had a “director of sales” at the top, two “VPs” on the
next level, four “sales
managers” on the next level and, finally, eight “sales representatives” on the bottom. In simple terms, participants paid money to BIMIC to
join the bottom of the pyramid and collected money from BIMIC when they reached
the top of the pyramid.
[4]
Once a director of sales had been paid by BIMIC,
the pyramid would split into two with the VPs each becoming directors of sales
of their own new pyramids and each having to work with others in their pyramids
to recruit eight new participants to fill the bottom of their pyramids. Directors
of sales who had been paid were encouraged to join new pyramids as sales
representatives.
[5]
Participants were each assigned a personal
account number by BIMIC. These account numbers were used to track a
participant’s earnings in the scheme and their withdrawal of those earnings. It
was as if each participant had his or her own bank account with BIMIC where his
or her earnings were held. Amounts that participants earned as directors of
sales were deposited into their accounts. Participants could do four different
things with the funds in their accounts:
a) Cash Withdrawal: Participants could ask
BIMIC to pay them funds out of their accounts. Such funds were paid by cheque.
b) Debit Card Withdrawal: Participants
could ask BIMIC to give them a pre-paid BIMIC debit card with a certain balance
on it. These pre-paid debit cards could be used to purchase goods and services
in the community at large using the Interac system in the same manner as a
regular pre-paid debit card.
c) Transfer: Participants could transfer
funds from their BIMIC account to the BIMIC account of another participant.
d) Re-Investment: Participants could use
the funds to buy into another pyramid.
[6]
Participants had to pay to join the bottom of a
pyramid. The cost varied but was either $3,000, $3,200 or $3,600. The money was
paid to BIMIC. First-time participants used bank drafts or certified cheques to
buy in. Repeat participants used funds from their BIMIC accounts.
[7]
The scheme was structured so as to create the
appearance that participants were buying goods or services rather than simply
buying a spot at the bottom of a pyramid. Those goods and services included
pre-packaged semi-precious gemstones, travel discount memberships, water
filtration systems, and stir sticks that BIMIC claimed had various health benefits
when used to stir water.
[8]
Ms. Mazo’s testimony made it clear that each
time she entered a new pyramid she viewed herself as buying into the pyramid.
It was clear to me that the products or services were incidental to her
decision to buy in. Her testimony also made it clear that, to make money, she
needed to attract new people to join the bottom of her pyramid.
[9]
A number of participants in the BIMIC pyramid
scheme brought a class action lawsuit against BIMIC and its promoters in
Federal Court and were awarded damages of $6,560,000 (Cuzzetto v. Business
In Motion International Corporation et al). Justice Rennie (as he then was) concluded that, while it “was presented as a classic multi-level
marketing plan”, the scheme was, in fact, a “scheme of pyramid selling” as defined in the Competition Act. He found that “the
objective of the scheme was on recruitment of participants rather than
developing repeat customers who actually sought to purchase the products”. The Competition
Act prohibits the establishment, operation, promotion or advertising of pyramid
schemes. As Justice Rennie explained, BIMIC’s scheme crossed over from being a
multi-level marketing plan into being a pyramid scheme because the scheme
required that “a participant
pay consideration for the right to receive compensation for the recruitment of
others who give consideration for the same right, into the plan”. He stated that “[i]n
legitimate multi-level marketing schemes, commissions are paid upon the sale of
products, not after the recruitment of others and the completion of a corporate
ladder”. Justice Rennie’s conclusions are consistent with the evidence
before me.
[10]
Despite all of the foregoing, the Respondent
maintains that BIMIC was a multi-level marketing company that was selling goods
and services, that the participants in the scheme were earning commissions for
making sales and that the money paid by the participants to join a pyramid was
paid to purchase goods and services from BIMIC for personal use. The evidence
before me, the conclusions of Justice Rennie and simple common sense show this
position to be wrong. I can see no reason for the Minister to take such a position
other than to artificially inflate the tax that the Minister can assess.
Perhaps the position might have been defensible early in the process when the
Minister did not fully understand the scheme, but I cannot understand why the
Minister continues to maintain it now.
[11]
I note that, to her credit, it was counsel for
the Respondent, pursuant to her duty as an officer of the Court, who drew my
attention to Justice Rennie’s decision. I understand the difficult position in
which the Minister has placed counsel and appreciate the professionalism with
which she handled it.
[12]
Based on all of the foregoing, I find that the
BIMIC scheme was a pyramid scheme and that participants were not buying goods
and services for personal use but were rather buying a spot at the bottom of
the pyramid. I also find that directors of sales at the top of the pyramids
were not earning sales commissions but were simply reaping the payoff of making
it to the top of the pyramid.
II. Taxation of Amounts Earned in the Scheme
[13]
The Federal Court of Appeal has had several opportunities
to consider the tax treatment of profits and losses from fraudulent schemes. Income
from a fraudulent scheme is taxable in the hands of its promoter (The Queen v.
Johnson). Income from a Ponzi scheme is taxable in the hands of a
participant if the participant’s contractual rights were honoured (Johnson).
By contrast, losses from a fraudulent scheme where there never was a business are
not non-capital losses (Hammill v. The Queen; Vankerk v. The Queen).
[14]
Although the two terms are often used
interchangeably, a pyramid scheme and a Ponzi scheme are not the same thing. Johnson
dealt with the taxation of profits from a Ponzi scheme. Should profits from a
pyramid scheme be treated any differently?
[15]
There are sufficient similarities between the
two types of schemes that I do not see any reason why they would be taxed any
differently. Both schemes are illegal. Both schemes rely on a continuous stream
of new participants injecting new cash in order to sustain the withdrawal of
funds by one or a few select individuals at the top. Both schemes will
inevitably collapse under their own weight, leaving their victims suffering
losses. In both schemes, while there is the illusion that people are making
money, ultimately only the promoters or a few lucky people manage to extract
more money than they put in.
[16]
The key difference between Ponzi schemes and
pyramid schemes is that participants in a Ponzi scheme normally believe that
they are making an investment that is, in turn, generating profits for them.
They do not normally realize that there is no investment, that there are no
profits and that any actual cash that they are receiving back from the supposed
investments is either a return of their own money or an appropriation of money
belonging to other participants. By contrast, while participants in a pyramid
scheme may not realize the full nature of the pyramid scheme or the fact that
it is doomed to fail, they are aware on some level that they are buying into a
structure whereby they receive profits through the recruitment of new people
into that structure. They are aware on some level that they are being paid
using money that comes from those new participants and that, if they themselves
are new participants, their money is being used to pay those above them. A
pyramid scheme may be cloaked with sales terms and the pretence that goods or
services are being purchased, but ultimately it is clear to everyone that
without new people at the bottom of the pyramid, they are not going to profit. Accordingly,
participants in a pyramid scheme are generally actively involved in the scheme
in that they work to recruit new participants. In simple terms, a participant in
a Ponzi scheme is conned by the promoter into investing in something fake. A
participant in a pyramid scheme is conned by the promoter into believing that
the scheme will actually work and that he or she will profit through his or her
own efforts.
[17]
Because of these differences between the two
types of schemes, it would generally be more appropriate to characterize the
income received by a participant in a Ponzi scheme whose contractual rights
have been honoured as property income and the income received by a participant
in a pyramid scheme whose contractual rights have been honoured as business
income.
[18]
In my view, participants in the BIMIC scheme were
being defrauded from the start. They were talked into buying into a scheme that
was doomed to failure but certain to put money in the promoters’ pockets. However,
pursuant to Johnson, participants like Ms. Mazo, who made money in the
scheme, should be subject to tax if their contractual rights were honoured. In
other words, Ms. Mazo should be taxed if “she received what she bargained for”.
[19]
What, then, did Ms. Mazo bargain for? She
certainly did not agree to join a pyramid scheme. There was no evidence that
she knew the scheme was a pyramid scheme. A participant who knew it was a pyramid
scheme would have extracted all but his or her reinvested earnings immediately.
He or she would not have left them sitting in an account waiting for the scheme
to collapse. He or she certainly would not have lent them to other participants
for no consideration.
[20]
If Ms. Mazo did not agree to join a pyramid
scheme, then what did she bargain for? I find that Ms. Mazo agreed to join what
she believed was a sales organization that would pay her commissions for
recruiting new salespeople. Since Ms. Mazo did recruit new people and was paid
for doing so, I conclude that those payments, net of any expenses, were
business income in her hands.
[21]
Having concluded that Ms. Mazo received business
income from BIMIC, I must now determine the amount of that income. To do so, I must
look at both the revenue she earned and the costs she incurred.
Revenue
[22]
There are two possible ways to calculate Ms.
Mazo’s revenue from the scheme. The first is to total the amounts that were
deposited to her BIMIC account when a pyramid on which she was a sales director
was completed. The second is to total the amounts that she actually extracted
from the scheme in the form of cheques and debit cards. The Minister used the
former method.
[23]
The Respondent submits that, once the funds were
deposited to Ms. Mazo’s BIMIC account, Ms. Mazo had complete control over
them and was free to withdraw them at any time. Thus, the Respondent submits
that Ms. Mazo realized her profits when the funds were deposited.
[24]
Ms. Mazo’s testimony supports the Respondent’s
position. Ms. Mazo spoke as if the money was hers once it was deposited to her
account. She withdrew it when she wanted to and purchased debit cards with it
when she wanted to. She lent it to other participants when she wanted to,
received repayment of some of those loans and still considers other loans to be
outstanding despite the collapse of the scheme. She reinvested in the scheme by
using the funds in her account to buy into new pyramids which, in turn, made
her more money which she, in turn, withdrew, lent or reinvested. At no point
did Ms. Mazo indicate that she had had problems with or had experienced
delays in getting access to her funds.
[25]
I reluctantly accept the Respondent’s position. I
am concerned that the BIMIC accounts may have been a means of tacking a Ponzi
scheme onto the BIMIC pyramid scheme. Instead of simply paying the money that
participants accumulated from the pyramid scheme out to the participants, BIMIC
designed an account system which allowed it to only release funds when
participants asked for them. This put BIMIC in a position where it could have
operated the accounts like a Ponzi scheme: appropriating money for itself when it
wanted to, using the accounts to make the participants think the money was
still there, and using new money earned by one participant to pay out any other
participant who asked to be paid out. If that were the case, then the only
appropriate way to determine Ms. Mazo’s revenue would have been to look at
the money that she actually received back from the scheme.
[26]
That said, there is no evidence before me on
which I could conclude that the BIMIC accounts were operated in that manner. My
concerns are not enough. Ms. Mazo’s clear evidence was that she believed the
money was hers and that she had full access to it. There is no evidence to
contradict her. Justice Rennie indicates that, when the scheme ultimately
collapsed, any remaining funds in the BIMIC accounts were not paid out. That strongly
supports my concerns. However, that evidence was not before me. It is one thing
for me to rely on the legal conclusions reached by Justice Rennie. It would be
another thing entirely for me to rely on evidence that was presented to him
that is neither before me nor consistent with the evidence that is before me.
[27]
Based on all of the foregoing, I find that Ms.
Mazo earned revenue from the scheme when funds from being a director of sales
were deposited to her BIMIC account. I also find that the amount of that
revenue was correctly calculated by the Minister.[14]
[28]
I note that the method used by the Minister and
accepted by me results in more tax being paid as it catches participants who
Justice Rennie indicates did not manage to extract their earnings before the
scheme collapsed. If a different taxpayer were to come before me with different
evidence about what happened to his or her account, I may well find that the
method used by the Minister was not appropriate and that the taxpayer’s revenue
should be based only on the net amount he or she actually extracted from the
scheme. That would be consistent with how the Minister has previously calculated
the income of taxpayers in Ponzi schemes (Johnson).
Cost
[29]
The Minister made an assumption of fact that participants
did not pay to participate in a pyramid but rather bought goods or services from
BIMIC for personal use. In accordance with that assumption, the Minister did
not allow Ms. Mazo any deductions for the amounts she paid to join pyramids.
[30]
Ms. Mazo has succeeded in demolishing that
assumption. The amounts Ms. Mazo spent to buy into pyramids are amounts she
laid out to earn the revenue she earned as a sales director and are properly
deductible. The only question that remains is how much she spent.
[31]
Ms. Mazo testified that she had bought into at
least 10 pyramids after her initial pyramid. She stated that it was her normal
practice to use some of the revenue that she received from being a director of
sales to buy into a new pyramid once her old pyramid ended. The Minister
introduced no evidence to show how many pyramids Ms. Mazo bought into. The
Respondent knew that the Minister’s assumption of fact was not defensible in
light of Justice Rennie’s decision. If the Respondent wanted me to rely on
something more specific than Ms. Mazo’s recollection of what happened nine
years ago, the Respondent should have introduced evidence in that regard.
[32]
In the circumstances, I am prepared to accept
that Ms. Mazo was a director of sales on 11 pyramids (being the initial pyramid
that she bought into and the minimum 10 additional pyramids that she testified
she had bought into).
[33]
As set out above, the cost of buying in varied.
In the absence of any documentary evidence, I will allow Ms. Mazo the lowest of
the three costs, namely $3,000 per pyramid.
[34]
In the absence of direct evidence on the point,
I must decide how to allocate Ms. Mazo’s 11 buy-ins among the years in
question. Looking at the pattern and timing of the deposits to Ms. Mazo’s
account, I find that she bought into two pyramids in 2007, nine in 2008 and
none in 2009.
[35]
Thus, based on all of the foregoing, I find that
Ms. Mazo had $6,000 in additional expenses in 2007 and $27,000 in 2008.
Currency
[36]
The Respondent called an auditor named John
Glatt as a witness. Mr. Glatt testified that initially amounts in BIMIC’s books
and records were recorded in US dollars. He explained that he converted those
amounts into Canadian dollars at the daily prevailing exchange rate for the
purpose of determining the amount of revenue earned by Ms. Mazo.
[37]
Ms. Mazo submits that her revenues have been
inflated by treating them as having been earned in US dollars. She testified
that all amounts were earned in Canadian dollars and should not have been
converted.
[38]
I prefer Mr. Glatt’s testimony as I find it to
be more reliable in the circumstances. He was responsible for the audit of the
entire BIMIC operation and oversaw the audits of all individual participants
selected for audit. He has access to and is familiar with a database of all of
BIMIC’s transactions with the participants. I accept Mr. Glatt’s evidence and
thus find that Ms. Mazo’s revenues have not been inflated.
Loans to Other Participants
[39]
Ms. Mazo lent significant amounts of money from
her BIMIC account to other participants to allow those participants to buy into
pyramids. Ms. Mazo was very clear that none of those loans was made for the
purpose of allowing a participant to buy into one of Ms. Mazo’s pyramids. Ms.
Mazo testified that most of the loans were never repaid. She submits that she
is entitled to deduct those loans against her business income from the scheme.
I disagree.
[40]
Once the funds arrived in Ms. Mazo’s BIMIC
account, she had complete control over them. Her choice to lend them had
nothing to do with her business. As stated above, she did not lend funds to
people who were buying into her pyramids and thus did not have any opportunity
to profit from making the loans. If anything, her loans helped other
participants to earn income in their own pyramids. Ms. Mazo did not introduce
any evidence that would suggest that she was in the business of lending money. The
rather loose manner in which she lent the funds suggests the opposite. Ms. Mazo
did not indicate that the loans were interest bearing.
[41]
Based on all of the foregoing, I conclude that Ms.
Mazo is not entitled to deduct her loan losses against her business income.
Other Expenses
[42]
While Ms. Mazo claimed to have incurred various
expenses trying to recruit other participants, she provided neither documentary
evidence of those expenses nor any details as to how much she had expended each
year and on what. Accordingly, I cannot allow her deductions for any such
expenses that she might have incurred.
[43]
I note that there are a few items flowing out of
Ms. Mazo’s BIMIC account that appear to have been business expenses paid to
BIMIC. A quick review of those items suggests that their deduction has already
been allowed by CRA Appeals.
III. Unreported Income
[44]
Based on all of the foregoing, I find that Ms.
Mazo had the following unreported business income from the scheme in the
following years:
|
|
2007
|
2008
|
2009
|
|
business income (as reassessed)
|
$13,893
|
$74,619
|
$3,025
|
|
cost of buying in
|
($6,000)
|
($27,000)
|
--
|
|
adjusted business income
|
$7,893
|
$47,619
|
$3,025
|
[45]
Ms. Mazo stated that she had reported her income
from BIMIC in her returns. However, she was unable to recall how she calculated
that income or how it was reported. She had no documentary evidence to support
her assertion.
[46]
Ms. Mazo did not report any business income in
her 2007, 2008 or 2009 tax returns. She did, however, report commission income.
She testified that she had one or two sources of commission income in each of
those years. The gross commission income reported by Ms. Mazo in 2008 is less
than half of the revenue she earned from the BIMIC scheme in that year. This
indicates to me that the commission income that she reported in that year did
not include her BIMIC income. The gross commission income reported by Ms. Mazo
in 2007 and 2009 was large enough to have included the revenue that she earned
from the scheme in those years. However, I find it unlikely that Ms. Mazo would
have reported her revenue from the scheme in 2007 and 2009 and not have
reported it in 2008. In addition, the gross commission income reported by Ms.
Mazo in 2009 is very similar to the gross commission income she reported in
2008. Having concluded that she did not report any revenue from the scheme in
2008, I find it to be more likely that she earned similar gross commission
income from other sources in 2009 and did not report her revenue from the
scheme than that she earned significantly less gross commission income from
other sources and reported her revenue from the scheme.
[47]
Based on all of the foregoing, I find that Ms.
Mazo did not report her income from the BIMIC scheme in 2007, 2008 or 2009.
IV. Statute Barred Year
[48]
Ms. Mazo’s 2007 tax year was reassessed after
the normal reassessment period. I am satisfied on the evidence before me that
Ms. Mazo made a misrepresentation in not reporting the $7,893 in income from
the scheme in her 2007 tax return. I am also satisfied that her failure to
report that amount was due to carelessness, neglect or wilful default.
Accordingly, Ms. Mazo’s 2007 tax year may be reopened for the purpose of
including that unreported income.
V. Gross Negligence Penalties
[49]
The amounts that Ms. Mazo failed to report are
significant, particularly when one considers the large number of people who
were not so lucky as to make money from the scheme. She failed to report an
entire source of income amounting to almost one-third of her total income in
the three years in question. Ms. Mazo was clearly aware that she was earning
this income. It would have been relatively simple for her to calculate her
earnings. She reported other income in the period and clearly understood the
requirement to do so. In the circumstances, I find that Ms. Mazo was grossly
negligent in failing to report her income from the BIMIC scheme.
[50]
I note that, although Ms. Mazo initially filed
her Notice of Appeal on the basis of what have been described as organized
pseudo-legal commercial arguments, she did not rely on such arguments in filing
her tax returns. Thus, I have not considered her belief in those arguments when
determining whether she was grossly negligent in failing to report her income.
Those arguments have not been discussed in these Reasons because Ms. Mazo
abandoned them at trial.
VI. Conclusion
[51]
Based on all of the foregoing, the Appeal is
allowed and the matter referred back to the Minister for reconsideration and
reassessment on the basis that Ms. Mazo was entitled to deduct additional business
expenses of $6,000 in 2007 and $27,000 in 2008.
VII. Costs
[52]
Ms. Mazo was originally represented by an agent
named Chris Shannon. Ms. Mazo’s choice of agent and her persistence in
following that agent’s advice in the face of clear indications that she should
not do so led to an unnecessary delay in this matter. It caused a trial that
should have taken half a day to extend not only to a full day but well into the
evening and it complicated the proceedings for all involved. The Respondent
should not have to bear the costs of that delay.
[53]
It is unusual for the Court to award costs
against a taxpayer in an informal procedure appeal. It is even more unusual for
the Court to do so when the taxpayer is partially successful. However, the
Court has discretion to do so pursuant to Rules 10 and 11 of the Tax Court
of Canada Rulers (Informal Procedure) if the Court finds that the actions
of the appellant unduly delayed the prompt and effective resolution of the
appeal.
[54]
In the circumstances, I award costs of $375 to
the Respondent in respect of the half day of hearing that was wasted.
Signed at Ottawa, Canada, this 14th day of October 2016.
“David E. Graham”
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