A Thirty Year Quest for Tax Deductions

[Burnaby49]

This post is somewhat of an oddity for me because it is involves an income tax issue that has no Freeman components at all. It does however include fraud and tax avoidance. The scheme involved tax deductions claimed from 1984 to 1988. I know what you're thinking. Why is that moron Burnaby49 posting about a thirty year old tax case? Well it's actually hot off the press; the taxpayer's appeals were decided in Tax Court last week! Beat that Americans! We can be far more lackadaisical than you.

A bunch of Canadian taxpayers bought in to a yacht rental scheme. The promoter claimed he was going to build a number of luxury yachts and lease them out. The taxpayers bought units in individual yachts and got hefty up-front deductions. Actually, from what I can see, a fairly sophisticated crowd who put up cash of about $90,000,000. The scheme was heavily promoted by lawyers and accountants who got a cut for touting it;

[6] The luxury yacht Limited Partnerships were promoted by various accountants, lawyers, and others, as tax shelters to their higher income-earning clients. The promoters received a commission for each investor that subscribed. The promoters heavily emphasized the tax advantages offered by the investment, which was the focus of much of the promotional material provided to potential investors. The tax attractions included the flow-through of losses from the substantial expenses incurred during the start-up phase before any revenue was generated, as well as the ability to claim depreciation on each yacht.

The idea was that investors would put cash in the scheme which would, at least initially, result in deductible losses greatly in excess of the taxpayers cash outlays as the business got off the ground. Unfortunately (for the taxpayers, not the CRA) it was all ponzi scheme with no yachts or any legitimate attempt to start a rental business. While there was some business-like activity it was just window dressing to entice new suckers and lull the existing ones. The investors merrily claimed business losses based on a bunch of cooked-up costs until the CRA started looking into it in 1986 and started a criminal investigation. The CRA disallowed all claimed loses on the basis that there was no business and therefore no business losses.

I make no claim to a working knowledge of American tax law but I believe you can claim tax deductions for fraud losses. However fraud losses are not deductible in Canada so when taxpayers are scammed they sometimes try and get the CRA or the Tax Court to agree their losses are actually business losses. If the CRA agrees then they at least get something. I covered this issue in a prior discussion thread where a lawyer sent money to Nigeria to get his hands on untold riches in an assassinated businessman's estate;

viewtopic.php?f=2&t=8320

So that is what approximately 300 of the 600 investors in this scam tried to do but the Tax Court didn't buy it. The court reviewed the whole sad history and concluded that there was never any actual business activity, it was all scam.

[352] The business indicia that the Appellants refer to are simply the window-dressing necessary to perpetuate the fraud from beginning to end on everyone that Mr. Bellfield came into contact with. There is no evidence that supports the intention to carry on any activity for profit as required by the Supreme Court of Canada decision in Stewart. This is not a case similar to the Tax Court decisions referred to previously in Johnston v. Canada,44 and Agnew v. The Queen,45 in which sufficient genuine business activities were undertaken. This is a case more akin to Vankeerk. In Vankeerk, a Statement of Agreed Facts established the fraudulent nature of the scheme and the fact that the Limited Partnerships were not genuine. In this case, the fraudulent nature of the entire scheme is established by the facts set out in the many examples of misrepresentations above.

[363] The evidence of misrepresentations presented at trial was enough to convince me of all of the foregoing. In fact, the volume of evidence is so overwhelming, voluminous, and uncontradicted, that when one looks at the evidence in its totality, one cannot come to any other conclusion other than that this was a fraud from beginning to end perpetrated by the mastermind Mr. Bellfield. He showed no mercy in terms of duping the public, the investors, the CRA, his own staff, and others, in his attempts to further his own personal interests and those of his family members. There was no genuine business carried on and I therefore conclude that the Appellants did not have a source of income from which they could deduct expenses or losses.

Apart from the indignities of being defrauded the taxpayers were unhappy that the CRA wasn't nice to them. Those damn innuendos, very hurtful!

[343] The Appellants throughout the trial made numerous suggestions or innuendos about a variety of aggressive or inappropriate behaviour by members of the CRA. My task is not to assess the conduct of the CRA, but rather to determine whether or not the expenses claimed in these appeals are legitimate. This is not a criminal prosecution. As stated in Ereiser v. Canada:43

Apparently the taxpayers blamed the CRA for their losses because the scheme collapsed as a result of the CRA investigating it;

[344] As I stated, the entire Ponzi-like scheme was set to collapse eventually. The conduct or intervention of the CRA did not turn this Ponzi-like scheme, a fraud from beginning to end, into a genuine business. All the intervention did was instigate the lifting of the veil to reveal the prevalent nature of the fraud.

This is a very long and convoluted decision, I've only skimmed it. I'll leave it with one last quote referring to the Tax Court's explanation of why it all took so long;

[13] These appeals have a lengthy procedural history. Notices of Assessment and/or Reassessment were first issued in 1989 and/or 1990. Notices of Objection were filed in those same years. The appeals were held in abeyance for many years pending negotiations between the litigants and the final outcome of Mr. Bellfield and Mr. Minchella's trials and appeals in the criminal process. The criminal matters ultimately came to a close in 2004. A number of Motions came before the Tax Court of Canada regarding these appeals and caused further delays.

[14] The taking of evidence began on December 6, 2010 under the General Procedure Rule 119 over twenty years after the first Notices of Assessment were issued. The trial proper began on January 11, 2012, and in total, over 62 days of evidence was given with some 34 witnesses plus some 23 Agreed Statements of Facts. The hearing of the evidence occurred over an extended period to facilitate availability of witnesses and to allow for a better organization and presentation of evidence by both. As an aside, counsel for both parties worked together most impressively and cooperatively in most instances to put evidence presented before the Court that included tens of thousands of pages of multiple volumes of exhibits that by my count has accumulated to the point of filling over 100 bankers boxes.

http://decision.tcc-cci.gc.ca/site/tcc- ... 6/index.do

[notorial dissent]

You're wright, I think you may well have us on the length of time to adjudicate on this one. Although our English brethren may have us both beat for time on some case or another. Convoluted is certainly a good description of it. I vaguely remember reading about something similar in American tax law back in the late 70's early 80's, but different circumstances, ended nearly as badly as I recall though. Our treatment of fraud loss would have produced a definitely different outcome though, I believe.

[Burnaby49]

I stand corrected! A reader has informed me that the link I posted to the decision in the yacht scam is actually a link to the case of the lawyer who fell for the charms of Purity Adams, the fictitious daughter of the fictitious Nigerian businessman. Here is the correct link to Garber at the Tax Court of Canada;

http://decision.tcc-cci.gc.ca/site/tcc- ... 1/index.do

Or, if like me, you prefer Canlii;

http://www.canlii.org/en/ca/tcc/doc/201 ... mVyAAAAAAE

[Dr. Caligari]

In the U.S., a tax case lingering for any length of time racks up interest at an above-market (usually way above market) rate. What is the rule in Canada?

[Burnaby49]

In the U.S., a tax case lingering for any length of time racks up interest at an above-market (usually way above market) rate. What is the rule in Canada?

Largely the same. A taxpayer who appeals an assessment has two choices, they can pay the tax now and get a refund if they win or they can hold off paying until the appeals process is over. If they pay now and win they get interest on what is essentially a loan to the government but if they lose they owe interest on a loan from the government. In order to discourage taxpayers from appealing pointless cases (not that they don't anyhow) to, in effect, get cheap financing the government charges somewhat above market rates but not way over market. Don't know how the interest the government pays matches market rates.

However this case has a bit of a twist. When I joined the CRA in 1972 all taxpayers had to pay immediately, even if they appealed. So we often took collection action against taxpayer who were appealing their assessments. That was changed by legislation to the current system, I believe sometime in the 1980s. So these taxpayers may have been caught under the old system and have already paid.

Tax practitioners generally recommend that their clients pay up front to stop the clock ticking on interest but the tax shelter and tax avoidance types, like the taxpayers in Garber, tend not to so these guys may have big bills owing. Thirty years of compound interest including the high-interest late 80's and 90s.

A story on this, one I really enjoyed. In 1993 a bunch of tax lawyers from Thorsteinssons, a big Canadian tax law firm centered in Vancouver, found what they thought was a sure thing tax avoidance scheme that could give about a $10 tax deduction for every dollar of actual investment. The scheme, while basically quite complicate, at heart involved transferring real estate investment losses from the actual losing entity to the tax shelter participants. The lawyers liked it so much they decided to participate in it themselves! The links below are for the Tax Court, Federal Court of Appeal and Supreme Court of Canada decisions. Note the some of the names of the appellants in the Tax Court decision;

STEVEN M. COOK, CHARLES E. BEIL, CRAIG C. STURROCK, JOHN N. GREGORY, DOUGLAS H. MATHEW, IAN H. PITFIELD, THE ESTATE OF THE LATE LORNE A. GREEN

All big names at Thorsteinssons and I personally dealt with most of them. This was top tax talent and they had reason to believe that they had found a little gold mine because their scheme, while totally against the intent of the Tax Act (loss transfers aren't allowed) was, through the complex application of various unrelated sections of the act, legally correct. In the past this would have done it for them because the CRA had no recourse against taxpayers exploiting the act as long as the transactions fell within it. But the government had just passed GAAR (the General Anti-Avoidance Rule) as section 245 of the Income Tax Act. Very simply put GAAR allowed the CRA to reassess transactions, even if legally correct, if they violated the intent and spirit of the Act. Very vague, deliberately so, it meant that we could essentially reassess under the smell test. GAAR was enacted because the government finally decided it was impossible to close all loopholes. As fast as they did so sharp practitioners found others, just endless, so GAAR allowed the nuclear option. However the legislation set a fairly high standard for the Crown to meet so we wouldn't just use it any old time we wanted.

The CRA reassessed the participants of this scheme using GAAR and it became a test case for the legislation. Since the taxpayers involved included a bevy of Canada's top tax experts the Tax Court case was very comprehensive, the taxpayers hit all the arguments including the claimed breach of Charter and Constitution rights. The Tax Court decision is very lengthy and extremely thorough. The taxpayers had one major problem. A very similar case had recently been decided at Tax Court, also based on GAAR reassessments, and that appeal had been dismissed. So this case ended in tears for the taxpayers too;

CONCLUSIONS

[504] But for the application of section 245 of the Act each of the Appellants would have obtained a tax benefit from a series of six transactions, none of which was undertaken or arranged primarily for a bona fide purpose other than to obtain the tax benefit. Having regard to the provisions of the Act read as a whole, the six transactions resulted in an abuse with respect to the general scheme in the Act against the transfer of losses between taxpayers.

[505] Section 245 of the Act does not present a "real or imminent" threat to the section 7 Charter rights to life, liberty and security of the person and cannot therefore be declared of no force and effect under subsection 52(1) of the Constitution Act, 1982.

[506] The rule of law is not a basis for invalidating legislation under subsection 52(1) of the Constitution Act, 1982.

[507] In view of the foregoing, the appeals are dismissed with costs to the Respondent. However, the fees with respect to the preparation and the conduct of the hearing are limited to those that would be applicable to one appeal only.

So the taxpayers took it to the Fedral Court of Canada and lost there too. They went to the Supreme Court of Canada which actually accepted Leave to Appeal and decided against them. By this time it was 2005 and the appellants, who had claimed a total of over $10,000,000 in deductions in their 1993 and 1994 tax returns, now owed the taxes along with ten years of accrued interest.

The part I enjoyed involved one of the appellants. A profane ranter who tried to intimidate every member of the CRA staff he dealt with. I had numerous dealings with him and once walked out of a meeting after I had enough of his anger and profanities. Members of staff who dealt with him while the appeal was in process told me that he would complain, to them, that if the Crown won he would have to declare bankruptcy. The thought gave everyone a warm glow.

http://decision.tcc-cci.gc.ca/site/tcc- ... cyAAAAAAAQ

http://www.canlii.org/en/ca/fca/doc/200 ... M3MQAAAAAB

http://www.canlii.org/en/ca/scc/doc/200 ... GV3AAAAAAE

[notorial dissent]

The part I enjoyed involved one of the appellants. A profane ranter who tried to intimidate every member of the CRA staff he dealt with. I had numerous dealings with him and once walked out of a meeting after I had enough of his anger and profanities. Members of staff who dealt with him while the appeal was in process told me that he would complain, to them, that if the Crown won he would have to declare bankruptcy. The thought gave everyone a warm glow.

Well, did he? Ah, I can well understand, I've known lawyers like that. i won't begin to tell you what I wished for some of them, but then kharma usually beat me to it, or their wives divorce lawyers.