Tax Forum
Food For Thought
In some cases, the government profits from the proceeds of crime. Should this be allowed?
FROM:
MAY-JUN 2004 ISSUE | BY
DON GOODISON
Have you ever heard someone say that money made by criminals is not subject to tax? I have, and actually, it has been well established in both Canada and the
United States that profits from illegal activities are subject to tax just the same as profits from legitimate business. A classic U.S. example is the infamous
Al Capone, who was never convicted for murder, gambling, or his bootleg operations, but rather, for not paying taxes on the money he earned from his crimes.
In Canada, there has been some controversy around whether criminals should be allowed to deduct expenses from the income they derive from their illicit activities. In
Joseph Thomas Toth, Appellant v. Her Majesty the Queen, Respondent, 2004
TCC 56, the Tax Court of Canada was called upon to determine the deductibility of funds seized under the
Criminal Code of Canada.
Toth operated a business — a placement agency known as Crystal Star. In actual fact, the "placement agency" was an escort service. In 1999, Toth reported gross income of $114,897.35, and a net business income of $37,225. In 2003, he filed a request for reassessment of his 1999 return, claiming an additional $30,000 in expenses. The additional claim resulted from seizure of the funds in 2003 by the government of Quebec under the
Criminal Code of Canada on the basis that the funds were profits from prostitution. The Minister of National Revenue refused to amend Toth's 1999 tax return on the basis that the seized funds represented an involuntary distribution of the income after it had been earned, much the same as a dividend, I suppose.
Toth argued that disallowing the deduction amounted to double jeopardy, as he had paid tax and it was not fair to disallow the deduction. In rebuttal, the Crown referred to a Tax Court case heard in 1997,
Neeb v. Canada, [1997]
T.C.J. No. 13 (Q.L.)
. In that case, the court stated:
The question of avoidability is not germane here.
Mr. Neeb did get caught and his marijuana and hashish were seized. I can see no reason why the Canadian public should be expected to subsidize a drug dealer's loss through forfeiture of illegal drugs by allowing him to write off the cost of drugs so forfeited, even if that cost had been established. If public policy has any role in fiscal matters, it must deny such a claim.
The court noted that the Neeb case was heard and the decision rendered prior to the Supreme Court of
British Columbia decision in
65302 British Columbia Ltd. v. The Queen, [1999] S.C.R.
Vol. 3, 804. The court held that the deduction of fines and penalties did not apply to the
Income Tax Act. It also held that it was well established that expenses laid out to earn income from illegal acts were deductible. The end result of the decision in
65302 British Columbia Ltd.was to permit the deduction of fines and penalties incurred in the ordinary course of business, such as overweight fines incurred by truckers.
Toth's appeal was dismissed, but not for the reasons advanced by the Crown. The court was unable to determine if the $30,000 forfeited constituted a fine or penalty, and held that 2003 was the appropriate year for the determination as to whether or not the $30,000 was a deductible expense. In the end, the court did not establish the deductibility of the $30,000.
When the court, in
65302 British Columbia Ltd., stated that it was well established that expenses laid out to earn illegal income were deductible, it referred specifically to the 1964 decision of the Exchequer Court in
M.N.R. v. Eldridge, [1964]
C.T.C. 545. Eldridge operated a call girl business in Vancouver in the 1950s and early 1960s. Eldridge filed returns claiming expenses, which were challenged only as to amount and not deductibility by the tax department. The case heard in 1964 was not for the purpose of determining if she could claim expenses incurred in 1959 and 1960, but for specific amounts under dispute. By not challenging Eldridge's right to claim expenses against illegally earned income, the department set the precedent that permitted expenses to be deducted from illegal activities.
Under the
Criminal Code of Canada, it is illegal to live off the proceeds of crime, and persons found to be doing so are liable to have their assets seized and, of course, wind up in jail. But by taxing the profits of an illegal activity, it could be said that the government is profiting from the proceeds of crime. As well, cash and proceeds from
auctioned-off assets seized from criminals go to the government. Should the government be permitted to benefit from the proceeds of crime? A number of years ago, BC Provincial Court Judge
Jack McGivern said that the government must follow the same rules as its citizens and could not benefit from the proceeds of crime. That decision caused quite a stir, and was very quickly overturned by the
BC Court of Appeal. Nonetheless, it provided food for thought.
Lest anyone get the impression that I have any sympathy for those who make their living from crime, I should tell you that many years ago, I was asked to assist a person whose funds were seized by the tax department. When I found out that the funds were seized during a raid and were from the sale of drugs, I flatly declined. I could care less if the seizure was within the rights of the tax department or not. I have absolutely no sympathy for anyone involved in criminal activities, and whatever happens to their ill-gotten gains is fine with me, as long as they don't benefit from them.
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Don Goodison, CFP, FCGA, is a partner of Kemp Harvey Goodison, Certified General Accountants, in Burnaby, B.C. E-mail
goodison@axionet.com.