http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/66957/index.do 
Roszko v. The Queen[1] (February 21, 2014) dealt with an $800,000 investment by the appellant with TransCap Corporation, which he subsequently discovered was a fraud. In 2008 he received payments totalling $156,000 which he reported in 2008 as interest income. In 2009 he became suspicious about his investment and ultimately the Alberta Securities Commission ruled that it was a fraudulent Ponzi scheme. Since he discovered that there was never any investment of his funds he objected to his 2008 assessment on the basis that the payment he received was a partial return of his capital, not interest.
[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.
[Footnote omitted]
The positions of the parties were diametrically opposed:
[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.
[Footnores omitted]
The court summarized its conclusion as follows:
[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.
[Footnote omitted]
Accordingly, Mr. Roszko’s appeal was allowed.
Comment: While one hopes that few taxpayers have the sort of misfortune suffered by Mr. Roszko, where they do it is refreshing to see the Tax Court apply a practical analysis so that tax payable on fictional income does not add to the losses. What is difficult is to understand why the Crown pursued such an aggressive line under the circumstances.
[1] 2014 TCC 59.