Beware of Ponzi schemes

Advisor's Edge


We often warn clients that if an investment sounds too good to be true, it probably is. And in the chase for superior returns, they could risk losing their entire investment to a fraudulent scheme, or end up in a prolonged fight with CRA over taxes owing on what turns out to be phantom income.

Take the recent case of Alberta investor Leonard Roszko (Roszko v The Queen, 2014 TCC 59). He ended up fighting a 2008 tax Advisor to Client (Keyword) bill on $156,000 of interest income from an investment that turned out to be part of the TransCap Ponzi scheme, which ultimately took $52 million from investors.

Here’s what happened. Roszko sold the family farm in 2006, and initially invested his portion of the proceeds with a reputable Alberta financial firm. Seeking a way to reduce the taxes owing on the sale of the farm, he attended a presentation by TransCap.

At the presentation, he was convinced by a representative of TransCap that “he could achieve significant returns on his investments in the range of 18% to 22%.” After a subsequent meeting—and without getting independent tax advice—he decided to try investing $100,000, set up in the form of a loan. He thought Trans-
Cap was buying and selling commodities at considerable profit in order to achieve the high returns promised to investors.

Roszko ended up investing a total of $800,000, and received monthly payments, as promised. In 2009, things began to unravel when, after the death of his son, he approached TransCap to return some of his money to cover the funeral expenses. His request was denied “in a manner which caused [him] some suspicion.” He dug deeper and his enquiries led to an investigation by the Alberta Securities Commission (ASC), which eventually found that TransCap was perpetrating a Ponzi scheme.

Alberta commission’s findings

ASC wrote that TransCap essentially made “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 [TransCap’s…] 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.”

In 2008, Roszko received $156,000 from TransCap, which he reported on his tax return as interest income. He paid tax on this amount. But since he later found out that the entire amount was really a return of his own money, which he’d loaned to Trans-Cap, he felt he should not have had to pay tax on the $156,000.

Fortunately, the judge agreed, writing that Roszko “was misled to believe interest would be funded by TransCap. It was not. The funding of those payments, described as interest, was from…investors’ own money.”

Though Roszko lost nearly half of the $800,000 he invested, he didn’t have to pay a tax bill on what was a return of his own capital.

Still, this case should serve as a warning to clients to steer clear of anything that seems too good be true. Not only can they lose money, but they could end up wasting time, effort and energy fighting the tax man to recover taxes paid on fictitious income.