Defrauding people isn't a business, court rules: Taxpayer's loss denied

National Post


Can a company be in the active business of defrauding people? That issue came
up in Tax Court last month when Hans Longerich lost $230,000 through his
investment in two Canadian private corporations and attempted to claim the loss
as an "allowable business investment loss" or ABIL on his tax return.

What is an ABIL? Normally, if you sell a stock or other security at a loss,
for tax purposes your loss is considered to be a capital loss. Capital losses
can't be deducted against your income but may only be deducted against capital
gains. If you don't have any capital gains in a particular year, the capital
loss can be carried back and applied to offset any capital gains realized in the
prior three years or carried forward indefinitely to be offset against gains in
any future year.

An ABIL arises when you lose money from investing in shares or debt of a
"small business corporation." A small business corporation is a private Canadian
company, engaged in an active business in Canada. The tax advantage of having
your loss qualified as an ABIL instead of an ordinary capital loss is that an
ABIL can be deducted against all sources of income -- not merely against capital

The question before the Court was whether the corporations in which Mr.
Longerich invested were engaged in an "active business" in Canada. The Canada
Revenue Agency argued that the only business activity the companies were
involved in was the collecting of money from investors, which alone is not
considered to be an active business.

Mr. Longerich, however, came up with an interesting counterargument -- the
corporations were engaged "in the active business of defrauding him" and thus
qualified as small business corporations.

In fact, this was not the first time this argument has been put forward. In a
2000 case, the Tax Court held "that an elaborate scheme of fraud being carried
out by certain corporations" could qualify as an active business.

In that case, the corporation involved hired employees, owned warehouses and
bought and sold merchandise. It also, however, used its assets to defraud
investors in a fraudulent pyramid scheme. As the judge in that case stated, "the
fact that such activities were criminal does not prevent them from being
characterized as a 'business' for income tax purposes." He thus concluded that
the investor was, indeed, entitled to an ABIL.

Unfortunately, Mr. Longerich was unable to convince the Tax Court that his
loss should also be considered an ABIL. As the CRA stated, "simply because a
taxpayer has lost money does not establish, for the Court, on a balance of
probabilities, that the entire scheme was nothing but a deliberate fraud,
perpetuated upon the investors ... such that [the corporation] is suddenly now
an active business, because there's no evidence of any other business going on
at that time."

Unsatisfied with the decision, last week Mr. Longerich decided to appeal his
case to the Federal Court of Appeal. Stay tuned...