Fraud – Doug Carroll

E-mail fraud causes tax trouble – One lawyer’s dismal drama

TV’s famous Addams Family may have been creepy and kooky, but the taxpayer in a recently reported case would no doubt have preferred those antics to the true-to-life horror visited on him by another Adams family.

Even the judgment reads like a screenplay, with a cast (as the judge called it) that included a 23-year-old girl whose father had just been assassinated; a security “diplomat”; trans-continental couriers; and a handful of pliable airport officials. Add to that our unsuspecting taxpayer — a Calgary lawyer named “CR” — and things were ripe for a $400,000 fraud.

I’ll come to the tax issue shortly, but first let’s set the stage.

Out of Africa

On Saturday, April 16, 2005, CR received an unsolicited (and as noted by the judge, grammatically challenged) e-mail from one Purity Adams, purporting to be a South African writing from Abidjan, Ivory Coast. Her father had been assassinated after a business trip during which he deposited US$8.5 million in a trunk now held by an Ivory Coast security service. She decided to reach out to a Canadian lawyer to assist her with obtaining the trunk’s release.

CR replied and within 90 minutes received the terms of his engagement. For facilitating the release, he would receive a 10% recovery fee, and act as trustee of the remaining funds for at least 10 years.

Needless to say, Purity belied her namesake.

Within the week, CR had wired over $20,000 to Purity and her beleaguered brother David. A month later the trunk was impounded at the airport and CR sent $200,000 to secure its release. While those funds were in transit, he advanced another $100,000. Military officials caught wind.

On receiving notice in July that the trunk had reached London, CR was asked for another $132,825 to cover freight charges. That’s when he got suspicious. He called the RCMP, and, flew to London. He was intercepted at the airport by New Scotland Yard; rode with two of the conspirators; and managed to call in the bobbies after a sprint across a hotel lobby. One of the men escaped; the other was arrested and later released without a hearing. No money was recovered.

And justice for all?

Despite the international intrigue, CR’s woes were not at an end. In his 2005 tax return, he claimed a $398,995 deduction in determining his income from his law practice. The deduction was denied, so an appeal ensued to the Tax Court of Canada.

To be entitled to a deduction, a taxpayer must have a source of income against which to claim that deduction. The judge sided with CR, agreeing his activities were carried out within the precincts of his practice, and were therefore a legitimate source of income.

Still, CR would have to show that the amount was reasonable in order to be entitled to the deduction, which the judge held could only follow from CR having a reasonable belief in the existence of a container with US$8.5 million in Ivory Coast.

In the end, the judge determined there were simply too many inconsistencies and questions about the story to sustain such a reasonable belief. Deduction was denied.

Ironically, the judgment was released April 3, mere days after the end of Canadian Fraud Awareness Month.

Advisor fraud and investor taxation

At issue

Fraud can rear its ugly head in any area of commercial activity, and the financial advisory field is certainly no exception. Indeed, the highly interpersonal nature of the advisor-client relationship can make it an especially fertile ground for the unscrupulous ‘con’fidence man.

Defrauded individuals may feel doubly victimized when the tax assessment shoe drops, with the potential for particularly harsh results when registered money is involved. Even the judges in the first two cases below suggest that Ministerial discretion may be warranted for these losing taxpayer-litigants.

On the other hand, fraudulent activity can lead to some anomalous results, as the last case demonstrates.

Mignault v. R. 2011 TCC 500

Advisor had Mr. Mignault withdraw $287,920 from his RRSP over four years, with the net $202,794 paid to the advisor’s corporation. It was the last Mr. Mignault saw of those funds.

While the judge acknowledged that Mr. Mignault may have believed that he was only reinvesting within an RRSP, the documents (prepared by the advisor) and his own testimony supported the factual finding of a withdrawal. He was liable for tax on the RRSP withdrawals, with $85,126 already having been withheld.

Penalties for two of the years were also upheld as Mr. Mignault could not show that he met either the objective or subjective standard for a due diligence defense.

St. Arnaud v. R., Braun v. R, Patenaude v. R., 2011 TCC 536

These three taxpayers were not directly connected to one another, but had the same advisor – to their mutual misfortune.

Each taxpayer moved RRSP or RRIF funds into new self-directed accounts to purchase shares of corporations purportedly poised for lucrative initial public offerings. Semi-annual statements were issued for 4 or 5 years before it came to light that the shares were worthless from the start, and otherwise not qualified for RRSP/RRIF investment.

For RRSP and RRIF acquisitions, consideration paid in excess of fair market value is brought into a taxpayer’s income. The judge found that though these taxpayers had done nothing wrong themselves, the purchasing funds “left the sheltered environment and so must, under the scheme of the Act, and its specific provisions, be subject to tax.”

Johnson v. R., 2011 TCC 540

The taxpayer was an innocent participant in a $45 million Ponzi scheme, being one of the ‘up’ investors. She was assessed for amounts she received in excess of what she had provided, totaling $614,000 and $702,000 for the 2002 and 2003 taxation years, respectively.

The scheme of the Income Tax Act requires that income must derive from a source. On the facts, the judge held that while Mrs. Johnson received something, there was an insufficient connection between the capital she provided and her receipts. Thus, as the capital was not a source, the receipts could not be characterized as income. [Ed. note: Case since reversed on appeal]

Practice points – for investor due diligence

Verify the credentials, licensing and professional ‘good standing’ of your advisor and the financial organization he or she represents.
Be aware of what reports and statements you are entitled to receive, be sure that you do receive them, and be careful to store them securely.
Review, respond and act immediately upon correspondence with the Canada Revenue Agency, and be prudent in deciding whether and who to appoint to communicate with CRA on your behalf.

You only die once – Choose your executor wisely

Back when I ran my estate law practice, clients often asked me, “Who do you think should be my executor?” My response was never to name names, but rather to suggest principles that might guide the decision process.

Principle number one: your executor must be someone you trust. After all, the nominee will not only execute your will instructions, but as trustee will become legal owner of everything you own at the point when you graduate to the great beyond.

At the same time, there should be adequate controls in place. In other words, you should not trust your trustee absolutely. Here’s a painful example illustrating why.

A $24-million estate devolves

Unless you are in the mining industry, you may not recognize the name Paul Penna. Born in 1922, he was a bucket-shop mining stock promoter and millionaire by the time he was 24, and went broke shortly thereafter. By 1972 his respectability and fortunes had risen once more, such that he was able to merge two mining companies into Agnico-Eagle Mines.

At the time of his death in 1996, he had an empire and fortune worth about $24 million — more than adequate, one would think, to fund a life estate for his wife Lorraine, and a charitable trust to boot.

The estate executors were two of Mr. Penna’s business colleagues and Lorraine herself. After Lorraine died in 2003, Mr. Penna’s nephew took her place in 2004.

A $24-million estate dissolves

By early 2005, a Mareva injunction had been ordered, freezing the assets of Barry Landen, one of the two business colleagues named as estate executors. A 2006 order replaced all three trustees with a court-ordered trustee.

According to the judge who oversaw the matter for much of the five and a half years it was before the court, “The Estate was neither properly nor honestly administered from the outset. The executors and trustees never probated the deceased’s will. Landen completely controlled all of the administration, including banking and cheque-writing. He never followed the terms of the will.”

Lorraine was entitled to a $1-million specific legacy in addition to payments as part of the life estate. She received neither. Instead, funds were fraudulently converted to Landen’s use, including:

A $2-million Forest Hill home purchased with estate funds, and registered to his wife
Four luxury car leases and season tickets for the Toronto Maple Leafs and Toronto Raptors
Over $2-million of itemized misappropriations or misdirections
Many millions of dollars more that remain unaccounted for

While Landen was the principal actor, the judge commented that had the co-trustees properly taken on the role entrusted to them, Landen could not have committed such a massive fraud over so many years. Eventually, the other two executors paid settlements to the estate.

In October 2010, Mr. Landen was found in contempt of court for breaching four court orders, and a sanction/punishment hearing occurred in November 2010.

An executor called to answer

Contempt of court attracts a range of possible sanctions, from orders to act or refrain from acting, to payment of court costs or fines, all the way to the potential for imprisonment.

Owing to Landen’s latent pennilessness, the judge ruled a fine to be pointless, and that there could be no positive act he could perform to purge his contempt. So, it’s prison for Landen — specifically, 14 months.

What’s more, there is no parole provision in civil contempt matters, so it will be a full 14 months. After that, the order requires him to appear before the court once more to account for what he did with the balance of the estate assets. Presumably, a failure to respond to that order could lead to a further finding of contempt, so this may not be over yet.

So, who do you think should be your executor?