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Wednesday, April 21, 2010

Jail Time for Small Business Tax Fraud

Jail Time for Small Business Tax Fraud


Jail Time for Small Business Tax Fraud

Until recently, it has been rare to see a person jailed for tax fraud; jail time has usually been reserved for the most egregious cases. However, the Ontario Court of Appeal has served notice that significant sentences are now on the table in cases where taxpayers act fraudulently or where they intentionally attempt to evade their tax obligations.

In Canada's self-assessment tax system, taxpayers are left to voluntarily assess and pay their taxes. Taxpayers who refuse to follow the rules risk being convicted of tax fraud or a variety of other possible crimes under, for example, sections 238 and 239 of the Income Tax Act and sections 280.1, 285, 326, and 327 of the Excise Tax Act. Convictions for offences under those provisions carry the possibility of serious penalties, including heavy fines and incarceration--and often both.

Recently, some provincial courts have begun to take a much harsher approach than they have in the past. In R v. Di Giuseppe (2010 ONCA 91), the Ontario Court of Appeal upheld a six-year jail sentence and a $2 million fine imposed by the Ontario Court of Justice on an offender who fraudulently evaded income tax and GST over a period of about two years.

Mr. D controlled all aspects of the operations of two financially successful adult entertainment clubs through three corporations that he also controlled. His daughters were exclusively responsible for processing the revenues generated by the clubs. Although the clubs generated taxable income during the applicable period, no corporate tax returns were filed and no income tax payments were made by the operating companies. Either no GST returns were made, or false GST returns were intentionally filed.

Mr. D's scheme was discovered by a chance seizure of some service income documentation (detailing the actual revenues of the clubs) during a non-tax investigation. The documentation was kept by an employee who failed to follow Mr. D's directive of destroying all records containing revenue data. Mr. D was charged with defrauding the public of more than $2.8 million in income taxes and more than $600,000 in GST by

  • deliberately failing to file corporate tax returns, or filing returns based on fraudulent income data;
  • intentionally withholding revenue data from his corporate controller, resulting in false or fraudulently understated data in the returns filed with the CRA;
  • manipulating revenue records or using other fraudulent means to direct the diversion or concealment of revenues with the purpose of underreporting the taxable income; and
  • implementing a sophisticated scheme of concealing and destroying source documents and/or supporting financial data that might reveal the actual income of the clubs.

Because the offence was a large-scale fraud involving some $3.5 million over an extensive period of time, the trial court sentenced Mr. D to six years in jail and imposed a fine of $2 million, with one year of additional incarceration in default of payment. Mr. D appealed both his conviction and the sentence, which in the past might have resulted in a reduction of the fine and the period of incarceration.

The Ontario Court of Appeal accepted all the trial judge's findings and dismissed Mr. D's appeal. The court was of the view that false GST returns were filed as a result of Mr. D's acts and that, by creating false records and destroying records, he had made it impossible for the corporations to comply with their legal duty to file income tax returns. The court commented that Mr. D's deceitful acts, which deprived the public of income taxes and GST, constituted fraud. The court also upheld the sentence imposed by the trial judge, finding it to be within the acceptable range for offences of this kind.

The Di Giuseppe decision underscores the potential liability facing taxpayers who fraudulently evade the payment of taxes. Taxpayers may want to take note of the case for very basic mathematical reasons.

For example, if a $3.5 million tax fraud results in six years' incarceration, would a $600,000 tax fraud result in one year's incarceration? Would a $300,000 tax fraud result in six months' incarceration? Would a $100,000 tax fraud result in 60 days' incarceration? Other recent cases indicate that even small-scale fraudulent activities (from $100,000 to $200,000) may result in jail time. For example, in R v. Chicoyne (2009 ONCJ 556), a fraud of $140,000 resulted in a jail sentence of 160 days.

As well, the court in Chicoyne refused to accept a plea bargain agreed to by defence counsel and the Crown; until recently, the courts were prepared to accept guilty pleas accompanied by a plea bargain for a fine only (no jail time).

The alternative for taxpayers with concerns about possible exposure to a tax fraud charge is the CRA's voluntary disclosures program, which allows taxpayers to disclose unreported income and to correct inaccurate or incomplete tax filings. When the CRA accepts the disclosure, the taxpayer is required to pay the additional taxes or charges owing, plus interest, but no penalty or prosecution is imposed. If the voluntary disclosure is made through a tax lawyer, solicitor-client privilege may afford some additional protection to the taxpayer, although the CRA makes it clear that a voluntary disclosure, to be effective, must completely disclose all items of unreported income.

Robert G. Kreklewetz and Jenny Siu
Millar Kreklewetz LLP, Toronto