Canada v. Johnson, 2012 FCA 253 (2012)

Parts:Canada v. Johnson
Reporting Judge:BLAIS C.J.
Docket Number:A-491-11
 
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Federal Court of Appeal - Canada v. Johnson [Anonymoused]

Source: http://decisions.fca-caf.gc.ca/en/2012/2012fca253/2012fca253.html

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Federal Court of Appeal

Cour d'appel fédérale

Date: 20121004

Docket: A-491-11

Citation: 2012 FCA 253

CORAM: BLAIS C.J.

SHARLOW J.A.

TRUDEL J.A.

BETWEEN:

HER MAJESTY THE QUEEN

Appellant and

DONNA M. JOHNSON

Respondent

Heard at Toronto, Ontario, on September 13, 2012.

Judgment delivered at Ottawa, Ontario, on October 4, 2012.

REASONS FOR JUDGMENT BY: SHARLOW J.A.

CONCURRED IN BY: BLAIS C.J.

TRUDEL J.A.

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Federal Court of Appeal

Cour d'appel fédérale

Date: 20121004

Docket: A-491-11

Citation: 2012 FCA 253

CORAM: BLAIS C.J.

SHARLOW J.A.

TRUDEL J.A.

BETWEEN:

HER MAJESTY THE QUEEN

Appellant and

DONNA M. JOHNSON

Respondent

REASONS FOR JUDGMENT

SHARLOW J.A.

[1] The respondent Donna M. Johnson appealed successfully to the Tax Court of Canada for an order vacating reassessments under the Income Tax Act , R.S.C. 1985, c. 1 (5 th Supp.) for 2002 and 2003 (2011 TCC 540). The Crown has appealed to this Court to restore the reassessments.

[2] The main issue in the appeal is whether Ms. Johnson is required to pay income tax on certain payments she received in 2002 and 2003 (net of related outlays) from Andrew Lech. When Ms. Johnson received the payments, she believed that they represented her share of the after-tax profit derived from option trading transactions engaged in by a trust managed by Mr. Lech. In fact, and unknown to Ms. Johnson, Mr. Lech was paying her from money he had obtained fraudulently from the victims of a Ponzi scheme he was operating. Ms. Johnson argued successfully in the Tax Court that the payments were not taxable in her hands because the Ponzi scheme could not be a source of income to her. For the reasons that follow, I have concluded that Ms. Johnson’s argument is wrong in law.

[3] If the payments in issue were properly included in Ms. Johnson’s income for 2002 and 2003, an issue arises as to whether the reassessments are invalid because they were made outside the “normal reassessment period”, defined in the Income Tax Act as three years after the date of initial assessment. The judge held that the reassessment for 2003 was valid, but not the reassessment for 2002. The Crown argues that the judge misapplied the applicable legal test for 2002 but not 2003. Ms. Johnson argues the contrary. For the reasons that follow, I agree with the Crown that the reassessments for both years were valid.

Facts

[4] The facts as found by the judge are not in dispute. Ms. Johnson worked as a registered nurse until the 1990s. She assisted her husband with a church they began in Peterborough in 1974, and from 1982 worked with him in a travelling ministry. Although Ms. Johnson has no formal training in business or finance, the judge found her to be astute in business matters. In connection with the transactions that are the subject of this case, Ms. Johnson drafted two documents that the judge characterized as “relatively sophisticated” (see paragraph 59 of the judge’s reasons; the two documents are described in the discussion below).

[5] In the late 1990s, Ms. Johnson was introduced to Andrew Lech by her friend Liz Wakeford. Ms. Wakeford is a bookkeeper who also files income tax returns and has some real estate experience. She told Ms. Johnson that she had invested successfully with Mr. Lech.

[6] From approximately 1997 until April of 2003, Ms. Johnson entered into numerous transactions with Mr. Lech, at first through Ms. Wakeford as an intermediary, and later directly with Mr. Lech. In each transaction, Ms. Johnson would give Mr. Lech a cheque and at the same time, he would give her a number of cheques, postdated to provide her with payments over eight to ten weeks in amounts that in total exceeded her payment to him. Typically, the last postdated cheque for each transaction represented the excess, or profit. It is not clear how many of these transactions occurred, but Ms. Johnson testified that there were approximately 70 in 2002 and 2003.

[7] Mr. Lech told Ms. Johnson that he was combining her money with money held in a family trust that he managed, and that he was using the money in option trading to generate profits. He assured her that she had no risk of loss. He also assured her that the family trust paid tax on the profits, and that the money he paid to Ms. Johnson was “after tax profits” that she was not obliged to report in her income tax returns. Ms. Johnson believed everything Mr. Lech told her.

[8] Ms. Johnson did not seek professional investment or tax advice before entering into the transactions with Mr. Lech, or at any time. Her own research consisted of seeking and obtaining an assurance from her banker that large profits could be made from option trading by someone who knew what they were doing. As to the tax consequences of her investments, she consulted only her friend Ms. Wakeford, who as indicated above was also an investor with Mr. Lech. Ms. Wakeford did not testify in the Tax Court. Ms. Johnson testified that Ms. Wakeford assured her that the amounts received from Mr. Lech should not be reported as income because the tax on the profits was paid by the trust.

[9] The transactions between Ms. Johnson and Mr. Lech were not fully documented. Ms. Johnson kept her own notes of the transactions. She also drafted two documents that she asked Mr. Lech to sign. He did so in March of 2000. Those two documents read as follows:
AGREEMENT BETWEEN ANDREW LECH & DONNA M. JOHNSON FOR INVESTMENT FUNDS AND INCOME TAX PURPOSES

I, Andrew Lech , declare and certify that all taxes payable for income tax purposes, for all the investments funded by Donna M. Johnson, have and are being paid through the Lech family trust account over which I am the financial manager. It is not necessary for Donna M. Johnson or her immediate family to report and declare investment income to be taxed again.

AGREEMENT BETWEEN ANDREW LECH & DONNA JOHNSON FOR INVESTMENTS

I, Andrew Lech , am acting as a trustee of investment funds for Donna M. Johnson, [………………..address omitted………..……]. All cheques, whether current or post-dated payable to Mrs. Donna Johnson and bearing my signature are to be honoured from the proceeds of my estate in the event of my death.

[10] Ms. Johnson testified that she did not require any documentation of the transactions with Mr. Lech because she believed and trusted him. She also testified that she believed it would be unreasonable of her to request disclosure of what she assumed would be private information relating to Mr. Lech’s family trust. The first document quoted above was intended only to provide documentary evidence in the event of enquiries from the tax authorities, and the second was intended to protect the position of Ms. Johnson in the event of the death of Mr. Lech.

[11] The last transaction between Ms. Johnson and Mr. Lech occurred in April of 2003. In that month Ms. Johnson gave Mr. Lech what would prove to be her last cheque to him, which was cashed. However, Mr. Lech’s bank accounts were frozen shortly afterward, and she could no longer cash his cheques. At about this time, a class action was commenced against Mr. Lech by others who had invested with him, and Ms. Johnson joined them. She testified that she did so in order to recover the money represented by the cheques that she was unable to cash. She was interviewed by the lawyer for the class action in December of 2003.

[12] The freezing of Mr. Lech’s bank account was part of or led to a police investigation that lasted approximately three years. Ms. Johnson was interviewed by the police in 2005. She testified that it was only at this point that she began to have doubts about the trustworthiness of Mr. Lech. Criminal charges were brought and Mr. Lech was convicted in 2007, receiving a sentence of imprisonment for six years.

[13] After 2003, Ms. Johnson embarked on a strategy of option trading on her own account because she believed that she had learned enough from Mr. Lech to do so successfully. She was initially successful, but the success did not last. By 2008, Ms. Johnson’s savings were gone.

[14] None of what Mr. Lech told Ms. Johnson was true. In fact, Mr. Lech and some other individuals were operating a Ponzi scheme. Ms. Johnson was not being paid a share of the profits from investments or option trading. Rather, unknown to her, she was being paid from money that Mr. Lech had received from other people through the operation of his Ponzi scheme.

[15] When the Ponzi scheme operated by Mr. Lech collapsed in 2003, many people in Canada and the United States lost significant sums of money. The Canada Revenue Agency audited 132 of the participants, and concluded that 32 of them had profited from their dealings with Mr. Lech. Ms. Johnson was one of them. Although she lost the value of the last cheque she gave him in 2003, she received $614,000 in 2002 and $702,000 in 2003 in excess of the amounts she paid to him.

[16] The judge commented at paragraph 28 of her reasons that those who lost money on Mr. Lech’s Ponzi scheme may have been able to assert a claim against Ms. Johnson for restitution ( Re Titan Investments Ltd. Partnership , 2005 ABQB 637; Den Haag Capital, LLC v. Correia , 2010 ONSC 5339). However, as of the date of the Tax Court hearing in 2011, no such claim had been made.

[17] Ms. Johnson prepared her own income tax return for 2002, and had an accountant...

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