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Everald Dewar | Taxing the windfall from Ponzi schemes

Published:Wednesday | November 2, 2016 | 12:00 AM
Everald Dewar

A taxpayer in a recently decided case in the Court of Appeal learnt the hard way when, based on his grounds of appeal, he received the sentence even before a verdict was reached against him.

William Andrew Chang challenged Tax Administration Jamaica (TAJ) over its assessment of his gains from the Olint investment scheme.

Getting a sense of the nature or source from which the income arose, Olint was later exposed as a Ponzi scheme.

A Ponzi scheme is where the operator pays returns to one investor from new capital he received from other investors, rather than from profit earned through trade or business.

In the twists and turns of his case, David Smith, Olint's operator, was eventually jailed for defrauding members of the investment scheme.

A Ponzi scheme is really a fraud perpetrated on investors and is therefore illegal. But are the gains not also illegal and therefore not subject to tax?

The tax authorities are clear that once it is established that a trade or business was in operation, any profits or gains arising from it is taxable. It would not matter if they are illegally obtained.

In Chang's case, Olint was ostensibly carrying on a business. Also, what was in the taxpayer's mind at the time is vitally important. To the taxpayer, there was nothing to say he knew or should have known that he was involved in a fraudulent transaction.

Law lords at the Privy Council, Lord Clyde and Lord Denning, expressed contrary views in other cases - casting doubt that systematic crime itself can constitute trading. This would mean that gains from, say, 'lotto scamming' could not be deemed 'taxable income'.




Some will argue that in these schemes the taxpayer never made any gains, as such; or that these gains were capital accumulation. It is basically like a 'partner' - an informal but popular savings system in Jamaica where, from a regular contribution made daily, weekly or monthly by member/

partners, the accumulation is paid to one of the partners. The scheme closes when all of the partners collect their lump sum.

However, the taxpayer's accountant shut the door on this proposition when he reported the gain, describing it as "income on investment".

As the court noted: "Surprisingly, the source was never disputed".

The taxpayer, through his attorney, went down the rabbit hole and argued about procedural improprieties and constitutional breach. He asked that precepts, set by the court in earlier judgments, be set aside.

The court had difficulties with this. They felt bounded by precedent. And this was nothing short of challenging their earlier judgments and the jurisdiction of the court itself.

The taxpayer argued based on premises grounded in the 1986 case of Winston Lincoln v Commissioner of Income Tax, which was decided against the Tax Commissioner. However, the law has long been changed on these matters. As the judge handing down the decision explained: "On virtually every issue raised by the taxpayer, the court was asked to revise matters that have already been covered" in earlier judgments.

The taxpayer also claimed that he acted as agent on behalf of a person overseas. It should be noted that the court was not saying that he was to be taxed for money earned by a non-resident investor, but that he failed to prove that this was so.

All cases must be decided on their own merit. It would be fair to say that this case does not set a precedent that gains from investment in illegal schemes are taxable.

It may be that other taxpayers could face challenges with the TAJ where they do not give an acceptable explanation of how you came by their gains, and would be 'up the creek' were they to say it came from a Ponzi scheme.

- Everald Dewar is senior taxation manager at BDO Chartered Accountants in Kingston.