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Doing Business on the “Dark Web” to Evade the Tax Man: David Rotfleisch on What You Need to Know About CRA’s Vast Audit Powers

posted 11 months ago

Since the advent of the widespread internet, taxpayers have taken precautions to secure themselves online and make sure that no one can watch what they do. The “dark web“—a clandestine, encrypted, and largely well-kept secret that developed into a parallel Internet with significant criminal activity—was one of the inevitable evolutions of this demand for protection.

In recent years, less tech-savvy internet users have started to penetrate the dark web’s surface, leading to what several government organizations—most notably the police—as well as taxing authorities like the Canada Revenue Agency (“CRA”) and the IRS—believe to be a thriving underground economy.  The American government has taken steps in recent years to close down illegal and illicit markets like the “Silk Road,” which provided those with access to it with a place to buy anything from weapons to recreational drugs to credit card information that was stolen to toxic chemicals.

The importance of getting the right guidance to make sure you are always operating within the boundaries of the Income Tax Act cannot be overstated for Canadian taxpayers who use the dark web, especially for business purposes. Whatever the legality of the activity, there is a Canadian tax reporting requirement for persons who participate in a business that includes unlawful activities.

All Income is Taxable

The majority of taxpayers are either blissfully unaware of or purposefully ignorant of the income tax laws, which state that income derived from illegal sources, such as theft, fraud, illegal sex work, drug sales, and other criminal activity, is subject to income taxes in the same way as any other legal source of income in Canada. There are many legal business transactions carried out surreptitiously, including the buying and trading in cryptocurrencies, but these are the typical types of activities that receive the most attention with regard to the dark web in Canada.

The CRA frequently conducts a tax audit of a taxpayer either by itself or in collaboration with another law enforcement agency, like the RCMP, for the purposes of administering and enforcing the Tax Act.  Despite this, the CRA generally moves forward with a civil tax audit regardless of the legitimacy of the actual business the taxpayer is engaged in, either in conjunction with or separate from any criminal investigation that is not related to income tax or GST/HST. This is true even though the CRA does recommend taxpayers for criminal prosecution on the basis of specific tax fraud.

The CRA’s Method for Tax Audits

The CRA is authorized to make assumptions during an income tax audit about a taxpayer’s income sources and tax obligations based on scant or occasionally even no evidence.  Frequently, during an audit, the CRA will do a bank analysis and add any unidentified amounts as income in the reassessment of a taxpayer. It’s crucial for those who conduct business on the dark web to keep in mind that even though the activities and records themselves may be private and inaccessible, there will still be an audit trail once money is deposited into a bank account, which is frequently required due to the electronic nature of transactions on the internet.  Due to this, we advise taxpayers to always keep track of their business activities, whether they are legal or not.

A Dark Web Tax Audit Response

For the simple reason that taxpayers frequently are unaware of the CRA’s tax audit powers and their rights in an audit scenario, if the CRA chooses a taxpayer for a tax audit who happens to have engaged in e-commerce using the dark web, the tax audit is likely to result in a high tax bill, frequently including gross negligence penalties and possible criminal tax evasion prosecution.

For instance, taxpayers are frequently surprised to learn that even though their business operations are unlawful, the income is nevertheless subject to the same laws as from other sources, including the right to deduct expenses and the obligation to pay tax only on net profits.

Here’s where keeping accurate records becomes important.  The onus is on the taxpayer to demonstrate either that the amounts are not income and, therefore, are not subject to income tax, or that the income amount is overstated because it does not account for expenditures made to earn the illegal income when the CRA audits and makes the broad assumption that 100% of any deposits are income.  The CRA won’t typically be able to retrieve this information on its own, as it does in a typical business tax audit where it can obtain banking and other records from third parties, which is why maintaining accurate records of all illegal business activities on the dark web is so crucial.  In other words, the best course of action is to conduct all of your dark web activities in the same manner as any other online or offline business in order to avoid a hefty and inflated tax bill and attendant penalties.  Since the blockchain offers a complete ownership record, using cryptocurrencies like Horizen or Bitcoin does not prevent leaving a paper trail.

Tax Pro Tip: The Key to Surviving a Dark Web Business Tax Audit is Good Recordkeeping

Contact our top Canadian tax law firm for guidance and assistance if you find yourself the target of a CRA tax audit and the auditor has uncovered sources of income that may have originated from dark web business operations, whether they were legitimate or not.  We have decades of experience with all types of tax audits, and we can effectively represent you to make sure you aren’t paying a penny more in taxes than you should. If you haven’t kept accurate tax records, we can hire an accountant on your behalf to help us maintain solicitor-client privilege while also attempting to recreate your business records while preparing thorough submissions to the CRA. When planning how to report “dark web” activities, knowing that our files and the files of any accountants we retain on your behalf are protected by solicitor-client privilege gives you a strong defense against CRA action.

Disclaimer:

“This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the articles. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.”

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