Taxation of Gambling and Poker Winnings – A Toronto Tax Lawyer Guide

Introduction – Taxation of Gambling and Sources of Income

Under section 3 of the Canadian Income Tax Act, a Canadian taxpayer’s income includes all income from a productive “source” inside or outside of Canada. Section 3 provides a list of productive sources of income, including:

1. office;
2. employment;
3. business; and
4. property.

However, income can still arise from other sources. What other sources of income there may be is not defined or stated in the Canadian Income Tax Act. Canadian tax courts have concluded that an income source should have one or more of the following characteristics:

• It recurs on a periodic basis;
• It involves an organized effort, activity or pursuit on the taxpayer’s part;
• It involves a marketplace exchange;
• It gives rise to an enforceable claim to payment; and/or
• Where it involves a business or property source, there is a pursuit of profit.

Following these principles, Canadian tax courts have generally accepted that windfall gains, gifts, inheritance, strike pay and lottery winning are not considered “sources” for income tax purposes. Gambling winnings, however, become more difficult to pin down. As the tax courts have identified, whether a taxpayer has a source of income requires analyzing whether that taxpayer intended to carry on an activity for profit. Depending on the particular way that a taxpayer engages in gambling, it may or may not be considered a business for the pursuit of profit and any profit becoming taxable income.

This article will first explore the legal principles that underlie characterization of gambling winnings in Canada for taxation purposes. It will then address the role that intent plays in determining whether gambling winnings are taxable, and the difference that needs to be drawn between “business-like” behaviour and actual business success. Finally, this article will explore the case law that applies uniquely to poker, and will provide some additional tax tips on how you can be proactive in avoiding conflict with the Canada Revenue Agency (“CRA”) when you take your gambling activities seriously.

When is Gambling a Hobby Versus a Business for Canadian Tax Law Purposes?

The Supreme Court of Canada laid out a succinct test in the seminal case Stewart v Canada, 2002 SCC 46, to determine whether a Canadian taxpayer is earning income from a business. There are two parts to the Stewart test:

• Is the taxpayer’s activity undertaken in pursuit of profit, or is it a personal endeavour?
• If it is not a personal endeavour, is the source of the income a business or property?

Under the first part of the test, if a taxpayer’s activity has elements suggesting it is the taxpayer’s hobby or another kind of personal pursuit, then the venture will only be considered a source of income if it is undertaken in a sufficiently commercial manner. In almost every case involving gambling, where the first part of the test is satisfied (that is to say, where the taxpayer’s gambling was undertaken in pursuit of profit), then the second part of the test will be irrelevant because the only real potential source of income would be from business and not from property.

In order for an activity to be commercial in nature, the taxpayer must have a predominant intention to make a profit. Again, for gambling, this subjective intention to earn a profit almost certainly exists given the nature and purpose of gambling. Whether earning a profit is the taxpayer’s dominant intention is still a fact-dependant analysis.

Gambling Must Also be Carried Out With “Businesslike” Behaviour

In order to be treated as a source of income, the taxpayer’s gambling must also be carried out in accordance with objective standards of businesslike behaviour. If the taxpayer’s gambling activities were commercial in nature and carried out with businesslike behaviour, then the gambling activity will be considered business activity and any wins or losses will be treated as taxable income or business losses.

It is important not to equate a concept of a successful venture with the concept of businesslike behaviour. Evidence of profit does not mean that a taxpayer’s venture must be a business generating taxable income. It would be inappropriate to simply conclude that every profitable venture must be a business, and an unprofitable venture must not have been run with sufficient businesslike behaviour, because doing so would ignore the subjective motivations of the taxpayer. This was made clear in the Tax Court of Canada case Leblanc v The Queen, 2006 TCC 680. In Leblanc, the two taxpayers were brothers who purchased sports lottery tickets on a massive scale. The brothers made approximately $50 million in bets and earned a profit of approximately $5 million. Additionally, the brothers tried to make deals with ticket vendors to get discounts on bulk purchases and hired helpers to visit different vendor locations and purchase tickets. However, the Tax Court of Canada determined that the objective standards of businesslike behaviour were not met by the brothers’ venture. Specifically, the court found that the brothers had no system in place that would mitigate risk and or increase their chances of winning when they gambled. The court found that the brothers bet massively and recklessly and were successful simply due to good luck.

On the other hand, in the case of Luprypa v. The Queen, [1997] 3 CTC 2363, the Tax Court did find evidence to suggest the taxpayer acted with businesslike behaviour. The taxpayer in Luprypa was a skilled pool player who made approximately $1,000 a week playing staked pool games against bar patrons. The taxpayer in Luprypa carefully managed his risks, focused on an activity where he was particularly skilled, and involved a system to maximize his chances of winning. Specifically, he would only play staked games after 11:00PM and would target inebriated bar patrons while remaining entirely sober. Furthermore, in the afternoons, he would consistently practice playing pool to perfect his skills. As such, the court found the taxpayer applied his knowledge and skills in the pursuit of profit to exhibit businesslike behaviour, and his earnings were taxable income.

Taxation of Poker Winnings

Poker as a game differs from many other gambling activities in that is widely considered that skilled players can significantly increase their chances of winning and can make a consistent profit playing. Cohen v. The Queen, 2011 TCC 262, is a key Canadian tax law case specifically addressing taxation of poker earnings. The taxpayer in Cohen was a lawyer who quit his job and became a professional poker player. He initially read books and articles on poker strategy and how to use math to increase his chances of winning. The taxpayer testified that he had a strategy where he would focus on playing against inexperienced players and win a high volume of small stakes games. The taxpayer attempted to deduct business losses of roughly $121,000 from his income. The CRA challenged his deductions on the basis the taxpayer was a hobby poker player and was not in the business of gambling.

The tax court in Cohen considered five predominant factors when determining whether there was evidence the taxpayer was engaged in a poker business:

1. Profit and loss experience in past years;
2. Taxpayer’s training;
3. Taxpayer’s intended course of action;
4. The capability of the venture to show a profit; and
5. The other factors from Luprypa.

In Cohen, the court found that the taxpayer just started his professional poker career and had no past history of gambling professionally. Further, the judge found that while there was some evidence the taxpayer researched poker strategy and that he attended a poker seminar, he did not have any special training nor was his knowledge or skill in poker unusual or beyond that of a normal poker player. The tax court compared the taxpayer’s circumstances to that of a hobby chess player, who might own enough game strategy books to fill a small library, but that such would not make one a professional chess player. The court also found that there was no overall business plan and that the taxpayer’s strategy of minimizing risk by playing low stakes games was quickly abandoned as he began to play high stake games with more experienced players. The Tax Court judge similarly found that there was no evidence that substantiated the taxpayer had a business plan, that he maintained no budget, no proper records of the number of games he played or how much he won in any particular game, all of which was inconsistent with a venture that had the capacity for profit. Finally, the court considered the factors in Luprypa, which overlapped in part with the first four factors. The court concluded that the taxpayer did not show any particular skill, did not see any evidence of a system which would increase his chances of winning and minimize risk. As such, the tax court concluded in Cohen that the taxpayer’s poker activities were not conducted in a sufficiently businesslike manner and thus denied the losses that the taxpayer claimed.

The opposite result can be seen with the taxpayer in D’Auteuil c Le Roi, 2023 CCI 3. In D’Auteuil, the taxpayer was reassessed for his 2008 to 2012 taxation years on the basis that he failed to report his poker winnings as business income. The taxpayer won over $5 million playing online poker during those years, which he reinvested into his poker-playing activities to maximize his potential earnings. The taxpayer used software not only to track his opponents, but also to track his own decisions, so that he could identify players that were more valuable to play against. The taxpayer spent time outside of playing poker studying theory in order to remain a competitive player. The taxpayer Canadian tax litigation lawyer and the CRA presented their own expert evidence at court, arguing in turn that the taxpayer’s abilities reflected that of a lucky enthusiast versus that of a savvy businessman.

The tax court almost all-together ignored the issue of whether poker could be viewed a game where skill prevails over chance. The tax court reaffirmed that the test for evaluating whether a taxpayer carried on a business followed the ruling in Stewart. That is, the question would be whether the taxpayer’s activities were done with a view to making a profit, or whether they were personal. And as reaffirmed in later cases, the taxpayer’s surrounding facts would play a role in determining whether the taxpayer had a subjective and reasonable expectation of profit, and more specifically, whether the taxpayer had a planned and reasonable expectation of making a profit. In considering the taxpayer’s activities, the court concluded they were far more organized than that of an enthusiast or a hobby player. He worked to mitigate his risks and maximize his profits, and almost completely centered his life around poker. The tax court concluded that on a balance of probabilities, the taxpayer had a subjective intention to profit and that his earnings from poker were taxable business income.

Pro Tax Tip – Claiming Gambling Losses Poses Additional Risks

A Canadian taxpayer’s poker activities will rarely be viewed as a business venture generating taxable income unless the taxpayer develops or uses a system to minimize risk and maximize chances of winning. That system must be more than what an enthusiastic hobbyist would use.

Although this offers some relief for casual and hobby gamblers in Canada, this does introduce additional risks for Canadian taxpayers who are seeking to claim their gambling losses as part of an organized gambling business. In order to claim non-capital losses from operating a gambling business, the high threshold of demonstrating businesslike behaviour will need to be met. This will depend substantially on the taxpayer’s subjective intentions and what objective evidence can be presented to show that the taxpayer held those subjective intentions. In the face of a CRA tax audit, it is not enough to simply claim you meant to operate a business. Rather, the burden will fall on the taxpayer to demonstrate there was a sufficient organized effort to gamble in a businesslike manner to justify deducting those losses.

As such, if you are a Canadian taxpayer considering deducting your gambling losses from your taxes, or are otherwise exploring your career options in the world of gambling, then you should absolutely speak with an experienced Canadian tax lawyer in Toronto. Obtaining a professional opinion on whether your gambling qualifies as a business for Canadian tax law purposes will not only help to ensure you take the correct filing position for your taxes, but it may also protect you from additional penalties should the CRA challenge that filing position in the future. Speak to one of our experienced Canadian tax lawyers today and make sure you won’t be surprised by a big tax bill or miss out on claiming a valid business loss.

FAQs:

1) What is the “Source Theory” of Income in Canadian Tax Law?

Section 3 of the Canadian Income Tax Act provides that a tax resident of Canada will be taxable on all income from sources inside and outside of Canada. An income source for Canadian tax law purposes should have one or more of the following characteristics: (1) it recurs on a periodic basis; (2) it involves an organized effort, activity or pursuit on the taxpayer’s part; (3) it involves a marketplace exchange; (4) it gives rise to an enforceable claim to payment; and/or (5) where it involves a business or property source, there is a pursuit of profit. Lottery winnings are not considered “sources” for Canadian income tax purposes, while gambling winnings may be considered sources where there is sufficient organized effort and a primary intent to pursue profit, among other factors.

2) When Might my Gambling Earnings be Viewed as Taxable Business Income?

The Supreme Court of Canada laid out a succinct test in the seminal case Stewart v Canada, 2002 SCC 46, to determine whether a Canadian taxpayer is earning income from a business. There are two parts to the Stewart test:

1. Is the taxpayer’s activity undertaken in pursuit of profit, or is it a personal endeavour?
2. If it is not a personal endeavour, is the source of the income a business or property?

A Canadian taxpayer will be found to have earned income from a gambling business where those gambling activities were carried on with commercial intent and the taxpayer’s primary purpose was earning profit, and where those activities were carried on with businesslike intent.

3) When Might my Poker Activities be Viewed as a Business?

The Tax Court of Canada in Cohen v The Queen, 2011 TCC 262 set out five predominant factors to consider when determining whether a Canadian taxpayer is engaged in a poker business:

1. Profit and loss experience in past years;
2. Taxpayer’s training;
3. Taxpayer’s intended course of action;
4. The capability of the venture to show a profit;
5. Other factors from Luprypa

Following the ruling in Cohen, a Canadian taxpayer’s poker activities will rarely be viewed as a business venture generating taxable income unless the taxpayer develops or uses a system to minimize risk and maximize chances of winning. That system must also be more than what an enthusiastic hobbyist would use.

Disclaimer:

“This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer.”

About the Author

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David J. Rotfleisch

David J. Rotfleisch, a leading Canadian tax lawyer, is not only a certified specialist in taxation but also a chartered professional accountant. Most recently, David is a pioneer in Canadian crypto taxation.

As of April 2020, he was one of 12 Ontario Certified Specialists In Taxation™.

Learn more about David J. Rotfleisch