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Tax Risks from Underground Banks: Toronto Tax Lawyer Analysis

Introduction – Underground Banks and Hawalas

Canada has been criticized for failing to police and control the growth of underground currency exchange and banking networks in Toronto. These underground banks criticized are being used for various illicit activities including drug money laundering, financing terrorist groups, and supporting the Iranian regime. It has been reported that there are up to 70 currency trading shops in Toronto. One currency shop, owned by Farzam Mehdizadeh, was raided in 2016 with Mehdizadeh charged for allegedly laundering $100 million in a single year. In response to some of these problems, Canadian Public Safety Minister Bill Blair announced in December, 2020, that the federal government would be funding nearly $100 million for new anti-money laundering units in B.C., Alberta, Ontario, and Quebec by the end of March, 2021.

Underground banks and Hawala networks are popular when the regular banking system is unable to fulfill people’s needs. For example, Canada has financial sanctions against Iran, making bank to bank fund transfers impossible. Other countries such as Iraq and Afghanistan have unstable financial systems which can also prevent individuals from transferring funds to and from Canada. Additionally, some countries such as China have limits on how much money their nationals can send out of their countries. In these situations, some of the only ways individuals who have funds in these foreign countries can move their funds to Canada, be it because they have immigrated to Canada or to help support their family, is to use underground banks or Hawalas.

The basic idea is that someone in the foreign country pays an amount of money to a Hawala broker who then provides them with a code. Someone else in Canada can then go to a related Hawala broker and use that code in order to receive a corresponding amount of cash minus a commission. Other underground banks also tend to use similar methods to allow people to bypass restrictions and move funds into Canada. These underground banks and networks operate on the basis of trust as, by nature, they are designed to fly under the radar and avoid surveillance and currency restrictions. However, beyond the risk of simply losing any money you pay into the system, there can also be tax consequences of using these systems. Furthermore, because of the difficulty identifying the source of funds received through these systems, authorities may not be able to easily differentiate between their use to by-pass currency restrictions from money laundering or from terrorist financing activities. This creates the additional risk for individuals who use them for (relatively) legitimate currency exchange purposes of being misidentified as participating in more serious criminal activities.

Untraceable Funds and Unreported Income

To be clear, Canada does not tax transfers of money or gifts and there is technically nothing wrong with using these underground banking services from a purely tax perspective. However, the real risk lies in that the CRA may mistake funds received through these services as unreported income. Individuals who use these services will typically receive their funds in the form of cash. Although it may be an option to simply keep the funds as cash, it is more practical to deposit the funds into a bank account, especially with large amounts of funds. Where the amount of funds being deposited is low, it may not be an obvious problem. But if large or regular deposits are being made that do not correspond with a reported amount of income, the CRA may believe that those amounts stem from unreported sources of income. Normally this assertion can be disproven by providing evidence showing where the funds are from. If the funds were sent through a normal wire transfer from a foreign bank, a clear trail would exist and it is easy to identify the source of the funds – be it from the individual’s own foreign account or a gift from a family member.

While some of these Hawala networks operate as genuine Canadian businesses with appropriate business licences and documentation, many operate unofficially. In these cases, there is usually little to no paper trail or documentation and the Hawala operators are also unlikely to be willing to co-operate with their customers and may refuse to corroborate their stories. Unfortunately, where no documentary evidence is available, the CRA is typically reluctant to believe taxpayers based only on their own testimony and is likely to assess unsupported funds as unreported income. Furthermore, when large amounts of unreported income is involved, the CRA will often impose additional gross negligence penalties which add an additional 50% to any tax owing on top of the standard 17% late filing penalty and interest that accrues from the day the tax should have been paid (typically several years in the past). Although rare, there is also the risk that the CRA may escalate this to a criminal investigation for tax evasion. If you have used or are considering using one of these services, consult with one of our top Toronto tax lawyers and learn how to mitigate your risk.

Pro Tax Tip – Document Your Source of Funds

Situations where the CRA is looking into large amounts of funds with minimal supporting documentation are an extremely serious and can lead to significant tax and penalty assessments by the CRA, even in where the money is actually from a non-taxable source. Furthermore, with the potential for gross negligence penalties and criminal sanctions, this type of situation should not be taken lightly. That said, although these situations tend to be difficult, even where no direct documentary evidence is available, other circumstantial evidence can be used to support where certain funds came from and additional arguments can be made with regards to penalties and criminal sanctions. Moreover, even if the underground banks themselves provide little documentation, efforts can be made to create a paper trail documenting the true circumstances if properly prepared prior to the fund transfers. Speak to one of our experienced Toronto tax lawyers to learn more about what can be done to document these transactions prior to receipt the funds and if the CRA has audited you or already assessed you for unreported income for funds that came from an underground bank or Hawala, contact our tax law firm for assistance. Finally, as a Canadian resident you are required to report worldwide income and any offshore assets. If you have used a Hawala to bring untaxed funds or unreported assets into Canada you are at risk of criminal tax evasion prosecution. You can avoid tax prosecution and tax penalties by filing a voluntary disclosure with the Canada revenue agency prior to the commencement of any tax audit. To obtain the protection of a voluntary disclosure contact one of our top Toronto tax lawyers.

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."

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Tax Risks from Underground Banks: Toronto Tax Lawyer Analysis
Tax Risks from Underground Banks: Toronto Tax Lawyer Analysis
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