Taxation and the “Dark Web”: A Canadian Tax Lawyer’s Analysis

Introduction: Canadian Taxes and the Dark Web

Since the beginning of widespread internet connection, taxpayers have taken steps to protect themselves online and to ensure that their activities cannot be monitored by third-parties.  One of the natural evolutions of this desire for security was the development of the “dark web”, a secretive, encrypted and mostly well-kept secret that evolved into a parallel Internet with extensive criminal activity.

More recently in the past few years, less savvy internet users have begun to crack the surface of the dark web, and it has resulted in what is assumed by various government agencies, mainly various police agencies but also taxation authorities such as the Canada Revenue Agency (“CRA”) and the IRS to be a thriving underground economy.  Over the past few years the government of the USA has taken steps to shut down illegal and illicit marketplaces, such as the “Silk Road”, which offered those who could access it a place to purchase anything from guns to recreational drugs to stolen personal identity and credit card data to toxic chemicals.

For those Canadian taxpayers that utilize the dark web, particularly for business purposes, proper advice to ensure that you are always operating onside of the Income Tax Act is paramount. For those who engage in commerce including illegal activities, there is a Canadian tax reporting requirement regardless of the legality of the activity.

All Income is Subject to Tax

Most taxpayers remain blissfully unaware or deliberately blind to the income tax rules that income from illegal sources, earned for example by way of theft, fraud, illegal sex work, drugs and other forms of criminal activity is subject to income taxes in the same manner as any other legitimate source of income in Canada. These are the typical types of activities that garner the most press with respect to the dark web in Canada, however there are also all sorts of legitimate business transactions conducted covertly, such as the purchasing and speculation in crypto-currencies.

For the purposes of the administration and enforcement of the Tax Act, the CRA often will audit a taxpayer alone or in conjunction with another law enforcement agency, such as the RCMP.  But, while the CRA does recommend taxpayers for criminal prosecution on the basis of tax fraud specifically, it will generally proceed with a civil tax audit regardless of the legality of the actual business that the taxpayer is engaged in either in conjunction with or separate from any criminal investigation that is not income tax or GST/HST related.

CRA’s Approach to Tax Audits

When conducting an income tax audit, the CRA is empowered to make assumptions about sources of income and the taxes payable by a taxpayer based on little or even sometimes no evidence.  Oftentimes at audit, the CRA will engage in bank analysis and include as income in a taxpayer’s reassessment any amount that is unidentified.  For those who conduct business on the dark web, it is important to remember that while the activities and records themselves may be secret and unobtainable, ultimately when funds are deposited in a bank account, as is often necessary due to the electronic nature of transactions on the internet, there will remain an audit track.  For this reason, we recommend to our clients that taxpayers always maintain records of their legal or illegal business activities .

Responding to a Dark Web Tax Audit

If the CRA does select a taxpayer for a tax audit, and they have been engaged in e-commerce utilizing the dark web, it is likely that the tax audit will result in a high tax bill, often including gross negligence penalties, and possible criminal tax evasion prosecution for the simple reason that taxpayers often do not realize the CRA’s tax audit powers, nor their rights in an audit scenario.

For example, it often comes as a surprise for taxpayers that despite the fact that their business activities are illegal, that income is still subject to the same rules as all other sources, namely the taxpayer is entitled to deduct expenses and pay tax only on the net amount of profit.

This is where proper record keeping comes in.  When the CRA audits and makes broad assumptions that 100% of any deposits are income, the taxpayer will bear the burden of showing either that the amounts are not income and thus not subject to income tax, or, that the income amount is overstated as it doesn’t take into account expenditures made to earn the illegal income.  The reason why the maintenance of proper records of all illegal business activities on the dark web is so paramount is that the CRA will in most scenarios not have any ability to retrieve this information itself, as it does in a normal business tax audit where it can procure banking and other records from third-parties.  In other words, if you want to be able to avoid a large and overinflated tax bill and the associated penalties, the smartest solution is to act as though all of your dark web activities are no different from any other business, online or otherwise.  The use of cryptocurrency such as Bitcoin or Dash does not avoid leaving a paper trail since the blockchain provides a complete ownership record.

Pro Tax Tip: Keeping Proper Records is Key for Dark Web Business Tax Audit

Should you find yourself on the end of a CRA tax audit and the auditor has discovered sources of revenue that may have come from dark web business activities, be they legal or not, reach out to our experienced Canadian tax lawyers for advice and representation.  We have decades of experience with handling tax audits of all kinds, and can provide effective representation to ensure that you are not paying a dollar more than you actually owe.  If you have not kept proper tax records we can retain an accountant to extend solicitor client privilege and work with that accountant to try to re-create your business records and prepare detailed submissions to the CRA. Our files are subject to solicitor-client privilege, as are those of accountants who are retained by us on your behalf, which provides you with an effective barrier to CRA action when strategizing about reporting “dark web” activities.

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