Taxation of the Proceeds of Fraud and Theft: A Comparative Analysis

Nick Beresford I Introduction

Is it morally appropriate for the State to use the criminal justice system to punish those who commit dishonesty offences, and on the other hand profit from these activities via the tax system? The issue of whether the proceeds of embezzlement constitute taxable income is vexing and has been grappled with by judiciaries and lawmakers worldwide. This paper sets out a comparative analysis and review of the taxation of the proceeds of fraud and theft (hereafter termed embezzlement). This will be looked at separately from the broader issue of taxation of illicit activities. Income from broader illicit activities is beyond the scope of this paper as it is well established that such income is considered no different (at least from a tax perspective) than income derived from a legitimate business.1 It is the view of the writer that the New Zealand position on the taxation of embezzlement is flawed. Furthermore, it is the writers view that there has been unsatisfactory and morally questionable amendments made to our income tax legislation. This aim of this paper is to examine the deficiencies in the law in New Zealand pertaining to the taxation of the proceeds of embezzlement. The position of other civil and common law jurisdictions will be examined and compared to New Zealands. II NZ Developments

A Taxpayer Undoubtedly the most significant decision in New Zealand in this area is the Court of Appeals decision in A Taxpayer v CIR.2 The Court of Appeals decision in A Taxpayer represents the New Zealands most comprehensive judicial discussion pertaining to the taxation of the proceeds of embezzlement. The Court of Appeal held that the funds which the taxpayer had embezzled from his employer were not taxable in his hands. In doing so the Court overturned the decision of Morris J in the High Court 3 and reinstated the decision of Willy J in the Taxation Review Authority.4

1 2

For example, see Case W27 (2003) 21 NZTC 11,276. A Taxpayer v CIR (1997) 18 NZTC 13,350 (CA). 3 A Taxpayer v CIR (1996) 17 NZTC 12,574 (HC). 4 Case Q3 (1993) 15 NZTC 5 ,033.

Taxation of the Proceeds of Fraud and Theft: A Comparative Analysis

A Taxpayer involved an accountant who embezzled funds from his employers bank accounts in order to speculate on the futures market. Over a 13 month period beginning in February 1987 he stole circa $2.3m. The taxpayer attempted to repay some of the stolen funds using profits derived from his futures trading but at the time of his arrest $831,758 remained outstanding. The Commissioner assessed the taxpayer for income tax on this amount. In finding for the taxpayer, the Court of Appeal (rather emphatically) rejected the notion that the proceeds of his fraud and theft constituted income. In doing so the Court placed much weight on two key findings. Firstly, that the proceeds of fraud and theft did not constitute income under ordinary concepts, in the absence of any statutory provision explicitly bringing them within the income tax net. Secondly, that an embezzler does not have any claim of right to stolen property and so to tax the embezzler on his proceeds would be at odds with the property law outcomes of the embezzlement. In holding that the proceeds of the embezzlement did not constitute income under ordinary concepts, the Court stated that:5
The money did not represent a profit or gain from any businessThe taxpayer was not in the business of stealing money. The taxpayer stole the money to inject it into his business of futures trading. The money was not a profit or gain derived from the carrying on of an undertaking or scheme entered into for the purpose of making a profitIf the taxpayer entered into a scheme at all it was to make profits on the futures exchange using his employer's money.

It was not denied by the taxpayer in this case that a person would be assessed on the proceeds of embezzlement if the persons business was stealing money. However, the Court found that in this case the taxpayer was not engaged in a business of stealing money:6
Although the analogy is not exact, the employer was in a sense the taxpayer's unwitting banker. In the same way as it would be quite unconvincing to say that a person who relies on bank finance to run their business is also in the business of borrowing money, so it is unconvincing to say that the present taxpayer was also in the business of stealing money.

In considering the property law concepts inherent in embezzlement, the Courts main comments were that the taxpayer had never derived the proceeds of his embezzlement beneficially:7
5 6

A Taxpayer v CIR, above n 2, at 13,350. Ibid, at 13,367. 7 Ibid, at 13,350.

Taxation of the Proceeds of Fraud and Theft: A Comparative Analysis

An embezzler does not have any claim of right to stolen property. In the absence of a specific statutory provision allowing for a recharacterisation of the misappropriation receipt for tax purposes, the ordinary rules apply. There is no gain to a taxpayer unless the receipt is derived beneficially by the taxpayer. Taxation by economic equivalence is impermissible.

The Court went on to state further: 8

The money stolen was not income in the taxpayer's hands at all. That money was, from the moment it was stolen, held in trust by the taxpayer for his employer. The taxpayer therefore never held it beneficially. To the extent the taxpayer made a gain from the theft, that gain was matched by an equal obligation to repay the employer. The taxpayer owed concurrent obligations to his employer; an obligation as constructive trustee, and an obligation as debtor in equity.

In the writers view, the arguments put forward by the Court of Appeal were persuasive, logical and well founded on established taxation and property law principles. The Court put forward many valid criticisms of the Commissioners submissions and the decision of Morris J in the High Court. Legislative Overturning In response to the Court of Appeals decision in A Taxpayer, the Government introduced a provision which explicitly overturned the Court of Appeals ruling. This new provision was s CD 6 (1) of the Income Tax Act 19949:
The gross income of a person is deemed to include an amount equal to the market value of property the possession or control of which that person obtained without claim of right.

On the other hand, a corresponding tax deduction became permitted for restitution made to the victim:10
In an income year in which the person makes restitution..the person is allowed as a deduction an amount equal to the amount of restitution made to a person beneficially entitled to the property.

These provisions have been replicated in the subsequent 200411 and 200712 re-writes of the Income Tax Act.
8 9

Ibid, at 13,368. Enacted via the Taxation (Tax Credits, Trading Stock, and Other Remedial Matters) Act 1998. 10 Income Tax Act 1994, s DJ 18.

Taxation of the Proceeds of Fraud and Theft: A Comparative Analysis

III

USA

One of the earliest USA authorities regarding the taxation of embezzlement is the US Supreme Court decision of Commissioner v Wilcox.13 The taxpayer in question was a bookkeeper (with a gambling addiction) whom misappropriated circa $13,000 from his employer and promptly lost the money in a casino. He was assessed for income tax on this sum. The key issue before the Court was whether the $13,000 constituted taxable income to the embezzler under Section 22(a) of the Internal Revenue Code, namely that the embezzled funds constituted gains or profits and income derived from any source whatever.14 In finding for the taxpayer, the Supreme Court held that:15
A taxable gain is conditioned upon (1) the presence of a claim of right to the alleged gain and (2) the absence of a definite, unconditional obligation to repay or return that which would otherwise constitute a gain.Where an embezzler receives the embezzled money without any semblance of a bona fide claim of right and remains under an unqualified duty and obligation to repay, the embezzled money does not constitute taxable income.

The Supreme Court left no doubt that the application of embezzled funds towards an income earning activity would bring the gains produced from that activity within the income tax net:
Nor can taxable income accrue from the mere receipt of property or money which one is obliged to return or repay to the rightful owner, as in the case of a loan or credit. Taxable income may arise, to be sure, from the use or in connection with the use of such property. Thus, if the taxpayer uses the property himself so as to secure a gain or profit therefrom, he may be taxable to that extent.16

It is pertinent to note that the Wilcox case contained a dissenting judgment from Burton J who would have held that the embezzled sum constituted taxable income to the taxpayer. Burton J criticised the Courts majority decision on the basis they had misinterpreted the statutory wording of 22(a). In particular he criticised the reasoning of the majority opinion which stated that gains arising without claim of right were not caught by 22(a):17
The embezzler's complete possession of the embezzled funds, his exercise of dominion over them to the extent of disposing of every cent of them and his transfer of possession of them to others in such a manner as to give the recipients title to them, amounts to such
11 12

Income Tax Act 2004, s CB 28 and s DB 35. Income Tax Act 2007, c CB 32 and s DB 44. 13 Commissioner v. Wilcox, 327 U. S. 404 (1946). 14 Internal Revenue Code 1939 22(a). 15 Commissioner v. Wilcox, n at 12, at 327. 16 Ibid. 17 Ibid, at 413.

Taxation of the Proceeds of Fraud and Theft: A Comparative Analysis

an ample enjoyment of them, use of them, dominion over them, disposition of them and receipt of benefits from them as to make them of obvious economic value to the embezzler. Such a readily realizable value presents no reasonable basis for exempting these funds from taxation that would be applied to them if earned in a lawful manner.

James The decision of the US Supreme Court in James v United States18 discussed the taxation of the proceeds of fraud and theft. The taxpayer in this case was a union official whom had embezzled the sum of $738,000 from his employer over a 3 year period and had been assessed by the IRS for federal income taxes on this amount. In expressly overruling the earlier Supreme Court decision in Wilcox which had held that stolen funds did not constitute income, the Court held that the embezzled funds constituted income to the taxpayer. The key legal issue to be decided by the Court was whether embezzled funds came within the definition of gross income for the purposes of the 193919 and 195420 Internal Revenue Codes, namely whether the funds constituted gains or profits and income derived from any source whatever21 or income from whatever source derived.22 In holding that the embezzled funds did constitute income to the taxpayer, the Court stated that:23
We should not continue to confound confusion [in regards to the Wilcox decision], particularly when the result would be to perpetuate the injustice of relieving embezzlers of the duty of paying income taxes on the money they enrich themselves with through theft while honest people pay their taxes on every conceivable type of income.

The majority opinion developed what the writer would term a legal reality approach which focusses on the absolute dominion (if not legal entitlement) which an embezzler holds over their misappropriated funds. The majority judgment were obviously influenced with comments made by the Supreme Court in an earlier decision of Commissioner v. Glenshaw Glass Co24 where the Court commented on the broad meaning of 61(a) of the Internal Revenue Code 1954:25
.all income from whatever source derived has been held [in Glenshaw] to encompass all accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.
18

James v United States 366 US 213 (1961). Internal Revenue Code 1939. 20 Internal Revenue Code 1954. 21 Internal Revenue Code 1939 22(a). 22 Internal Revenue Code 1954, 61(a). 23 James v United States, n at 17, at 220. 24 Commissioner v. Glenshaw Glass Co., 348 U. S. 426 (1955). 25 James v United States, n at 17, at 219.
19

Taxation of the Proceeds of Fraud and Theft: A Comparative Analysis

The decision in James was countered by a spirited minority dissent by Justices Black, Douglas and Whittaker. In criticising the majority view that the embezzled funds constituted taxable income, the Court stated that Our trouble with this aspect of the Court's action is that it seems to us to indicate that the Court has passed beyond the interpretation of the tax statute and proceeded substantially to amend it.26 The dissenting judgment was also critical of the Courts interpretation of their prior decision in Wilcox:
The Chief Justices opinion, although it correctly recites Wilcox's holding that embezzled money does not constitute taxable income to the embezzlerfails to explain or to answer the true basis of that holding. Wilcox did not hold that embezzled funds may never constitute taxable income to the embezzler. To the contrary, it expressly recognized that an embezzler may realize a taxable gain to the full extent of the amount taken if and when it ever becomes his.27

The dissenters further criticised the legal realities doctrine advocated by the majority judgment:28
Since any consideration which may have passed is not legally recoverable, its recipient has realized a taxable gain, an "accession to income," as clearly as if his "indebtedness" had been discharged by a full release or by the running of a statute of limitations. As we have already shown at length, quite the opposite is true when an embezzlement occurs; for then the victim acquires an immediately ripe and enforceable claim to repayment, and the embezzler assumes a legal debt equal to his acquisition.

IV

Canada

Developments by the Canadian judiciary in this area have tended to closely follow the decisions of their neighbours. Indeed the Court of Appeal in A Taxpayer stated that:29
It seems clear [that] Canada is much influenced by the accretion to wealth approach of the majority in James, and by what the Canadian Judges have called the realities of the situation.

26 27

Ibid at 224. Ibid at 249. 28 Ibid at 255. 29 A Taxpayer v CIR, n at 2, at 13,363.

Taxation of the Proceeds of Fraud and Theft: A Comparative Analysis

The two leading Canadian cases on the taxation of embezzlement proceeds are R v Poynton30 (which was the first case on this point in Canadian legal history) 31 and Buckman v Minister of National Revenue.32 Poynton The Poynton case involved an employee who, via an accomplice, defrauded his employer of the sum of $21,000 via the issue of fake invoices. The Canadian Department of National Revenue assessed the taxpayer for income tax on the fraudulently obtained sum. The Supreme Court of Ontario overturned the decision of the trial court and found that the embezzled funds constituted taxable income in the hands of the taxpayer. In doing so the Court were clearly persuaded by the reasoning in James:33
Strict legal ownership of money was not the exclusive test of its taxability; regard must be had for the circumstances surrounding its receipt and the manner in which it was held. Adopting the ratio decidendi of the majority judgment in James v. United States (infra), the embezzled funds were to be viewed as part of the taxpayer's income, within the allembracing definition of income in section 3.

The Poynton case is very interesting and important in a comparative analysis of taxation of embezzlement in the writers view. This is because the Court discussed property law outcomes and constructive Trusts which conflict with the comments of the Court of Appeals decision in A Taxpayer (bearing in mind Poynton preceded A Taxpayer by circa 25 years):34
If one receives money under a trust for another, he is under an obligation to turn over the proceeds to his cestui que trust. If he does so then he fulfils his duty and no question of taxability qua trustee arises. If however, in breach of his duty to account, the trustee converts to his own use he is taxable, not on the basis that the quality of the money or his entitlement thereto has changed, but on the basis that the manner of holding has altered. The moneys are still trust moneys and the trustee is liable in law to account but because of the theft or conversion the trustee in reality holds the money for his own account. The fact that a defaulting trustee may be called upon to return his ill-gotten benefits flows from his relationship to his cestui que trust while his taxability results from the manner in which he actually holds the benefit.

The passage above is interesting as the discussions regarding constructive trusts and the requirement in equity to account for the embezzlers ill-gotten gains is entirely consistent
30 31

R v Poynton [1972] CTC 411. Ibid at 417. 32 Buckman v Minister of National Revenue [1991] 2 CTC 2608. 33 R v Poynton, n at 29, at 411. 34 Ibid at 419.

Taxation of the Proceeds of Fraud and Theft: A Comparative Analysis

with the Court of Appeals statements in A Taxpayer. However, there is a clear difference in opinion between the Courts in respect of the tax outcomes of holding the embezzled property under a constructive trust for the victim. The Supreme Court of Ontario, as demonstrated in the above passage, are of the view that embezzled funds held in a constructive trust for a victim are nonetheless taxable to the trustee on the basis that the trustee has converted the funds to their person use. This is at odds with the Court of Appeals comments in A Taxpayer where it was stated that although the money was held in trust by the taxpayer for his employer from the time it was stolen, The money stolen was not income in the taxpayer's hands at all.35 The decision in Poynton is also significant in the writers opinion for the public policy arguments advanced by the taxpayer. Whilst these arguments were ultimately dismissed by the Court as self-serving and disingenuous, they are nonetheless interesting and worthy of note. They also serve to highlight the moral and practical issues inherent in the taxation of embezzlement proceeds:36
It was argued on behalf of the respondent that there is something repugnant in the taxation of moneys in the hands of a thief because it places the rightful owner in contestation with government over money which properly belongs to him. Whatever merit there may be in such argument, it hardly lies in the mouth of the thief to advance it. The solicitude of a thief for the financial welfare of his victim must be viewed with suspicion and my only observation is that in practice the likelihood of such a contestation would infrequently arise and in any event it is a legislative rather than a judicial problem.

Buckman The Buckman case concerned a solicitor who embezzled circa $522,000 from clients over a 3 year period. He was assessed for income tax on this amount by the Canadian revenue authorities. He contended that the proceeds of his embezzlement did not constitute taxable income to him on the basis that he had merely borrowed the funds from his clients. The taxpayer put forth the argument that under generally accepted accounting principles (GAAP) a liability back to his clients was created as a result of the purported loans and he therefore had no net income. The Tax Court of Canada, via the presiding Judge Sobier T.C.J rejected the proposition by the taxpayer that the stolen funds were in fact loans from his clients. The Court also rejected the notion that GAAP could or should prevail over the Courts task at hand, which was to

35 36

A Taxpayer v CIR, n at 2, at 13,368. R v Poynton, n at 29, at 419.

Taxation of the Proceeds of Fraud and Theft: A Comparative Analysis

decide the taxability of the embezzled funds based on reference to income tax statute. The Court stated that:37
The appellant received the money, appropriated it unto himself and used and enjoyed it for his own benefit. It was never treated by him as a loan. There was no intention to repay the Funds. Mr Buckman was engaged in an ongoing, long term scheme to steal from his clients. In reality, he intended to hold the Funds for his own account and did so in fact.

The Buckman decision is interesting because the Court held that the embezzled funds were taxable not only due to the well-established earlier precedent set in Poynton. The Court also found that due to the ongoing nature and repetition of the embezzlement, the taxpayer was actually engaged in a business of embezzlement (which differs from most of the other cases cited in this paper):38
The fact that the funds are to be treated as income flows from the realities of the situation.... Mr Buckman was engaged in a business [being the business of embezzlement] separate and apart from his law practice and mortgage broker's activities and what he received from this business was income.... The funds received were income from a business and therefore taxable. This was the reality of the situation

The Court comments further demonstrated the differences between the North American approach and the New Zealand approach to deciding the taxability of embezzlement proceeds. The decision in Buckman re-emphasised that the North American approach was to decide taxability based on economic and legal realities, rather than the A Taxpayer approach which was to examine taxability based on whether embezzled funds constituted income under ordinary concepts. Indeed the Court in Buckman stated that The fact that the funds are to be treated as income flows from the realities of the situation.39 This is in stark contrast with the comments of the Court of Appeal that "taxation by economic equivalence is impermissible.40 V Australia

The leading Australian authority on the taxation of embezzlement proceeds is the decision of Burchett J in Zobory v Commissioner of Taxation.41 The Zobory case had a very similar fact situation to A Taxpayer. The taxpayer in question was an accountant whom stole circa $1m from his employer and then invested the funds in interest bearing bank accounts. The funds
37 38

Buckman v Minister of National Revenue, n at 31, at 2616. Ibid, at 2617. 39 Ibid. 40 A Taxpayer v CIR, n at 2, at 13,350. 41 Zobory v FC of T 64 FCR 86.

Taxation of the Proceeds of Fraud and Theft: A Comparative Analysis

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were mixed with a relatively small amount of his personal funds. The Commissioner of Taxation included the interest received from the deposits in the taxpayers personal tax returns. The taxpayer made an unsuccessful bid to overturn the assessments in the trial Court, and then appealed, where he was successful. This case is notable as at no time did the Commissioner attempt to assess the original stolen sum as income of the taxpayer. Because of this, this case is perhaps less helpful in a broad discussion regarding the taxation of embezzlement. However, the Court did make valuable statements regarding the income tax outcomes of a constructive trust arising as a result of the taxpayers embezzlement. The issue at hand was:
whether the income represented by the interest, although fully disgorged to the rightful owner of the moneys, is nevertheless taxable as the income of the applicant [i.e. the defendant] himself.42

This case is also analogous to A Taxpayer in that the stolen funds were invested and a return derived on the investment which undoubtedly had the character of income. However, the Court in Zobory held that in applying principles of equity, such income was actually derived by the victim beneficially as a result of a constructive trust and did not therefore constitute taxable income to the embezzler:
a constructive trust, as well as an express trust or resulting trust, would be fully effective to divert the liability to income tax to the beneficiaryThe taxpayer was a fiduciary and held the moneys and the interest on constructive trust for the employer . 43

VI

Philosophy

As the authorities cited from other jurisdictions have shown, there have been significant divergences of opinion on how to tackle the taxability of the embezzlers proceeds. It is the writers view that the Court of Appeal decision in A Taxpayer (putting aside for a moment its subsequent legislative overturning) represents a much more logical, principled and sensible approach at statutory interpretation and broader public policy decision-making than that of their American and Canadian judicial colleagues. There are several reasons why the writer believes this is so, including the morality of State competing for the proceeds of embezzlement; the fact that imposing a tax embezzlement and allowing a corresponding deduction for restitution will often provide State with a timing advantage only; ordinary capital versus income distinctions; and the on the the

42 43

Ibid at 90. Ibid at 91.

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divergence of tax treatment of embezzlement from the underlying equitable remedies arising from such embezzlement. State Competing with Victim It is submitted that by taxing the proceeds of embezzlement, and thereby levying a cost on the embezzler, the State is in fact competing with (or even trumping) any equitable rights of restitution which may be available to the victim. Regardless of any causes or action or equitable remedies (such as a constructive trust) which a victim may have against an embezzler, the writer can think of none which would rank above a statutory tax impost on the embezzler. This raises a very interesting moral dilemma. As was discussed in the case of McKnight v Commissioner:44
Moreover, the direct result of such a doctrine [that the proceeds of embezzlement are taxable] would be that the United States would assert a preferential claim for part of the dishonest gain, to the direct loss and detriment of those to whom it ought to be restored. If the sum were large enough, the United States might take half. We do not believe the income tax laws are intended to raise any such competition.45

The dissenting judgment in James was also wary of the mischief that would be enacted by putting the State in competition against a victim:46
The fact that an embezzler's victim may have less chance of success than other creditors in seeking repayment from his debtor is not a valid reason for us further to diminish his prospects by adopting a rule that would allow the Commissioner of Internal Revenue to assert and enforce a prior federal tax lien against that which "rightfully and completely belongs" to the victim. It was recognised in A Taxpayer that: The exclusion of stolen money or other property from the tax net is consistent with wider public policies. The imposition of a fine is the traditional means of hitting felons in their pockets. Sentencing policy under New Zealand law also emphasises the importance of reparation. Whatever the position in other jurisdictions, there is no room for approaching the taxability of the thief's receipt on the premise that the thief will not in practice be called on to make reparation.47

Timing Advantage
44 45

McKnight v. Commissioner, 127 F.2d 572 (1942). Ibid at 574. 46 James v United States, n at 17, at 252. 47 A Taxpayer v CIR, n at 2, at 13,350.

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In the writers view the fact that an embezzler is allowed a corresponding deduction for restitution made to a victim (both under common law and now, in New Zealand, under DB 44 of the Income Tax Act) serves to negate much of the revenue gathering efficiency of CB 32. The writer agrees that it would be unjust to tax an embezzler on their proceeds but now allow a corresponding deduction for restitution. However, it is submitted that given embezzlement is now taxable under CB 32, when coupled with the fact that the legal title in stolen property does not pass to the embezzler (and the stolen property will in all likelihood be ordered to be repaid through civil action or equitable remedy) this makes for a strange state of affairs. In some cases it is likely that all the State will receive is a timing advantage by levying a tax impost in one year but having some or all the impost effectively reversed in the following year by an allowable deduction. It would seem that the State will benefit more in a situation where the embezzler has in fact dissipated all the embezzled funds and so is therefore incapable of carrying out any restitution orders. It would seem like a strange moral situation where the Revenue is going to benefit the most where an embezzler dissipates some or all of the misappropriated funds to the extent that little or no restitution is able to be paid. Capital v Income Distinctions In the writers view the decision in A Taxpayer was also far more logical than the corresponding USA and Canadian decision in respect of traditional capital versus income distinctions. The writer finds the submissions for the taxpayer in Case Q3 (the Taxation Review Authority hearing of A Taxpayer) to be most persuasive on this point. Judge Willy in the Taxation Review authority agreed with counsels submission, which was as follows:48
The writing out of cheques by the objector in his own favour did not produce income according to ordinary concepts but merely a transfer of capital, and a non-consensual transfer at that, from one person to another. The act of stealing money, by whatever means, does not have any income tax consequences because no property is brought from, nor any services performed for any other person. Judge Willy endorsed the submissions made by counsel for the taxpayer in response: The fact is that the objector is absolutely obliged in law to repay the stolen money to the extent that he is able. Such an obligation is inconsistent with any notion of the money being "assessable income" in the hands of the objector. He rendered no services for it, it is not paid to him pursuant to any obligation which the employer may have had. He has

48

Case Q3, n at 3, at 5,043.

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no right title or interest in that money and it is clearly outside the definition of "monetary remuneration.49

The capital v income distinction was not discussed at length in the Court of Appeal, other than to tacitly endorse Judge Willys comments and to criticise the comments made by Morris J which endorsed the North American approach. The Court of Appeal also endorsed the comments made by Judge Willy that the stolen funds constituted fixed capital in the hands of the taxpayer. Such funds were converted into circulating capital when used on the futures market, and only then did the fruits of the circulating capital become taxable. As was discussed in the case of BP Australia Ltd v C of T of the Commonwealth of Australia:50
Fixed capital is prima facie that on which you look to get a return by your trading operation. Circulating capital is that which comes back in your trading operations.51

It is submitted that this approach is superior to the Northern American legal reality approach. The Court of Appeal attempted (successfully in the writers opinion) to decide whether embezzled funds constituted income according to ordinary concepts in the absence of any specific legislative provision bringing them within the tax net. On the other hand, their judicial colleagues in Canada and the USA appear to have departed from a traditional exclusionary52 approach to statutory interpretation of tax legislation and adopted a more activist approach. The undesirability of this activism and the departure from previously established taxation concepts was emphasised by the dissenting judgment in James:53
But embezzled funds, like stolen property generally, are not "earnings" in any sense, and are held without a vestige of a colorable claim of right; they constitute the principal of a debt. Of no significance whatever is the formality of "consensual recognition, express or implied" of an obligation to repay. By substituting this meaningless abstraction.t he prevailing opinion today goes far beyond overruling Wilcox - it reduces a substantial body of tax law into uncertainty and confusion.

It is likely that the Inland Revenues response to the assertions in this paper would be to say that the Government has legislatively overturned case law before to change the tax treatment of a receipt which the Courts had found to constitute capital. 54 Although this has brought certainty by imposing a blanket rule that the proceeds of embezzlement are taxable it is still not satisfactory law-making in the writers opinion.
49 50

Ibid. BP Australia Ltd v C of T of the Commonwealth of Australia [1966] AC 224 (PC). 51 Ibid at 265-266. 52 See for example FCT v Westraders Pty Ltd (1980) 80 ATC 4357. 53 James v United States, n at 17, at 257. 54 For example, see CH 2 Of ITA 1994, which was inserted by Taxation (Beneficiary Income of Minors, Services-Related Payments and Remedial Matters) Act 2001 in response to the decision in Henwood v CIR (1995) 17 NZTC 12,271.

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Equity and Property Law Concepts The North American approach to tax an embezzler based on the legal reality of the situation and the embezzlers purported dominion over the funds is in the writers view irreconcilably at odds with the equitable outcomes of embezzlement. At equity, from the point of embezzlement the misappropriated funds are held in a constructive trust for the rightful owner of the property. As was mentioned in A Taxpayer, From the moment the money was stolen it was held in trust by the taxpayer for his employer. The taxpayer never held it beneficially.55 Contrast this with the Courts comments in Poynton:56
The principle as I apprehend it, is that strict legal ownership is not the exclusive test of taxability but that a court in determining what is income for taxation purposes must have regard to the circumstances surrounding the actual receipt of the money and the manner in which it is held.

Analogies made in A Taxpayer regarding the victim being the embezzlers unwitting banker57 further underline the inevitable equitable remedies that would flow from civil action or an action in equity. Such comments are clearly at odds with the North American cases cited in this paper which focus on the control or dominion exercised by the embezzler over the funds:
A gain constitutes taxable income when its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it.58

The dissenting judgment in James was highly critical of this approach:59

An embezzler, like a common thief, acquires not a semblance of right, title, or interest in his plunder, and, whether he spends it or not, he is indebted to his victim in the full amount taken as surely as if he had left a signed promissory note at the scene of the crime.

In the writers view the North American approach is illogical. It seems bizarre to treat misappropriated property as for all intents and purposes remaining in the beneficial ownership of the victim, but to nonetheless levy a tax impost on the embezzler. In the

55 56

A Taxpayer v CIR, n at 2, at 13,350. R v Poynton, n at 29, at 418. 57 A Taxpayer v CIR, n at 2, at 13,368. 58 Commissioner v. Glenshaw Glass Co., 348 U. S. 426 (1955) cited with approval in James at 219. 59 James v United States, n at 17, at 251.

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writers opinion the North American decisions have been based of an incorrect and inconsistent view of property rights and equity. VII Conclusion

In the writers view, the Governments enactment of CD 6 (1) (now CB 32) to bring New Zealand into line with the North American approach represents a victory for short sighted reactive law-making over both principled, logical statutory interpretation and desirable public policy. The Court of Appeals decision in A Taxpayer was founded upon well-constructed, logical and (in the writers opinion) non-controversial statutory interpretation and policy grounds. In the writers view this decision constituted clearly superior and clearer law than the approach taken by the US and Canadian Courts. In contrast, the North American Courts have departed from a structured enquiry as to whether embezzled funds constitute income under ordinary concepts, in the absence of specific statutory direction. They have attempted to read into tax legislation distinctions between embezzlement and the lending of money which whilst appearing logical in theory, do not practically exist in the world of restitution, civil, and equitable remedies. Of course, now that section CB 32 is firmly in place a return to the state of law at the time of the A Taxpayer decision does not look likely. Nonetheless the writer maintains that the state of affairs brought in by the enactment of CB 32 is unsatisfactory. The enactment of s CB 32 places the State in direct competition with the victim for embezzled funds. It is contrary to long established common law concepts of capital and income. Finally, it is irreconcilable with the legal outcomes of restitution, viz civil action and equitable remedies. It is the writers view that the enactment of s CB 32 is reactive law-making at its worst. It has overturned carefully considered and robust statutory interpretation by the judiciary in A Taxpayer. Whilst it has not the first time Parliament has overturned tax legislation to redefine the capital versus income distinction, it is a bad precedent to have set and represents a fundamental lack of understanding (or contempt of) the Court of Appeals well considered decision.

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Bibliography
Statutes Income Tax Act 1994. Income Tax Act 2004. Income Tax Act 2007. Taxation (Tax Credits, Trading Stock, and Other Remedial Matters) Act 1998. Internal Revenue Code 1939. Internal Revenue Code 1954. Cases A Taxpayer v CIR (1997) 18 NZTC 13,350 (CA). A Taxpayer v CIR (1996) 17 NZTC 12,574 (HC). Case W27 (2003) 21 NZTC 11,276. Case Q3 (1993) 15 NZTC 5 ,033. Europa Oil (NZ) Ltd v C of IR [1976] 1 NZLR 546. Partridge v Mallandaine (Surveyor of Taxes) (1886) 18 QBD 276. Commissioner v. Glenshaw Glass Co., 348 U. S. 426 (1955). Commissioner v. Wilcox, 327 U. S. 404 (1946). James v United States 366 US 213 (1961). McKnight v. Commissioner, 127 F.2d 572 (1942). Rutkin v. United States, 343 U.S. 130 (1952). BP Australia Ltd v C of T of the Commonwealth of Australia [1966] AC 224 (PC). FC of T v La Rosa [2003] FCAFC 125 FCT v Westraders Pty Ltd (1980) 80 ATC 4357. Zobory v FC of T 64 FCR 86. Buckman v Minister of National Revenue [1991] 2 CTC 2608. R v Poynton [1972] CTC 411. Journal Articles Bell, R.E Taxing the Proceeds of Crime (Journal of Financial Crime, Vol. 8 Iss: 2 1993).

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Chan, Winnie and Simester, Andrew Tax, Equity and the Priority of Property Law (Vol 8:1 NZJTLP 24 2000). Gupta, Ranjana Taxation of Illegal Activities in New Zealand and Australia (Journal of the Australasian Tax Teachers Association 2008 Vol.3 No.2). Lund, Siska Deductions Arising From Illegal Activities (Revenue Law Journal: Vol. 13: Iss. 1, Article 7 2003). Wallace, Robert Taxation of the Proceeds of Embezzlement (Vol 2:4 NZJTLP 201 1996).