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Tax Implications of Ponzi Scheme Losses: What You Need to Know

Tax Implications of Ponzi Scheme Losses

Key Takeaways

  • A Ponzi scheme is a fraudulent investment scheme that pays returns to investors from their own money or the money of new investors, rather than from actual profits.
  • Ponzi schemes are illegal and can result in criminal charges, civil claims, and tax liabilities for both the operators and the investors.
  • Crypto assets, such as Bitcoin and Ethereum, are not recognised as legal tender or financial instruments in South Africa, but they are subject to income tax and capital gains tax according to the existing tax framework.
  • Investors who lose money in Ponzi schemes involving crypto assets may not be able to claim a deduction or a capital loss for their losses, unless they can prove that they incurred the losses in the production of income or in the course of carrying on a trade.
  • Investors who recover money from Ponzi schemes or receive distributions from liquidators or receivers may have to include the recovered amount as gross income in their tax returns, depending on whether they previously declared and paid tax on their income from the scheme or not.
  • Investors who donate money to victims of Ponzi schemes may be able to claim a deduction for their donations, if they meet certain requirements, such as donating to a registered public benefit organisation or a qualifying relief fund.
  • Investors who receive donations from victims of Ponzi schemes may have to include the donations as gross income in their tax returns, depending on whether they previously declared and paid tax on their income from the scheme or not.
  • Investors who settle claims with Ponzi scheme operators or other parties may have to include the settlement amount as gross income in their tax returns, depending on whether they previously declared and paid tax on their income from the scheme or not.
  • Investors should comply with the tax laws and regulations and report all income and losses from Ponzi schemes accurately and timeously, or they may face penalties and interest for underreporting their income.
  • Investors should seek professional advice from a reputable cloud accounting and tax consulting firm, such as Thrive CFO, to help them with their tax affairs and to avoid potential pitfalls and penalties.

Introduction

If you are an investor who has been lured by the promise of high returns and low risk in an investment scheme that turned out to be a Ponzi scheme, you may be wondering what are the tax implications of your Ponzi scheme losses. You may also be wondering what are the tax implications of any money that you may recover from the scheme or receive from other sources, such as donations, distributions, or settlements.

A Ponzi scheme is a fraudulent investment scheme that pays returns to investors from their own money or the money of new investors, rather than from actual profits. The scheme relies on a constant inflow of new investors to sustain itself, but eventually collapses when the inflow dries up or when the operators abscond with the money. Ponzi schemes are illegal and can result in criminal charges, civil claims, and tax liabilities for both the operators and the investors.

In recent years, South Africa has seen a surge of Ponzi schemes involving crypto assets, such as Bitcoin and Ethereum. Crypto assets are digital representations of value that are not issued by any central authority or backed by any legal tender. They are traded on online platforms and can be used for various purposes, such as payments, investments, or speculation. Crypto assets are not recognised as legal tender or financial instruments in South Africa, but they are subject to income tax and capital gains tax according to the existing tax framework.

Some of the most notorious Ponzi schemes involving crypto assets in South Africa include:

  • Mirror Trading International (MTI): MTI was a company that claimed to offer automated trading services using Bitcoin. It promised investors returns of up to 10% per month and operated a referral system that rewarded investors for recruiting new members. MTI collapsed in December 2020 after it was placed under provisional liquidation by the High Court. It is estimated that MTI defrauded about 280 000 investors worldwide of more than R10 billion.
  • BTC Global: BTC Global was a company that claimed to offer investment services using Bitcoin. It promised investors returns of up to 14% per week and operated a referral system that rewarded investors for recruiting new members. BTC Global collapsed in February 2018 after its founder, Steven Twain, disappeared with more than R600 million .
  • Finalmente Global: Finalmente Global was a company that claimed to offer advertising services using Bitcoin. It promised investors returns of up to 106% after 40 days and operated a referral system that rewarded investors for recruiting new members. Finalmente Global collapsed in January 2021 after it was placed under provisional liquidation by the High Court. It is estimated that Finalmente Global defrauded about 210 000 investors worldwide of more than R4.8 billion.

 

In this article, we will discuss the tax implications for investors who lose money in Ponzi schemes involving crypto assets, as well as the tax implications of any money that they may recover from the scheme or receive from other sources. We will also provide some tips and recommendations on how to comply with the tax laws and regulations and avoid potential pitfalls and penalties.

The legal status of Ponzi schemes and crypto assets in South Africa

Before we delve into the tax implications of Ponzi scheme losses, it is important to understand the legal status of Ponzi schemes and crypto assets in South Africa.

Ponzi schemes are illegal and fraudulent activities that violate various laws and regulations, such as the Financial Advisory and Intermediary Services Act, the Financial Intelligence Centre Act, and the Prevention of Organised Crime Act. These laws and regulations aim to protect consumers from financial crimes, money laundering, terrorist financing, and organised crime. They also require financial service providers to be licensed, registered, and supervised by the relevant authorities, such as the Financial Sector Conduct Authority (FSCA) and the South African Reserve Bank (SARB).

Investors who participate in Ponzi schemes may face criminal charges, civil claims, and tax liabilities, regardless of whether they knew about the fraudulent nature of the scheme or not. They may also lose their entire investment or only recover a fraction of it, depending on the outcome of the liquidation or receivership process. Investors who are victims of Ponzi schemes should report their losses to the FSCA, the SARB, the South African Police Service (SAPS), and the National Consumer Commission (NCC).

Crypto assets are not recognised as legal tender or financial instruments in South Africa, but they are subject to income tax and capital gains tax according to the existing tax framework. This means that investors who trade or invest in crypto assets must declare and pay tax on their income or gains from these transactions, as well as keep records of their transactions for tax purposes.

The SARB has issued a position paper on crypto assets in 2014, which outlines its views and approach towards these assets. The position paper states that:

  • The SARB does not oversee, supervise, or regulate crypto assets or platforms.
  • The SARB does not endorse or guarantee crypto assets or platforms.
  • The SARB does not provide any legal protection or recourse for users or investors of crypto assets or platforms.
  • The SARB does not consider crypto assets to be currency or money.
  • The SARB considers crypto assets to be digital representations of value that are not issued by a central authority.
  • The SARB advises users and investors of crypto assets to exercise caution and be aware of the risks involved.

The SARB, together with other regulators, such as the FSCA, the National Treasury, and the South African Revenue Service (SARS), has also established a Crypto Assets Regulatory Working Group (CARWG) in 2018, which aims to develop a regulatory framework for crypto assets in South Africa. The CARWG has published a consultation paper on crypto assets in 2019, which proposes a phased approach to regulate crypto assets in South Africa. The consultation paper proposes that:

  • Crypto asset service providers (CASPs), such as exchanges, wallets, brokers, and advisors, should be registered with a designated authority and comply with certain requirements, such as anti-money laundering and counter-terrorism financing rules.
  • Crypto asset activities should be included in the scope of existing financial sector laws, such as the Financial Markets Act and the Collective Investment Schemes Control Act.
  • Crypto asset users should be provided with adequate disclosure and consumer protection measures.
  • Crypto asset taxation should be aligned with the existing tax framework.

The CARWG is currently working on finalising its recommendations and drafting legislation to implement its proposals. Until then, crypto asset users and investors should follow the existing tax framework and guidance issued by SARS.

7 Tax Implications of Ponzi Scheme Losses

The tax treatment of income received from Ponzi schemes

One of the first questions that investors who are involved in Ponzi schemes may have is how to treat their income received from these schemes for tax purposes.

The answer is that any income received from Ponzi schemes, whether in cash or in crypto assets, is taxable as gross income in the hands of the investors, regardless of whether they knew about the fraudulent nature of the scheme or not.

This is because gross income is defined as “the total amount, in cash or otherwise, received by or accrued to or in favour of any person” , which includes any amount received from …

The tax treatment of losses incurred from Ponzi schemes

Another question that investors who are involved in Ponzi schemes may have is how to treat their losses incurred from these schemes for tax purposes.

The answer is that investors who lose money in Ponzi schemes may not be able to claim a deduction or a capital loss for their losses, unless they can prove that they incurred the losses in the production of income or in the course of carrying on a trade.

This is because deductions and capital losses are only allowed for expenses or losses that are incurred for the purposes of trade, which is defined as “every profession, trade, business, employment, calling, occupation or venture, including the letting of any property and the use of or the grant of permission to use any patent as defined in the Patents Act, 1978 (Act No. 57 of 1978), or any design as defined in the Designs Act, 1993 (Act No. 195 of 1993), or any trade mark as defined in the Trade Marks Act, 1993 (Act No. 194 of 1993), or any goodwill attached thereto” .

Investors who are not in the business of lending money or investing in crypto assets may not be able to establish a nexus between their losses and their income or trade, and therefore their losses may be considered capital in nature. Capital losses can only be offset against capital gains, and not against other types of income. Capital losses that exceed capital gains in a year of assessment can be carried forward to subsequent years, but they cannot be carried back to previous years.

Investors who are in the business of lending money or investing in crypto assets may be able to claim a deduction or a capital loss for their losses, but they will have to provide sufficient evidence to support their claim, such as contracts, invoices, receipts, bank statements, and correspondence with the scheme operators. They will also have to show that they applied the principles of financial accounting and tax law consistently and correctly when determining their income or gains and expenses or losses from these transactions.

The following table summarises the tax treatment of losses incurred from Ponzi schemes for different types of investors:

Type of investor Nexus with income or trade Tax treatment of losses
Not in the business of lending money or investing in crypto assets No Capital loss
In the business of lending money or investing in crypto assets Yes Deduction or capital loss

The tax implications of recovering money from Ponzi schemes

A third question that investors who are involved in Ponzi schemes may have is how to treat any money that they may recover from these schemes for tax purposes.

The answer is that investors who recover some or all of their money from Ponzi schemes may have to include the recovered amount as gross income in their tax returns, depending on whether they previously declared and paid tax on their income from the scheme or not.

This is because gross income includes any amount received by way of recoupment, which is defined as “any amount received by or accrued to any person by way of recovery or recoupment (whether directly or indirectly) by such person (other than by way of damages) in respect of any allowance granted to him under this Act” .

Investors who previously declared and paid tax on their income from the scheme may be able to claim a deduction or a capital loss for the amount recovered, if they can show that they suffered a loss when they invested in the scheme. This is because deductions and capital losses are allowed for recoupments that relate to expenses or losses that were incurred for the purposes of trade.

Investors who did not previously declare and pay tax on their income from the scheme may have to pay tax on the full amount recovered, as well as penalties and interest for underreporting their income. This is because recoupments that relate to income that was not declared or taxed are fully taxable and subject to penalties and interest.

The following table summarises the tax implications of recovering money from Ponzi schemes for different types of investors:

Type of investor Declared and paid tax on income from scheme Tax implications of recovery
Not in the business of lending money or investing in crypto assets Yes Gross income minus capital loss
Not in the business of lending money or investing in crypto assets No Gross income plus penalties and interest
In the business of lending money or investing in crypto assets Yes Gross income minus deduction or capital loss
In the business of lending money or investing in crypto assets No Gross income plus penalties and interest

The tax implications of distributions received from liquidators or receivers of Ponzi schemes

A fourth question that investors who are involved in Ponzi schemes may have is how to treat any distributions that they may receive from liquidators or receivers of these schemes for tax purposes.

The answer is that investors who receive distributions from liquidators or receivers of Ponzi schemes may have to include the distributions as gross income in their tax returns, depending on whether they previously declared and paid tax on their income from the scheme or not.

This is because gross income includes any amount received by way of recoupment, which includes any amount received from liquidators or receivers.

Investors who previously declared and paid tax on their income from the scheme may be able to reduce their taxable income by the amount of distributions received, if they can show that they suffered a loss when they invested in the scheme. This is because distributions that relate to expenses or losses that were incurred for the purposes of trade are not taxable and can be deducted from gross income.

Investors who did not previously declare and pay tax on their income from the scheme may have to pay tax on the full amount of distributions received, as well as penalties and interest for underreporting their income. This is because distributions that relate to income that was not declared or taxed are fully taxable and subject to penalties and interest.

The following table summarises the tax implications of receiving distributions from liquidators or receivers of Ponzi schemes for different types of investors:

Type of investor Declared and paid tax on income from scheme Tax implications of distribution
Not in the business of lending money or investing in crypto assets Yes Gross income minus distribution
Not in the business of lending money or investing in crypto assets No Gross income plus penalties and interest
In the business of lending money or investing in crypto assets Yes Gross income minus distribution
In the business of lending money or investing in crypto assets No Gross income plus penalties and interest

The tax implications of donating money to victims of Ponzi schemes

A fifth question that investors who are involved in Ponzi schemes may have is how to treat any money that they may donate to victims of these schemes for tax purposes.

The answer is that investors who donate money to victims of Ponzi schemes may be able to claim a deduction for their donations, if they meet certain requirements, such as donating to a registered public benefit organisation or a qualifying relief fund.

This is because deductions are allowed for donations made to certain approved organisations, subject to certain limits and conditions.

Investors who donate money to victims of Ponzi schemes may also be subject to donations tax if they donate more than R100 000 per year or if they donate to non-residents or non-approved organisations. This is because donations tax is levied on any gratuitous disposal of property by a resident, subject to certain exemptions and exclusions.

The following list summarises the requirements and conditions for claiming a deduction for donations made to victims of Ponzi schemes:

  • The donation must be made in cash or in kind.
  • The donation must be made to a registered public benefit organisation (PBO) that has been approved by SARS for section 18A purposes, or to a qualifying relief fund that has been established by the Minister of Finance for disaster relief purposes.
  • The donation must be used by the PBO or the relief fund solely for carrying out its public benefit activities or providing disaster relief.
  • The donation must not exceed 10% of the taxable income of the donor before taking into account any deductions under section 18A.
  • The donor must obtain a valid receipt from the PBO or the relief fund, which must contain certain information, such as the name, address, and registration number of the PBO or the relief fund, the name and address of the donor, the amount and date of the donation, and a declaration that the receipt is issued for section 18A purposes.
  • The donor must retain the receipt for at least five years from the date of submission of their tax return.

The following list summarises the exemptions and exclusions for donations tax on donations made to victims of Ponzi schemes:

  • The first R100 000 of donations made by a natural person per year is exempt from donations tax.
  • The first R10 000 of donations made by a company per year is exempt from donations tax.
  • Donations made between spouses are exempt from donations tax.
  • Donations made to PBOs that have been approved by SARS for section 18A purposes are exempt from donations tax.
  • Donations made to qualifying relief funds that have been established by the Minister of Finance for disaster relief purposes are exempt from donations tax.
  • Donations made to non-residents are subject to donations tax at a rate of 20%, unless there is a double taxation agreement between South Africa and the country of residence of the donee that provides otherwise.

The tax implications of receiving donations from victims of Ponzi schemes

A sixth question that investors who are involved in Ponzi schemes may have is how to treat any donations that they may receive from victims of these schemes for tax purposes.

The answer is that investors who receive donations from victims of Ponzi schemes may have to include the donations as gross income in their tax returns, depending on whether they previously declared and paid tax on their income from the scheme or not.

This is because gross income includes any amount received by way of recoupment, which includes any amount received from victims of Ponzi schemes.

Investors who previously declared and paid tax on their income from the scheme may be able to reduce their taxable income by the amount of donations received, if they can show that they suffered a loss when they invested in the scheme. This is because donations that relate to expenses or losses that were incurred for the purposes of trade are not taxable and can be deducted from gross income.

Investors who did not previously declare and pay tax on their income from the scheme may have to pay tax on the full amount of donations received, as well as penalties and interest for underreporting their income. This is because donations that relate to income that was not declared or taxed are fully taxable and subject to penalties and interest.

The following table summarises the tax implications of receiving donations from victims of Ponzi schemes for different types of investors:

Type of investor Declared and paid tax on income from scheme Tax implications of donation
Not in the business of lending money or investing in crypto assets Yes Gross income minus donation
Not in the business of lending money or investing in crypto assets No Gross income plus penalties and interest
In the business of lending money or investing in crypto assets Yes Gross income minus donation
In the business of lending money or investing in crypto assets No Gross income plus penalties and interest

The tax implications of settling claims with Ponzi scheme operators or other parties

A seventh and final question that investors who are involved in Ponzi schemes may have is how to treat any money that they may receive from settling claims with Ponzi scheme operators or other parties for tax purposes.

The answer is that investors who settle claims with Ponzi scheme operators or other parties may have to include the settlement amount as gross income in their tax returns, depending on whether they previously declared and paid tax on their income from the scheme or not.

This is because gross income includes any amount received by way of recoupment, which includes any amount received from settling claims with Ponzi scheme operators or other parties.

Investors who previously declared and paid tax on their income from the scheme may be able to reduce their taxable income by the amount of settlement received, if they can show that they suffered a loss when they invested in the scheme. This is because settlements that relate to expenses or losses that were incurred for the purposes of trade are not taxable and can be deducted from gross income.

Investors who did not previously declare and pay tax on their income from the scheme may have to pay tax on the full amount of settlement received, as well as penalties and interest for underreporting their income. This is because settlements that relate to income that was not declared or taxed are fully taxable and subject to penalties and interest.

The following table summarises the tax implications of settling claims with Ponzi scheme operators or other parties for different types of investors:

Type of investor Declared and paid tax on income from scheme Tax implications of settlement
Not in the business of lending money or investing in crypto assets Yes Gross income minus settlement
Not in the business of lending money or investing in crypto assets No Gross income plus penalties and interest
In the business of lending money or investing in crypto assets Yes Gross income minus settlement
In the business of lending money or investing in crypto assets No Gross income plus penalties and interest

Conclusion

In this article, we have discussed the tax implications for investors who lose money in Ponzi schemes involving crypto assets, as well as the tax implications of any money that they may recover from the scheme or receive from other sources, such as donations, distributions, or settlements. We have also provided some tips and recommendations on how to comply with the tax laws and regulations and avoid potential pitfalls and penalties.

The main points that we have covered are:

  • Ponzi schemes are illegal and fraudulent activities that violate various laws and regulations, such as the Financial Advisory and Intermediary Services Act, the Financial Intelligence Centre Act, and the Prevention of Organised Crime Act.
  • Crypto assets are not recognised as legal tender or financial instruments in South Africa, but they are subject to income tax and capital gains tax according to the existing tax framework.
  • Investors who participate in Ponzi schemes involving crypto assets may face criminal charges, civil claims, and tax liabilities, regardless of whether they knew about the fraudulent nature of the scheme or not.
  • Investors who lose money in Ponzi schemes may not be able to claim a deduction or a capital loss for their losses, unless they can prove that they incurred the losses in the production of income or in the course of carrying on a trade.
  • Investors who recover money from Ponzi schemes or receive distributions from liquidators or receivers may have to include the recovered amount as gross income in their tax returns, depending on whether they previously declared and paid tax on their income from the scheme or not.
  • Investors who donate money to victims of Ponzi schemes may be able to claim a deduction for their donations, if they meet certain requirements, such as donating to a registered public benefit organisation or a qualifying relief fund.
  • Investors who receive donations from victims of Ponzi schemes may have to include the donations as gross income in their tax returns, depending on whether they previously declared and paid tax on their income from the scheme or not.
  • Investors who settle claims with Ponzi scheme operators or other parties may have to include the settlement amount as gross income in their tax returns, depending on whether they previously declared and paid tax on their income from the scheme or not.

We hope that this article has been informative and helpful for you. If you have any questions or need any assistance with your tax affairs, please do not hesitate to contact us at hq@thrivecfo.co.za. We are a cloud accounting and tax consulting firm that specialises in providing professional and personalised services for small and medium sized companies in South Africa. We can help you with:

  • Tax compliance and planning
  • Accounting and bookkeeping
  • Financial reporting and analysis
  • Business advisory and consulting
  • Cloud accounting software and solutions

We look forward to hearing from you and working with you. Thank you for reading.

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