Taxation and the "Dark Web": An Analysis by a Canadian Tax Lawyer

Introduction: Dark Web and Canadian Taxes

Taxpayers have taken precautions to safeguard themselves online and make sure that their activities can't be tracked by outside parties since the widespread use of internet connectivity. The "dark web," which started as a clandestine, encrypted, and largely kept secret Internet and then developed into a parallel one with significant criminal activity, was one of the inevitable evolutions of this demand for protection.

Less tech-savvy users have started to penetrate the dark web's surface more recently in the past few years, and this has led to what is believed to be a thriving underground economy by a number of government organizations, including taxing authorities like the Canada Revenue Agency ("CRA") and the IRS as well as various police agencies. The US government has adopted measures in recent years to close down unlawful and criminal markets, such as the "Silk Road," which provided individuals with access to it a place to buy anything from firearms to recreational drugs to deadly chemicals to stolen personal information and credit card data.

Cryptocurrency has become the “fuel of choice” to facilitate dark web transactions. For example, when the Dutch government shut down the child pornography website Dark Scandals they found that all purchases were paid for using crypto since PayPal had dropped the website.

The importance of getting the right guidance to make sure you are always working within the boundaries of the Income Tax Act cannot be overstated for Canadian taxpayers who use the dark web, especially for commercial purposes. Whatever the legality of the activity, there is a Canadian tax reporting obligation for persons who participate in a business that includes unlawful operations.

Every Form of Income is Taxable

The majority of taxpayers are either blissfully unaware of or purposefully ignorant of the income tax laws, which state that income, including crypto receipts, derived from illegal sources, such as theft, fraud, illegal sex work, drug sales, and other criminal activity, is subject to income taxes in the same way as any other legal source of income in Canada. However, there is a wide range of legal commercial operations carried out surreptitiously, including the acquisition and speculation of cryptocurrencies. These are the usual types of activities that receive the most coverage with regard to the dark web in Canada.

The CRA frequently conducts a tax audit of a taxpayer either by itself or in collaboration with another law enforcement agency such as the RCMP, for the purposes of administering and enforcing the Tax Act. Despite this, the CRA generally moves forward with a civil tax audit regardless of the legitimacy of the actual business the taxpayer is engaged in, either in conjunction with or separate from any criminal investigation that is not related to income tax or GST/HST. This is true even though the CRA does recommend taxpayers for criminal prosecution on the basis of specific crypto tax fraud.

The CRA's Methodology for Tax Audits    

The CRA is authorized to make inferences during an income tax audit concerning a taxpayer's sources of income and the taxes owed by them based on little or occasionally absolutely no supporting documentation. The CRA frequently conducts bank analyses during tax audits and includes any unidentified sums as income in a taxpayer's reassessment. It's extremely crucial for those who conduct business on the dark web to keep in mind that even though the activities and records in and of themselves may, or may not, be private and inaccessible, there will always be an audit trail once money is transferred into a bank account, which is frequently required due to the electronic nature of internet transactions. Determining whether a taxpayer's business operations are lawful or illegal is important, thus we advise our customers to always keep records of all transactions.

Reacting to a Tax Audit from the Dark Web        

For the simple reason that taxpayers frequently are not aware of the CRA's tax audit powers, nor their rights in an audit scenario, if the CRA does choose a taxpayer for a tax audit and they have been involved in e-commerce using the dark web, with or without a cryptocurrency, the tax audit is likely to result in a high tax bill, frequently including gross negligence penalties, and possibly criminal tax evasion prosecution.

For instance, it frequently comes as a surprise to taxpayers because even if their business operations are unlawful, the revenue is still subject to the same laws as all other sources, namely the taxpayer is allowed to deduct expenditures and pay tax only on the net amount of profit.

This is where maintaining accurate records is important. When the CRA audits and makes the broad assumption that 100% of any deposits are income, the taxpayer will be responsible for proving either that the amounts are not income and are not therefore subject to income tax, or that the income amount is inflated because it does not account for expenses incurred to earn the illegal income. The CRA won't usually be able to get this information on its own, as it does in a conventional business tax audit where it may obtain banking and other documents from third parties, which is why maintaining accurate records of all unlawful business activity on the dark web is so crucial. In other words, the best course of action is to appear as though all of your dark web operations are no different from any other business, whether it be online or off, in order to avoid a high and inflated tax bill and related penalties. Using a cryptocurrency like Bitcoin or Dash won't prevent you from leaving a paper trail since the blockchain gives you a comprehensive ownership record, as the Dark Scandals criminal investigation and prosecution showed.

Pro Tax Tip: Maintaining Accurate Records is Crucial for Avoiding a Dark Web Business Tax Prosecution

Reach out to our skilled Canadian tax crypto lawyers for guidance and counsel if you find yourself at the receiving end of a CRA tax audit and the auditor has identified possible sources of income that came from dark web or crypto business operations, whether they were legitimate or not. We can effectively represent you to make sure that you aren't paying a penny more in taxes than you should since we have decades of expertise with crypto tax audits of all stripes. If you've failed to maintain accurate tax records, we can retain an accountant to help protect the solicitor-client privilege and work with that accountant to try to recreate your business records and submit thorough filings to the CRA. When tax planning and planning how to disclose "dark web" activities, you have a strong defense against CRA action thanks to the solicitor-client privilege that applies to both our files and the files of any accountants we retain on your behalf.

Disclaimer:

"Only general information is provided in this article. Only as of the publishing date is it current. It hasn't been updated; therefore it could no longer be relevant. It cannot or ought not to be relied upon since it does not offer legal advice. Each tax circumstance is unique to its facts and will be different from the instances described in the articles. You should speak with a lawyer if you have particular legal inquiries."