Jan 14, 2026
Taxation of Illegal Income: What Canadian Taxpayers Need to Know
For obvious reasons, there is a tendency to conceal income derived from illegal activities from government authorities. However, there is no “pass” for failing to pay taxes owed to the Canada Revenue Agency (CRA) on such income.
Taxpayers who earn income through illegal activities are still required to report that income and pay the applicable taxes to the CRA. Failure to do so may expose such taxpayers to interest; penalties; and criminal prosecution by the CRA where such non-payment constitutes tax evasion, potentially resulting in significant fines or imprisonment.
This article examines the taxation of income derived from illegal activities.
Taxing Illegal Income: CRA Policies and Public Interest
Illegal activities are generally taxed in the same manner as legal activities. The Canada Revenue Agency (CRA) considers it inequitable to allow individuals engaged in illegal activities to avoid taxation while individuals engaged in lawful activities remain subject to tax.
The CRA also prefers that income from illegal activities be taxed in order to reduce the multiplier effect of reinvesting untaxed proceeds into further illicit conduct thereby funding the underground economy. Rather than allowing such income to remain untaxed, the CRA seeks to collect it for public use.
Tax Compliance and Record-Keeping for Income from Illegal Activities
Taxpayers engaged in theft, drug trafficking, fraud, sex trafficking or other illegal activities are subject to taxation on income derived from those activities.
In calculating taxable income, such taxpayers may claim allowable expenses incurred in earning the illegal income. This makes it necessary for individuals engaged in criminal activities to maintain sufficient records in order to meet their tax compliance obligations and support claimed expenses.
Failure to keep those records will generally result in a denial of deductible expenses. However, certain kinds of expenses related to illegal activities are not deductible. For example, bribes and other illegal payments to Canadian or foreign public officials; expenses incurred in the commission of certain offences; fines and penalties imposed by law; and the cost of property forfeited as a result of such fines or penalties are generally not deductible.
Failure to maintain proper records of the taxpayer’s activities may result in an arbitrary assessment by the CRA based on information available to it, although the taxpayer’s reasonable estimates of disputed amounts may be allowed, where such estimates are supported by available records, evidence or credible explanations.
Tax Consequences and Enforcement Powers Relating to Illegal Income
Failure to pay taxes arising from illegal activities attracts interest and penalties in the same manner as unpaid taxes arising from lawful activities. The Canada Revenue Agency (CRA) retains full authority to audit such taxpayers and to pursue collection of outstanding tax liabilities using the same enforcement mechanisms available in respect of lawful income. These mechanisms include garnishment, seizure, liens, and other collection tools within the CRA’s statutory powers where assessed or reassessed tax amounts remain unpaid.
A taxpayer is entitled to participate in the CRA tax audit process and may request an internal review or file a notice of objection or seek judicial review where applicable.
As stated, the taxpayer has the right to object to an assessment or reassessment where he believes that the taxes assessed on his illegal income are incorrect. If the objection is unsuccessful, the taxpayer may appeal to the Tax Court of Canada. Where the taxpayer’s appeal fails at the TCC, the taxpayer may have rights of appeal to the Federal Court of Appeal, and may also further appeal, with leave, to the Supreme Court of Canada.
Criminal Convictions, CRA Audits, and Tax Evasion Exposure
A criminal conviction arising from a taxpayer’s illegal activities does not preclude the Canada Revenue Agency (CRA) from assessing and collecting taxes owing on income derived from those activities. In fact, a criminal conviction may prompt a CRA tax audit.
The CRA has authority to assess convicted taxpayers for unpaid taxes, together with interest and penalties, and to commence collection proceedings.
Law enforcement agencies investigating criminal conduct may also report the taxpayer to the CRA and provide evidence of tax non-compliance. Such information may prompt the CRA to tax audit, assess, and collect outstanding taxes, interest, and penalties where applicable.
Where a taxpayer’s non-compliance meets the statutory threshold for tax evasion, the Canada Revenue Agency (CRA), through the Public Prosecution Service of Canada (PPSC), may initiate prosecution independently, without requiring a prior conviction or referral from the police or any other government authority. As tax evasion is a criminal offence, the tax lawyer acting for the CRA must establish both intent and commission of the offence beyond a reasonable doubt.
A conviction for tax evasion may result in fines and possible imprisonment, separate from any underlying tax debt, interest, and penalties already imposed. This remains the case even where the taxpayer has previously been convicted for the illicit activities that brought the matter to the CRA’s attention.
Pro Tax Tips: Don’t Wait for the CRA to Act
Even where a person is involved in illicit or fraudulent activities, seeking advice from experienced Canadian tax lawyers regarding outstanding tax liabilities is strongly advisable. The Canada Revenue Agency (CRA) will not hesitate to pursue unpaid taxes, together with interest and penalties. Police services or other government authorities investigating criminal conduct may also alert the CRA to instances of tax non-compliance and provide supporting evidence.
It is therefore critical to address potential tax exposure proactively. A Canadian tax lawyer can assess the circumstances and develop an effective strategy for presenting your tax affairs to the CRA, with the objective of managing risk and limiting further legal and financial consequences. One of these available initiatives is the CRA Voluntary Disclosure Program, which allows non-compliant taxpayers to come forward and correct past errors or omissions in exchange for relief from penalties and interest, as well as protection from criminal prosecution.
Frequently Asked Questions (FAQs):
Are Canadian taxpayers required to report income earned from illegal activities?
Yes. Canadian taxpayers are required to report income earned from illegal activities and pay the applicable taxes to the Canada Revenue Agency (CRA), even when the source of the income is unlawful.
What are the consequences of failing to report illegal income to the CRA?
Failure to report illegal income will generally expose a taxpayer to interest, penalties, and criminal prosecution where the non-payment constitutes tax evasion. Conviction for tax evasion will include significant fines or imprisonment.
Does a criminal conviction prevent the CRA from assessing or collecting taxes?
No. A criminal conviction does not preclude the CRA from assessing and collecting taxes owing on illegal income. A conviction may actually prompt a CRA tax audit.
Disclaimer: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.
