Taxpayers are typically surprised to learn that income from illegal activities is still subject to tax here in Canada. The scenario usually plays out that someone is convicted of a crime (drug-dealing), and following this, that same individual is then audited for unreported income.
It can be extremely difficult, if not impossible to lower the amount of income assessed by the Canada Revenue Agency (“CRA”). This is because criminals usually do not keep books and records. Without books and records, CRA will not provide deductions for expenses, Input Tax Credits, etc.
According to Justice Hogan: “[i]t is well established that a taxpayer is subject to tax on his income regardless of its source. A taxpayer must keep reliable books and records for all of his income, including income from illegal sources.”
Canadian Imperial Bank of Commerce v The Queen, 2013 FCA 122 – Legality, Morality, and Taxation
The Queen v Johnson, 2012 FCA 253 – Taxability of Funds received from a Ponzi Scheme
Brown v. The Queen 2012 TCC 251 – Income From Criminal Activities and the Use of Information by the CRA obtained by Police in the Course of a Criminal Investigation
More detailed case law analysis may be found here: http://ita-annotated.ca/RecentDecisions/category/substantive-provision/illegal-income/