A C$500,000 fine has taught one Canadian mortgagee the taxable income lesson.

Mention "mortgage interest" to most Canadians and they think of the principal cost of property ownership. However, mortgage interest also means "investment income" for the mortgagee-- the mortgage holder -- even if that's you holding a mortgage for your children.

The Canada Revenue Agency (CRA, formerly CCRA) recently announced that, after prosecution in Quebec Court, lawyer Jean Chalifoux pleaded guilty to tax-evasion charges. A CRA investigation revealed that for taxation years 1995 to 1999, Chalifoux did not report interest income of $1,672,906 from mortgage loans, thus evading $441,802 in income taxes. This interest income had been deposited in a separate bank account used exclusively for these transactions. During a tax audit, Chalifoux provided the auditor with all his banking information except details on the account designated for income from the mortgages he held.

Chalifoux was fined $500,000, equivalent to approximately 115 per cent of the tax evaded. In addition to the fine imposed by the Court, Chalifoux must pay all of the taxes evaded, plus penalties and interest.

Interest earned on mortgages and other investments as well as investment income from other sources are part of a taxpayer's total income and must be reported on the federal tax return. Although Canadians do not pay tax on profit made from the sale of their principal residence, profit from other real estate transactions and from mortgage lending are deemed income. The exception is mortgages held in Self-directed Registered Retirement Savings Plans . These RRSPs allow mortgage investors to shelter interest income from tax.

Mortgages are attractive investment alternatives to volatile stocks and bonds because they are secured against real estate and yields are higher. Earned interest compounds annually, semi-annually or even more frequently if the borrower agrees. This interest-on-interest brings greater returns than simple interest like that paid on savings accounts and RRSPs vehicles like guaranteed investment certificates. (For compounding and self-directed RRSPs, read PJ's column "Are Canadians Overlooking Compounded Returns?," a perennial favourite.)

Canadians who have filed false income returns under any circumstances have a second chance. They may still voluntarily correct their tax affairs and make full disclosure before CRA begins action against them. Consulting a tax lawyer or accountant may be advisable before you proceed. The Voluntary Disclosures Program (VDP) promotes voluntary compliance with the accounting and payment of duty and tax provisions under the Income Tax Act, Customs Act and Excise Tax Act. This fairness program provides Canadians with a self-correction opportunity that renders them compliant. Local tax services offices can explain the Voluntary Disclosures Program (VDP) further, but ensure you have accurate information before you act.

Don't get caught by income tax deadlines either:

• Tax returns are due April 30 if you owe the government.

• Self-employed individuals may file by June 15, but must pay any money due by April 30.

• If you don't have the cash on hand, file by April 30 anyway to reduce penalties. Once you get your assessment notice, call CRA and arrange payment terms.

• RRSPs must be set up by March 1, 2005 to be deductible in the 2004 taxation year.