Schafer v. R. – TCC: Court Applies Gross Negligence Penalties to Lawyer’s Unreported Professional Income

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Schafer v. The Queen[1] (December 2, 2013) involved unreported professional income of a senior lawyer practising through a professional corporation.  The main defence was that the bulk of the unreported income was a shareholder’s loan.  The second issue was whether the facts justified the imposition of gross negligence penalties.

The court did not accept the taxpayer’s evidence:

[29]         There ended Mr. Schafer’s testimony. Portions of it have been quoted at length in these Reasons for Judgment to give a sense of the implausible nature of many of his answers, prime among them the account set out directly above. The transcripts also reveal a certain evasiveness: key questions about why or how certain things had been done went unanswered, his justification being his lack of involvement in the business side of the practice. Yet, in spite of acknowledging this “shortcoming” and having gone to some pains to inform the Court of his extensive legal background, Mr. Schafer chose not to call those to whom he had delegated these tasks. He offered no explanation as to why he had not called Mrs. Schafer or the Accountant, leaving the impression that their absence was more litigation strategy than amateur oversight. In all the circumstances, I accept the submission of counsel for the Respondent that the Court ought to draw a negative inference from the Appellants’ failure to call Mrs. Schafer and/or the Accountant to answer questions that Mr. Schafer insisted he could not.

 [32]        What is particularly troubling about the Appellants’ lack of documentation is that the kinds of documents Mr. Schafer referred to – client invoices, agreements, financial statements, income tax returns – are all those which a law practice would typically maintain. Indeed, he volunteered during cross-examination that, as of the time of the hearing, they were “probably” still in his possession. He also acknowledged that any original documents provided to the Canada Revenue Agency during the audit had been returned to him. In spite of that, Mr. Schafer offered no explanation for having chosen not to bring documents with him – except to say somewhat testily on redirect that as he had provided information to the Canada Revenue Agency during the audit and documents to the Crown in the Lists of Documents and on Examination for Discovery, it was ‘inappropriate” for counsel for the Respondent to invite the Court to draw a negative inference from his failure to tender supporting documents at the hearing.

[33]        That reaction might be understandable coming from a self-represented taxpayer with no legal background. Coming from Mr. Schafer’s mouth, it fell a little flat. In my experience, a taxpayer with documents available to justify his claims is usually eager to present them, shoebox and all. It defies belief that a man of Mr. Schafer’s intelligence, education and litigation experience would not think to do so. The more likely scenario is either that corroborating documents do not exist or that whatever documents are available do not say what Mr. Schafer would have the Court believe.

[34]        The great weakness of Mr. Schafer’s testimony was its overall lack of credibility. His entire course of conduct upon learning of the audit cast an aura of suspicion over his true motives in revising Amisk’s books and records and amending the company’s 2005 return. In my view, what lay behind his actions was an attempt to retool the company’s decision not to report the Fee & Interest Payments and Unidentified Deposits and to divert them directly to Mr. Schafer’s account; the strategy included the recharacterization of the $223,628 Payment appropriated by Mr. Schafer as a shareholder loan.

In the end the court dismissed both appeals and upheld the imposition of penalties:

[42]        Mr. Schafer’s own evidence was that he is a well-educated litigation lawyer with extensive experience in corporate and commercial law. Nothing in his conduct at the hearing is consistent with his portrayal of himself as a man adrift in an administrative and financial morass. Despite his stated lack of involvement in the administrative side of his practice, he was somehow able to plan for and achieve early retirement with some $2 million in assets. He admitted that two of the payments comprising the Fees & Interest were large amounts in relation to his usual billings, so significant that he could recall with clarity the details of their billing long after the fact. On cross-examination, he did not contradict the Respondent’s contention that there was a material difference in the Appellants’ respective reported and unreported incomes: in Amisk’s case, $114,348 versus $214,770; for Mr. Schafer, $39,640 versus $241,088.

[43]        Notwithstanding the above, he would have the Court believe that his failure to report or accurately record these amounts was the unintended consequence of sloppy business practices. He attributed the errors, in part, to the fact that most of the Fees & Interest was for legal services invoiced several years before. In spite of that, when initially filing Amisk’s 2005 return, Mr. Schafer chose to rely on his memory rather than verify how these two large payments had been recorded and treated for tax purposes – even though at all times up to and including the hearing of these appeals the relevant client files, invoices, security agreements and tax records were available for his review. As for the smaller amounts making up the Fees & Interest received 2005, he did not provide a credible explanation for how these amounts had been inadvertently not reported.

[44]        In my view, Mr. Schafer in his personal capacity and as the directing mind of Amisk was at best, indifferent to complying with the requirements of the Income Tax Act in failing to keep proper books and records, to report the Fees & Interest and Unidentified Deposits in the Amisk’s 2005 return, and to include in income the $223,628 Payment appropriated from Amisk for his own benefit. It was only when faced with the prospect of an audit that the Appellants took steps to amend the existing documentation to conform with the more palatable version of events Mr. Schafer planned to present to the Canada Revenue Agency during the audit. This brings his conduct within the definition of “gross negligence” established in Venne v. Canada (1984), 84 D.T.C. 6247: “a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not”. In all the circumstances, the Minister was justified in imposing penalties in respect of the reassessments of Amisk’s and Mr. Schafer’s 2005 taxation years.

[45]        For the reasons set out above, the appeals are dismissed, with costs to the Respondent.

[1] 2013 TCC 382.