Tuesday, February 12, 2013
Case Citation
Summary
Section 227.1 of the Income Tax Act (“ITA”) and section 323 of the Excise Tax Act (“ETA”) deal with what is referred to as director liability. In essence, where a corporation fails to remit certain amounts (e.g., payroll taxes, Part XIII tax, GST) the director’s are personally liable for these amounts and the government will take action to collect debt from directors. This case deals with this scenario.
There are two defences: first, the individual is not a director and second the director exercised due diligence in managing the affairs of the business. This case addresses both these points.
On the question of being a director, it’s clear one must look to commercial law, the laws governing the corporation, to determine if the person is considered a director. This is referred to as a de jure director. In this case, the individual sent notice to resign as a director; however, subsequent to his resignation, he behaved in a manner consistent with being a director and hence was considered to be a de facto director.
Since, the judge concluded he was a director and the assessment was made within the two year time limits of ITA 227.1(4) and ETA 323(5), the next question to address was whether the individual exercised due diligence.
The judge’s opinion was no. Given the plaintiff knew about the financial difficulties of the business and it’s obligations to remit taxes to the government, a reasonable person would not use funds to support a failing business and neglect its remittance obligations.
Issue
[1] The appellant, Allan A. Chell, is appealing three director’s liability assessments issued against him on May 5, 2008. One assessment pertains to the failure of cDemo Inc.’s (“cDemo”) to remit payroll source deductions (“source deductions”) for its 2003, 2004 and 2005 taxation years. The assessed amount is $53,768.95. Another assessment relates to cDemo’s failure to remit goods and services tax (“GST”) amounts in 2005. The assessed amount is $3,289.39. The third assessment pertains to the failure of Global Autolink Corp. (“Global”) to remit payroll source deductions. The assessed amount is $239,838.42. These appeals were heard on common evidence.
[15] There are two issues in these appeals:
1. First, was the appellant either a de jure or de facto director of cDemo or Global within the two years preceding the assessments?
2. If so, can the appellant rely on the so-called due diligence defence under subsections 227.1(3) and 323(3) of the Income Tax Act (“ITA”) and Excise Tax Act (“ETA”) respectively?
ITA / ETA
| Section 227.1—Liability of directors for failure to deduct |
| 227.1(1)—Liability of directors for failure to deduct |
| 227.1(3)—Idem [Limitations on liability] |
| 227.1(4)—Limitation period |
| Section 323—Tax liability re transfers not at arm’s length |
| 323(1)—Liability of directors |
| 323(3)—Diligence |
| 323(5)—Time limit |
| 227.1(1)—Liability of directors for failure to deduct |
| 227.1(3)—Idem [Limitations on liability] |
| 227.1(4)—Limitation period |
| Section 323—Tax liability re transfers not at arm’s length |
| 323(1)—Liability of directors |
| 323(3)—Diligence |
| 323(5)—Time limit |
Cases Cited
| Aujla v. Canada (2008 FCA 304) |
| Bremner v. Canada (2009 FCA 146) |
| Buckingham v. Canada (2011 FCA 142) |
| Bremner v. Canada (2009 FCA 146) |
| Buckingham v. Canada (2011 FCA 142) |
Analysis
[16] The appellant argues that he ceased to be a director of cDemo and Global on January 11, 2006, the date on which he posted his letter of resignation at the offices of the two corporations. The appellant submits that, consequently he is not liable for the unremitted source deductions and GST because his resignation occurred more than two years before the assessments. According to the appellant, his continued involvement with cDemo and Global was solely in the capacity of creditor and shareholder, and not as a director. Finally, in the event of a finding to the contrary, the appellant claims that he exercised due diligence to prevent cDemo and Global from failing to remit the source deductions and GST.
[17] In response, the Minister submits that the appellant did not cease to be a director of cDemo or Global more than two years before the assessments. Further, the Minister contends that the appellant did not exercise due diligence to prevent cDemo and Global from failing to remit the source deductions and GST. Therefore, he is liable for their payment.
[20] In the present appeals, it is therefore necessary to determine whether the appellant was a director within the two years preceding the assessments for director’s liability.
[21] Neither the ITA nor the ETA defines when an individual ceases to be a director for the purpose of the director’s liability provisions. Rather, the corporate law of the relevant jurisdiction is determinative: Aujla v. Canada, 2008 FCA 304, [2009] 3 F.C.R. 93, at paragraphs 23 to 25.
[22] A director may be a de jure director or a de facto director for the purpose of director’s liability under the ITA and ETA: see Mosier v. R., [2001] G.S.T.C. 124 (TCC), at paragraph 23. A de jure director is an individual who has been appointed as such pursuant to the corporate law of the jurisdiction in which the corporation was created or continued, as the case may be. A de facto director can exist in two forms. As Bowman A.C.J., as he then was, observed in Mosier, at paragraph 23, “de facto directors can be those who are ostensibly duly elected but who may lack some qualification under the relevant company law, and those who simply assume the role of director without any pretence of legal qualification”. Either de jure or de facto directorship can give rise to director’s liability.
[23] If the appellant was a de jure or de facto director within the two years preceding the assessments for director’s liability, then he is liable for the unremitted source deductions and GST. This is so unless he can rely on the due diligence defence available under both the ITA and ETA.
[27] By posting his letter of resignation at the offices of cDemo and Global on January 11, 2006, the appellant provided to the corporation’s proper notice of resign action under both Delaware and Alberta corporate law. Since he ceased to be a de jure director more than two years before the assessments, it is necessary to determine whether the appellant was a de facto director of cDemo and Global despite his legal resignation.
[28] Following his legal resignation as a director of cDemo, the appellant continued to be actively involved with that company. As discussed above, the appellant negotiated the sale of certain assets of cDemo, signing his name on the corresponding bill of sale. Only a director of cDemo could have authorized the sale of cDemo’s assets. Although this sale occurred May 16, 2007, de facto directorship “must be considered to endure at least as long as [the] person manages or supervises the management of the business and affairs of the corporation in question”: see Bremner v. The Queen, 2009 FCA 146, at paragraph 8.
[29] The appellant continued to act as a de facto director of cDemo until at least June 2006. As noted above, the appellant signed in that month a statutory declaration removing a fellow director from the Alberta Corporate Registry. Such a declaration is effective only if signed by a director. Although the appellant claimed at trial that he was unaware that he was signing in the capacity of director, it is difficult to accept that he thought he could have made that change in the capacity of creditor or shareholder. This evidence suggests that the appellant was a de facto director of cDemo until at least June 2006.
[32] By continuing to act on behalf of Global, the appellant created the impression that he was still a director of the corporation. In my view, the evidence demonstrates that the appellant was a de facto director of Global until at least October 2006, at which time he ceased attempting to conclude a long‑term contract with a prospective client of Global’s.
[36] In The Queen v. Buckingham, 2011 FCA 142, the Federal Court of Appeal confirmed that an objective standard must be used to determine whether a director has satisfied the conditions of the due diligence defence under subsections 227.1(3) of the ITA and 323(3) of the ETA. Mainville J.A. stated:
37 . . . I conclude that the standard of care, skill and diligence required under subsection 227.1(3) of the Income Tax Act and subsection 323(3) of the Excise Tax Act is an objective standard . . . .
38 . . . Consequently, a person who is appointed as a director must carry out the duties of that function on an active basis and will not be allowed to defend a claim for malfeasance in the discharge of his or her duties by relying on his or her own inaction . . . .
39 An objective standard does not however entail that the particular circumstances of a director are to be ignored. These circumstances must be taken into account, but must be considered against an objective “reasonably prudent person” standard. . . .
Clearly, subsections 227.1(3) of the ITA and 323(3) of the ETA entail a modified objective analysis which involves considering what a reasonable person would have done in the circumstances of the individual under assessment.
[37] To establish the defence, the director or former director must show that he or she took positive actions to prevent the corporation’s failure to remit the amounts in question. In Buckingham, the Federal Court of Appeal compared the aforementioned provisions with paragraph 122(1)(b) of the Canada Business Corporations Act, which requires directors and officers to “exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances”. Mainville J.A. wrote:
40 The focus of the inquiry under subsections 227.1(3) of the Income Tax Act and 323(3) of the Excise Tax Act will however be different than that under 122(1)(b) of the CBCA, since the former require that the director’s duty of care, diligence and skill be exercised to prevent failures to remit. In order to rely on these defences, a director must thus establish that he turned his attention to the required remittances and that he exercised his duty of care, diligence and skill with a view to preventing a failure by the corporation to remit the concerned amounts.
[38] At trial, the appellant agreed that he was an inside director who was very familiar with the businesses of both cDemo and Global. The appellant also described his function with the two corporations as being to find new clients in order to develop new business. A reasonably prudent director with that level of familiarity with the businesses of cDemo and Global would have been aware of the significant financial difficulties facing the two corporations. The evidence shows that the appellant did not take any positive steps to ensure that the corporations continued to meet their remittance obligations. Instead, the source deductions and GST were diverted to fund the corporations’ failing businesses.
[40] The evidence shows that the appellant did not exercise “the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances”. A reasonable person in the appellant’s circumstances would have anticipated that the corporations’ financial difficulties could affect the remittance obligations of the two corporations and would have taken steps to prevent failures to remit. The appellant’s lack of oversight and his inaction cannot serve as the foundation of a due diligence defence.
Decision
[44] For all these reasons, the appeals are dismissed, with one set of costs to the respondent.
Note
A paragraph beginning with a number in square brackets is a direct quote from the case.
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