Category Archives: 227.1(3)

Martin v The Queen, 2012 TCC 239

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Directors’ Liability for Unremitted GST/HST and for Payroll Taxes – Due Diligence Defence

Martin v The Queen, 2012 TCC 239

At issue was whether the Taxpayer has exercised the of care, diligence and skill to prevent the failure to remit the net tax and payroll deduction amounts that a reasonably prudent person would have exercised in comparable circumstances, and thus whether he was liable under subsection 323(1) of the Excise Tax Act (ETA) with respect to one of the corporations’ failure to remit net tax and under section 223 of the Income Tax Act (ITA) with respect to payroll deductions and employer contributions payable by the corporation he was a director of, plus interest and penalties.

The Court partially allowed the appeal. For the 2001 tax year, the court held that the taxpayer was concerned with remitting the relevant amounts, and

had turned his attention to the required remittances, and did in these circumstances exercise the care, diligence and skill that a reasonably prudent person would have exercised in similar circumstances for the 2001 year.  HOWEVER, the court held that for the 2002 tax year, the taxpayer was no longer directing his efforts towards avoidances of failures to remit.

FACTS

The Taxpayer was a shareholder and director for the relevant corporations as well as  for more than a dozen other related corporations. The corporations ran into financial difficulties, and the taxpayer became concerned with the corporations’ ability to pay its GST/HST and payroll taxes.  The Taxpayer hired an accountant as CFO, and this CFO consulted with the corporation’s solicitors, agreeing to consult a bankruptcy expert.  The taxpayer and these experts were in communication with the CRA regarding the difficulties and their concern as to the taxes due.

The internal dealings among the related corporations were subject to GST/HST as the corporations had not elected under section 156 of the ETA to have supplies made among them treated as having been made for nil consideration.  The corporation was also unable to reduce its GST/HST owing by reducing its invoices amounts by the amounts charged but unpaid, pursuant to subsection 232(2), but found out about this provision outside the 4 year period allowed.  If these provisions were properly used, the result would be that the corporation has in fact overpaid payroll taxes and GS/HST by $160,000.00.

ANALYSIS

The Court began by reviewing the liability of directors under ETA s 323 and ITA section 227.1.

With regard to the question of whether the taxpayer exercised the degree of care, diligence and skill to prevent the failure to remit that a reasonably prudent person would have exercised in comparable circumstances, the Court referred to two decision of the FCA being Balthazard v. Canada, 2011 FCA 331, and Canada v. Buckingham, 2011 FCA 142.  In Balthazard the FCA summarized the legal framework as

a.   The standard of care, skill and diligence required under subsection 323(3) of the Excise Tax Act is an objective standard as set out by the Supreme Court of Canada in Peoples Department Stores Inc.(Trustee of) v. Wise, 2004 SCC 68, [2004] 3 S.C.R. 461. This objective standard has set aside the common law principle that a director’s management of a corporation is to be judged according to his or her own personal skills, knowledge, abilities and capacities. However, an objective standard does not mean that a director’s particular circumstances are to be ignored. These circumstances must be taken into account, but must be considered against an objective “reasonably prudent person” standard.

b.   The assessment of the director’s conduct, for the purposes of this objective standard, begins when it becomes apparent to the director, acting reasonably and with due care, diligence and skill, that the corporation is entering a period of financial difficulties.

c.   In circumstances where a corporation is facing financial difficulties, it may be tempting to divert these Crown remittances in order to pay other creditors and thus ensure the continuity of the operations of the corporation. That is precisely the situation which section 323 of the Excise Tax Act seeks to avoid. The defence under subsection 323(3) of the Excise Tax Act must not be used to encourage such failures by allowing a care, diligence and skill defence for directors who finance the activities of their corporation with Crown monies, whether or not they expect to make good on these failures to remit at a later date.

d.   Since the liability of directors in these respects is not absolute, it is possible for a corporation to fail to make remissions [sic] to the Crown without the joint and several, or solidary, liability of its directors being engaged.

e.   What is required is that the directors establish that they were specifically concerned with the tax remittances and that they exercised their duty of care, diligence and skill with a view to preventing a failure by the corporation to remit the amounts at issue.

The court held that the financial difficulties of the corporation were somewhat unforeseeable, and that when difficulties arose the taxpayer was concerned with paying taxes first.  He and his experts were of the view that the GST/HST would be a wash but, though not wrong, because the group of companies were not a closely related group of companies as defined for GST/HST purposes and therefore could not benefit from subsection 231(1) of the ETA, and because no bad debt was available between the related companies, and the companies could not benefit from a reduction with respect to unpaid invoiced under subsection 232(2) of the ETA, the corporations were left with no recourse.

The Court noted two other things:

  • At the time, this was only 10 years after the GST/HST regime was introduced, and it was not surprising that all its details were not known;
  • The corporations had good history with the CRA and were in communication with them, but the CRA did not inform them of the relief available under the legislation when the corporations and the CRA met to discuss potential problems.

The Court, after referring to the overpayment if the relief provisions available had been used, partially granted the appeal.

Sas Ansari, BSc BEd PC JD LLM PhD (exp) CPA In-Depth Tax 1, 2 &3

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Deakin v The Queen, 2012 TCC 270

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“Due Diligence Defence” Against Directors’ Personal Liability for Unremitted Source Deductions and GST NOT Available Where Directors consciously Use These Funds to Keep Business Afloat.

Deakin v The Queen, 2012 TCC 270

At issue was the applicability of the due diligence defence for directors of a corporation in relation to unremitted source deductions under the ITA and unremitted GST under the ETA giving rise to director liability pursuant to ITA s 227.1(1) and ETA s 323(1).

The Court held that the due diligence defence is not available where directors consciously use unremitted funds to keep the business afloat in hopes of receiving payments that will allow them to remit the amounts due at some later point, and emphasised that ”[g]iven the specific wording of the subsections and the Federal Court of Appeal’s comments in Buckingham, it appears somewhat difficult to imagine circumstances in which an informed and active owner-manager and director of a corporation will not be liable for unremitted employee source deductions and unremitted GST amounts”.  Where directors chose to use unremitted funds for business purposes they are making all Canadian taxpayer’s unwilling investors in their business, and the provisions that provide for Directors’ personal liability for these unremitted amounts are akin to personal guarantees by the directors to the Canadian public.

FACTS

The taxpayers were directors and shareholders of the subject corporation.  The corporation was encountering cash flow issues and awaiting a large cash payment. In order to be able to continue operations, the corporation used the source deductions to fund operations.  The corporation eventually declared bankruptcy with significant amounts owing under the ITA and ETA.

ANALYSIS

The Court reviewed the employer’s obligation to withhold and remit source deductions on behalf of employees, and the obligation on a business to collect and remit net GST.  Subsection.

Though directors are not generally liable to a corporation’s own income tax liability, pursuant to .1 of the ITA and subsection 323 of the ETA provide that the directors of a corporation will be personally liable for a corporation’s failure to remit employee withholdings and GST as required by law. This reflects the degree of control directors have over a corporation’s management and affairs.  Directors are not personally liable under the preceding sections if they  exercised a degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.

The Court referred to the FCA decision in Her Majesty the Queen v. Buckingham, 2011 FCA 142, were the due diligence defence was considered in relation to unremitted source deductions.  The FCA recognised that the provisions in question aim at the prevention of failures to remit and stated:

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.

[…]

The traditional approach has been that a director’s duty is to prevent the failure to remit, not to condone it in the hope that matters can be rectified subsequently: Canada v. Corsano, [1999] 3 F.C. 173 (C.A.) at para. 35, Ruffo v. Canada, 2000 D.T.C. 6317, [2000] 4 C.T.C. 39 (F.C.A.).

[…]

In circumstances where a corporation is facing financial difficulties, it may be tempting to divert these Crown remittances in order to pay other creditors and thus ensure the continuation of the operations of the corporation. It is precisely such a situation which both section 227.1 of the Income Tax Act and section 323 of the Excise Tax Act seek to avoid. The defence under subsection 227.1(3) of the Income Tax Act and under subsection 323(3) of the Excise Tax Act should not be used to encourage such failures by allowing a due diligence defence for directors who finance the activities of their corporation with Crown monies on the expectation that the failures to remit could eventually be cured.

[…]

A director of a corporation cannot justify a defence under the terms of subsection 227.1(3) of the Income Tax Act where he condones the continued operation of the corporation by diverting employee source deductions to other purposes. The entire scheme of section 227.1 of the Income Tax Act, read as a whole, is precisely designed to avoid such situations. In this case, though the respondent had a reasonable (but erroneous) expectation that the sale of the online course development division could result in a large payment which could be used to satisfy creditors, he consciously transferred part of the risks associated with this transaction to the Crown by continuing operations knowing that employee source deductions would not be remitted. This is precisely the mischief which subsection 227.1 of the Income Tax Act seeks to avoid.

[emphasis original]

The Court also referred to the FCA comments in Buckingham regarding the decision in HMQ v. McKinnon, [2001] 2 F.C. 203 CA, subnom Worrell v. Canada where the FCA wrote:

69.      It will normally not be sufficient for the directors simply to have carried on the business, knowing that a failure to remit was likely but hoping that the company’s fortunes would revive with an upturn in the economy or in their market position. In such circumstances directors will generally be held to have assumed the risk that the company will subsequently be able to make its remittances. Taxpayers are not required involuntarily to underwrite this risk, no matter how reasonable it may have been from a business perspective for the directors to have continued the business without doing anything to prevent future failures to remit.

The Court stated that the relevant considerations of the due diligence defence in the Worell circumstances will have to be developed by the courts, but in this case the earnest efforts by the directors to try to remedy the failure to remit after it had occurred could also not support the due diligence defence on the facts.  There was no interfering person that exercised power over payments, and there was no evidence on which the court could determine the reasonableness of the anticipation of the funds expected.

The Court concluded by stating:

Source deductions and GST remittances are required by law to be made by a business corporation. These are not the corporation’s own funds. The corporation has collected them from its employees and customers. Those employees and customers are given credit for these amounts once withheld and collected, even when not remitted. When owner-managers and directors decide to use these funds to keep their business afloat and support their investments, they are making all Canadian taxpayers invest involuntarily in a business and investment in which they have no upside. In doing so, shareholders and corporate decision-makers are investing or gambling with other people’s money. Directors should be aware of that when they cause or permit this to happen. The directors’ liability provisions of the legislation should be regarded by business persons as somewhat similar to a form of personal guarantee by the directors that can expose them to comparable liability for the amount involved. It is they who are deciding to invest the funds in their own business, for their own gain, not the government or people of Canada. They are doing so contrary to clear law and it appears appropriate as a policy matter that Parliament has legislated clearly that they will generally be responsible for such decisions and the loss resulting from them. In essence, if a corporation and its directors choose to unilaterally “borrow” from Canadian taxpayers and the public purse, Canadians get the benefit of security akin to personal guarantees of the directors.

– Sas Ansari, BSc BEd PC JD LLM PhD (exp) CPA In-Depth Tax 1, 2 &3

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