Directors Liability under Corporate Taxing Statutes

Directors Liability under Corporate Taxing Statutes Resource type: Practice Note Status: Maintained Jurisdiction: Canada This Note discusses the liability of directors for withholding and remittance obligations under legislation governing income tax, HST, CPP and employment insurance. It also covers the defences available to directors against these liabilities. Prepared by Daniel Kiselbach and Ryan Adkin of Deloitte Tax Law LLP Contents Directors Liability under Tax Statutes Who is Liable as a Director? Statutory Limitations on Directors Liability Due Diligence Defence An Objective Standard Judicial Deference under the Business Judgment Rule Illustrative Applications Checklist of Steps Supporting Due Diligence Defence Disputing the Underlying Corporate Assessment Certain tax statutes require directors to take reasonably prudent measures to prevent the corporation on whose board they sit from failing to withhold, collect or remit amounts that the corporation receives. The Canada Revenue Agency (CRA) may issue a director s assessment to a director who chooses, for example, to use amounts earmarked on account of employee source deductions or goods and services tax ( GST ) in a failed attempt to continue to run a business. This Practice Note provides information to assist directors and their advisors who wish to take preventive steps to avoid or deal with directors liability assessments. It discusses directors liability for employee source deductions under section 227.1 of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supplement) (ITA) and unpaid harmonized sales tax (HST) or GST under section 323 of the Excise Tax Act, R.S.C. 1985, c. E 15 (HST Act). Other tax statutes also provide for directors liability provisions. CRA s policy on directors liability is provided in Information Circular 89 2R3 (Directors Liability) dated April http://ca.practicallaw.com/2 589 6766 1/9

10, 2014. Directors Liability under Tax Statutes Section 227.1(1) of the ITA provides that directors of a corporation at the time the corporation was required to deduct, withhold, remit or pay the following amounts are jointly and severally liable, together with a corporation to pay that amount, and any interest or penalties relating to it if the corporation fails to: Deduct or withhold an amount required by section 153 (employee payroll deductions). Deduct or withhold an amount required by section 215 (non resident withholding tax). Remit or pay an amount as required under VII or VIII (share purchase and scientific research tax credit taxes). Section 323(1) of the HST Act provides that directors of the corporation at the time are jointly and severally liable, together with the corporation, if the corporation does not: Remit an amount of net tax as required under section 228(2) or (2.3). Pay an amount as required under section 230(1) that was paid to, or was applied to the liability of, the corporation as a net tax refund. Directors are liable for their corporations unremitted net tax and over paid net tax refunds whether or not the GST or HST was collected by the corporation. Under the ITA and HST Act, the liability of directors extends to the unpaid tax as well as penalties and interest. Other legislation is similar to section 227.1 of the ITA and section 323 of the HST Act. An employer who fails to deduct or remit Canada pension plan contributions or employment insurance premiums will also be exposed to liability. In particular: Section 21(1)(1) of the Canada Pension Plan, R.S.C. 1985, c. C 8 (CPP) imposes liability on directors of the corporation at the time that the corporation fails to deduct or remit an amount as and when required under section 21(1). Section 83(1) of the Employment Insurance Act, S.C. 1996, c. 23 (EI Act) provides that, if a corporate employer fails to deduct or remit an amount as and when required under section 82(1), the directors of the corporation at the time when the failure occurred are jointly and severally liable, together with the corporation, to pay that amount and any related interest or penalties. Other tax statutes that provide for directors liability include: Section 81 of the Air Travellers Security Charge Act, S.C. 2002, c. 9. http://ca.practicallaw.com/2 589 6766 2/9

Section 95 of the Softwood Lumber Products Export Charge Act, 2006, S.C. 2006, c. 13. Section 294 of the HST Act. Section 77 of the Alberta Personal Income Tax Act, R.S.A. 2000, c. A 30. Section 207 of the Provincial Sales Tax Act, S.B.C. 2012, c. 35. The Federal Court of Appeal has held that similarly worded provisions should be similarly interpreted. (See Buckingham v. R., 2011 CarswellNat 1295 (F.C.A.), at paragraph 47.) Who is Liable as a Director? For an individual to be liable under the directors liability provisions, she must have been a director of the corporation at the relevant time. An individual may either be a legally appointed (de jure) director or a director in fact (de facto). A de jure director is a person who has the authority to act as a director as a matter of law. The term director is not defined in the ITA or the HST Act. The governing corporate law in the appropriate jurisdiction and the constating corporate documents must be reviewed to determine whether or not a person is or was a de jure director of a corporation. Case authority (see Wheeliker v. R., 1999 CarswellNat 417 (Fed. C.A.)) indicates that a person may become a de facto director (that is, a director in fact). On some occasions, a de jure director may formally resign a directorship, but continue to carry on corporate director roles. In that case, the individual risks becoming a de facto director. All of the circumstances must be taken into account to determine whether or not an individual becomes or ceases to be a de facto director. To cease to act as a director, the individual must stop all management activities and must not hold herself out as a director to others. If a person continues to perform functions as a director, or hold herself out as a director, then she is a director. (See Bremmer v. R., 2007 CarswellNat 2624 (T.C.C. [Informal Procedure]), confirmed 2009 CarswellNat 1224 and Snively v. R., 2011 CarswellNat 1377 (T.C.C. [Informal Procedure]).) Individuals who have not complied with the technical requirements for resignation or cessation of directorship have been held to be personally liable for unpaid tax because their resignations were invalid. (See Campbell v. R, 2010 CarswellNat 2447 (T.C.C. [General Procedure]) and Shepherd v. R., 2008 CarswellNat 2065 (T.C.C. [Informal Procedure]).) For example, under section 108 of the Canada Business Corporations Act, R.S.C. 1985, c. C 44 (CBCA), the resignation of a director takes effect on the later of the time that the director's written resignation is provided to the corporation and, if the written resignation specifies that the resignation is to take effect at a specified date, on a specified date and time or on the occurrence of a specified event. Under section 119(2) of the Ontario Business Corporations Act, R.S.O. 1990, c. B.16 (OBCA), the resignation of the first director named in the articles of incorporation is ineffective unless a meeting of shareholders has been held or a replacement director has been appointed. http://ca.practicallaw.com/2 589 6766 3/9

The assignment of the corporation into bankruptcy does not result in the cessation of a person s directorship in the corporation (see Butterfield v. R., 2010 CarswellNat 4703 (F.C.A.)). The revival of a corporation is retroactive to the date of its dissolution, with the result that the corporation and its directors are returned to the same position that they would have if the corporation had not been dissolved (see Leger v. R., 2007 CarswellNat 1960 T.C.C. [General Procedure], at paragraph 26). The ITA, HST Act and other relevant legislation provide limits on the time during which the CRA may assess a director for a corporation s liability. Such an assessment must not occur more than two years after an individual has ceased to be a director. However, where a person is no longer a de jure director but continues to be a de facto director, the CRA is still able to assess. It is often critical for individuals to properly document when they became directors and when they resigned or otherwise ceased to be directors. As well, it is important to ensure that the public record at all times accurately reflects changes in the composition of the board of directors. Many individuals have been sued precisely because the public record was not updated to show that they had ceased to be directors. Statutory Limitations on Directors Liability Statutory provisions limit the liability of directors for unpaid source deductions. The CRA must establish at least one of the following conditions precedent to liability: A Federal Court certificate for the amount for the corporation s liability has been registered in the court and execution for that amount has been returned unsatisfied in whole or in part. The claim must be proved within six months. The corporation has commenced liquidation or dissolution proceedings or has been dissolved and a claim for the amount of that corporation s liability has been proved within six months after the earlier of the date of the commencement of the proceedings on the date of dissolution. The corporation has made an assignment or bankruptcy order has been made against it under the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B 3 (BIA) and a claim for the amount of the corporation s liability has been proved within six months after the date of the assignment or bankruptcy order (see section 227.1(2), ITA and section 323(2), HST Act). Directors liability for source deductions under section 227.1 of the ITA or HST under section 323 of the HST Act does not crystalize until one or more of these conditions precedent have been met. (See Worrell v. R., 2000 CarswellNat 2344 (Fed. C.A.), at paragraph 74 and Walsh v. R., 2009 CarswellNat 3554 (T.C.C. [General Procedure]).) Due Diligence Defence Section 227.1(3) of the ITA and section 323(3) of the HST Act provide for a statutory due diligence http://ca.practicallaw.com/2 589 6766 4/9

defence. A director is not liable for a failure to pay tax where the director exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. Due diligence means the care that a reasonably prudent person would take in the similar circumstances to ensure that the corporation deducts, withholds, collects, remits or pays the tax that is due and owing. The standard under the ITA and HST Act is the same (see Buckingham v. R., 2011 CarswellNat 1295 (F.C.A.), at paragraph 47). Extensive jurisprudence provides guidance to directors on how to protect themselves from liability. An Objective Standard In People's Department Stores Ltd. (1992) Inc., Re, 2004 CarswellQue 2863 (S.C.C.), the Supreme Court of Canada interpreted section 122(1)(b) of the CBCA, a provision whole language parallels that in section 227.1(3) of the ITA and section 323(3) of the HST Act. The court held that the CBCA imposes an objective standard, not a subjective objective standard. Imposing an objective standard makes it clear that the factual aspects of the circumstances surrounding the actions of the director or officer are important (as opposed to the subjective motivation of the director). The court noted that courts have developed a rule of deference to business decisions called the business judgment rule. Judicial Deference under the Business Judgment Rule Under the business judgment rule, courts should not second guess the application of business expertise to the considerations that are involved in corporate decision making. Courts can, however, determine whether a director exercised an appropriate degree of prudence and diligence when reaching what is claimed to be a reasonable business decision. Perfection is not demanded (see Smith v. R., [2001] 2 C.T.C. 2494 (F.C.A.)). The statutory due diligence provision relieves directors of liability if they act prudently and on a reasonably informed basis. They must make reasonable business decisions in light of the circumstances about which the directors knew or ought to have known. The Federal Court of Appeal has now applied the objective standard adopted by the Supreme Court in People's Department Stores to a director s duty of care under section 227.1(3) of the ITA. In Buckingham, paragraph 34, the court stated that the due diligence relates only to attempts to prevent, not attempts to remedy, the failure. In light of the objective standard, it may not be possible to simply rely upon a director s lack of experience or knowledge (see McKenzie v. R., 2013 CarswellNat 4371, at paragraph 106). Illustrative Applications The onus is on the director to prove her due diligence defence on a balance of probabilities. A court must consider and weigh the totality of the evidence. Some factors include: One important element of any due diligence defence is to establish that the director took positive http://ca.practicallaw.com/2 589 6766 5/9

steps to ensure that her corporation made the requisite deductions, collections and remittances. In Leger v. R., 2007 CarswellNat 1960 (T.C.C. [General Procedure]), the director was found liable for certain failures to remit even where the director had taken reasonable steps to prevent other failures. Courts have held that a director exercised due diligence where she relied upon another person to ensure corporate compliance. As noted, the due diligence defence in the ITA and HST Act is an objective standard. Arguably, therefore, any reliance on another person must be objectively reasonable (see Constantine v. R., 2012 CarswellNat 5472 (T.C.C. [Informal Procedure])). For example, a director may be entitled to rely on a long term manager until the director becomes aware of financial difficulties (see D Amore v. R., 2012 CarswellNat 4069 (T.C.C. [General Procedure])). Financial contributions to help a company cope with adverse financial circumstances may support a due diligence defence. See, for example, Balthazard v. R., 2011 CarswellNat 4964 (F.C.A.) in which the Federal Court of Appeal found that a director s financial contributions to help a company indicated his due diligence. He was found not liable for a period where GST liability was revealed only later after an audit. Actions to address the tax liability and bring it to the attention of directors who have control over the finances may support a due diligence defence. See, for example, Lau v. R., 2007 CarswellNat 4248 (T.C.C. [General Procedure]) where the director who took steps to bring the corporation s failure to deal with GST liability to the attention of remaining directors was found not liable. However, certain activities may not be sufficient to support a due diligence defence. For example: A director s reliance on a manager may not be reasonable if a director knows a corporation was in financial difficulty (see Kaur v. R., 2013 CarswellNat 2477 (T.C.C. [General Procedure])). If a director appoints an outside firm to take control of finances, the director is still required to take positive compliance steps (see Mignardi v. R., 2013 CarswellNat 1121 (T.C.C. [Informal Procedure]) respecting GST remittances). A director does not exercise reasonable reliance if she blindly relies on her husband (see Constantine v. R., 2012 CarswellNat 5472 (T.C.C. [Informal Procedure])). Checklist of Steps Supporting Due Diligence Defence A director will not be liable if she took all reasonable care to prevent the failure of the corporation to deduct, collect or remit tax. The following is a checklist of steps or considerations which may be used in support of a due diligence defence: Set up a separate bank account for withholdings, collections and remittances of tax amounts and do not comingle funds for such taxes with other funds used by the corporation. Ask corporate accountants to: provide regular reports on the status of withholdings, collections and remittances of tax amounts; and confirm that withholdings and remittances are being made on a regular basis in the required http://ca.practicallaw.com/2 589 6766 6/9

amounts. Ask the company s lawyers to provide advice on the: nature of the legislative requirements concerning the deduction, withholding and remittance of tax amounts; nature of the directors liability for unpaid corporate tax amounts; and steps that should be taken to establish a due diligence defence in light of recent case law indicating that acts or omissions will be measured against the standard of a reasonably prudent person. Implement a corporate system (including policies and procedures) which result in the regular deduction, withholding and remittances in accordance with all legal requirements. Implement lines of communication and reporting policies to ensure that all persons responsible for the withholding, collection and payment of tax report any tax non compliance to the board of directors. Contact company legal counsel to deal with any discovered tax non compliance in order to maintain solicitor client privilege and privilege over self critical analysis, audits or reports that may be generated by the corporation. Develop measures to deal with corporate financial distress including: enhanced reporting to the directors; adopting procedures to ensure that source deductions, HST or other trust funds do not fall into arrears; segregating funds to cover source deductions, HST and other deemed trusts to protect directors; ensuring that funds are properly segregated to cover source deductions, HST and other deemed trusts long before the corporation takes protection under the BIA or the Companies Creditors Arrangement Act, R.S.C. 1985, c. C 36 (CCAA), as these may constitute a preference to the Crown. Deliver a written resignation as a director effective immediately if the power to carry out director s management of the business is lost as a result of the assignment or appointment of a trustee in bankruptcy, receiver or receiver manager. Once a written resignation has been delivered, refuse to participate in any corporate management activities in order to avoid becoming a deemed or de facto director. Obtain an indemnity (from a major shareholder) and directors and officers liability insurance. Obtain a perfected security interest from the corporation to secure any contingent tax liability. Disputing the Underlying Corporate Assessment http://ca.practicallaw.com/2 589 6766 7/9

Directors liability is a type of secondary liability. In the case of secondary liability, the liability of the director is secondary to the primary obligant, which is the corporation. Early Tax Court of Canada decisions related to a director disputing the underlying corporate liability went both ways. However, more recent decisions of the Federal Court of Appeal have allowed directors to appeal the corporation s underlying or primary liability. (See Abrametz v. R., 2009 CarswellNat 5465 (F.C.A.), Doncaster v. R., 2012 CarswellNat 1191 (F.C.A.) and Gougeon c. R., 2012 CarswellNat 4505 (F.C.A.), as well as the discussion in Siow v. R., 2010 CarswellNat 4446 (T.C.C. [General Procedure]).) The Federal Court of Appeal decisions align with the view that directors should be entitled to dispute an underlying corporate tax assessment because of the absence of mutuality of parties. According to these decisions: A primary assessment may be issued against the corporation and derivative assessment may be issued against its directors. A director should not be prejudiced by the failure of the corporation to successfully appeal a tax assessment. There may be good reasons why the corporation failed to appeal. These include lack of funds, insolvency or disagreement amongst the directors. A requirement that the Tax Court of Canada enquires into why the primary assessment was not challenged or whether the directors should have influenced the corporation to appeal is not required (see Scavuzzo v. R., 2005 CarswellNat 4238 (T.C.C. [General Procedure]), Bowman C.J.). Natural justice requires that a person who has been issued a secondary assessment should have the right to challenge the primary assessment (see Barry v. R., 2009 CarswellNat 4855 (T.C.C. [General Procedure])). A director may dispute the primary corporate tax assessment respecting unpaid source deductions where the payments were being made by the corporation as agent of a related corporation (see Marshall v. R., 2012 CarswellNat 108 (T.C.C. [General Procedure])). As with a regular assessment, a director may object to an assessment on the basis that no notice of assessment was ever mailed to the director. The onus will shift to the CRA to prove that the notice of assessment was in fact mailed. Call us toll free 1 844 717 4488 (in Toronto 416 649 9318) Email us carswell.plcanada@thomsonreuters.com Monday to Friday 8:30 a.m. to 4:30 p.m. ET You can also send us feedback with any questions or comments on the site. For more options to contact us click here. 2014 Thomson Reuters. All rights reserved. Use of Practical Law websites and services is subject to the Terms of Use and Privacy Policy. Practical Law Company services are now a Thomson Reuters Legal Solution. http://ca.practicallaw.com/2 589 6766 8/9

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