Date: 19980213
Docket: 96-1621-GST-G
BETWEEN:
JOHN VAN DYKE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Hamlyn, J.T.C.C.
[1] A Partial Statement of Agreed Facts was filed. It reads:
The following is a list of those facts which are agreed to as between the Appellant and the Respondent and that form a part of the evidence in the above referenced appeal:
Description
1. Harring Manufacturing Incorporated ("Harring") was incorporated effective as of April 10, 1989.
2. Harring was engaged in the manufacture or production of custom wood millwork and wood doors for use in higher end applications such as professional or executive office finishing.
3. The first directors of Harring were John Van Dyke, the Appellant, and Dave Butler.
4. The Minutes of a Special General Meeting of the Shareholders of Harring, dated April 10, 1989, confirm that, on a motion duly made, seconded and unanimously carried, it was resolved that the Appellant and David Butler act as directors of Harring. The resolution was executed by the Appellant, as Chairman, and David Butler, as Secretary.
5. David Butler resigned as an officer and director of Harring effective February 1, 1991, which resignation was accepted and consented to by the shareholders of Harring as recorded by a resolution of the shareholders of Harring dated March 1, 1991.
6. At all times, material to this appeal, the Appellant was the sole director, the sole shareholder, and officer of Harring.
7. Ms. Petra Becker was hired as an employee of Harring to perform office work, including day to day bookkeeping.
8. Harring registered for the purposes of Part IX of the Excise Tax Act ("GST") by way of a GST registration form, dated October 31, 1990, and remained so registered thereafter. This registration was effective for the purposes of the GST which tax became effective as of January 1, 1991.
9. Harring was a quarterly filing registrant for the purposes of the GST at all times.
10. Harring neither filed a return for the purposes of the GST nor remitted any amount on or on account of GST payable to Revenue Canada after 1991.
11. Harring entered into a "GENERAL SECURITY AGREEMENT", dated December 23, 1992, in favour of the Appellant. By its terms, this agreement constituted a general and continuing collateral security for the payment of all existing and future indebtedness and liability of Harring to the Appellant. The collateral granted as security extended to "now owned or hereafter acquired, and whether tangible or otherwise". The Schedule to this security agreement show the fair market value of the machinery attributed to the door division of Harring as being $116,000.00 and the fair market value of the machinery attributed to the millwork division of Harring as being $154,350.00.
12. In August of 1993 Revenue Canada commenced a GST audit of Harring for all reporting periods commencing with and following January 1, 1991.
13. On August 9, 1993, Distress was taken by the Landlord, Haselden Investments Limited, of the Harring premises.
14. On August 12, 1993 Harring filed an assignment in bankruptcy.
15. Notice of "First Meeting of Creditors" was issued by the Trustee, DAVIS, MARTINDALE & CO. INC., dated August 17, 1993.
16. The Respondent, through Revenue Canada, Customs, Excise and Taxation, filed a proof of claim, pursuant to the Bankruptcy and Insolvency Act, dated September 1, 1993, in the amount of $80,199.28. This amount comprised $73,262.78 as net tax, $3,547.69 as interest, and $3,388.81 as penalty.
17. A Notice of Assessment, number 08PD0100620 and dated September 7, 1993, was issued by Revenue Canada to Harring for the aforesaid amounts of $73,262.78 as net tax, $3,547.69 as interest, and $3,388.81 as penalty. Harring did not object to the aforesaid assessment.
18. A Notice of Assessment - Third Party, number 12053 and showing date mailed as December 19, 1994, was issued by Revenue Canada to the Appellant in the amount of $92,339.18. This amount was stated to comprise $79,563.51 as net tax, $5,807.26 as interest, and $6,968.41 as penalty.
19. The difference in the amount claimed as net tax as shown on the proof of claim and the subsequent Notice of Assessment - Third Party reflects an adjustment down to account for the day on which Harring filed the assignment in bankruptcy.
20. The Appellant objected to the aforesaid Notice of Assessment - Third Party by Notice of Objection dated February 15, 1995 and date stamped received by Revenue Canada on February 23, 1995.
21. By Notice of Decision No. SWO S100018, dated September 15, 1996, the Minister of National Revenue confirmed the Notice of Assessment - Third Party issued to the Appellant.
22. The Appellant filed a Notice of Appeal in this matter with the Tax Court of Canada on May 9, 1996.
23. The Appellant filed an Amended Notice of Appeal in this matter with the Tax Court of Canada.
24. The Respondent filed a Reply in this matter on June 24, 1996.
THE EVIDENCE AT TRIAL
[2] The Appellant was involved in the ownership and operation of businesses for several years.
[3] From February 1, 1991, the Appellant was the principal owner and sole director of Harring Manufacturing Incorporated ("Harring"). Harring was in business from April l989 to August l993 manufacturing doors and processing custom millwork. Originally, the Appellant purchased the assets of Harring with the intent that another individual (David Butler) would invest and manage the business. This intention did not materialize and the individual (David Butler) left the company. Further, a manager hired by David Butler, because of alleged misdeeds, was eventually released by the Appellant. About this time, Petra Becker was engaged to be the office manager (Spring 1991) and this arrangement continued until the receivership of the company (August l993).
[4] In the Spring of 1991, the Appellant became more involved with the company and specifically sought to develop the sales and promotional aspects of the business.
[5] A management team and a management committee system was set up. The committee met once per month increasing to once per week in the waning weeks of the company's life.
[6] The management committee was composed of the heads of the several sections of the company's structure including Petra Becker as office manager (Petra Becker at the time of her employment attained the fifth level of an uncompleted CGA accountant training program). Aside from being the director, the Appellant's specific duties were directed towards building a dealer network and the selling of product. In terms of accounting with bookkeeping duties, the Appellant maintained he did not have accounting or bookkeeping expertise, that he was not a numbers person and for such matters he relied on Petra Becker.
[7] The life of the corporation was always under serious financial pressure with cash shortfalls and credit line constraints. This in the view of the Appellant was the result of a lack of investors, a poor business economic climate, some client bankruptcies and previous manager malfeasance.
[8] Aside from his marketing activities the Appellant attended the management committee meetings. The Appellant stated the meetings reviewed profit and loss statements, payrolls, receivables, sales, production, deliveries and overall matters concerning the company.
[9] Each of the management committee personnel addressed their particular corporate interests at the meetings.
[10] Petra Becker had the specific responsibility for accounting; including payrolls, accounts payable and accounts receivable. She stated that at the committee meetings she addressed these issues.
[11] The Appellant and three other members of the management committee (Brian Gray, Jeff Bruinsma and Martin Timmermans) gave evidence that Petra Becker never raised the issue of GST remittances and the failure to make such remittances at the management meetings.
[12] Petra Becker in her evidence stated she continually raised the issue of GST liability and that she filed documents (balance sheets) at each meeting indicating the GST liability. Further, during this period of time, she said she was asked by the Appellant as to when the GST issue would attract the attention of Revenue Canada and she replied that a Revenue Canada audit of the corporation would eventually expose the failure to remit.
[13] The Appellant did confirm there was a remittance problem in relation to source deductions and that a payment schedule was worked out with Revenue Canada to satisfy this liability, but he believed any outstanding GST liability was included in this arrangement.
[14] The Appellant's evidence also maintained the first time he had an indication that there was a significant problem with GST remittances was in the Spring of l993.
[15] The Appellant and his wife (she operated a restaurant business) alleged that in the Spring of l993 they experienced certain business deceptions at the hands of Petra Becker. (As well as her duties at Harring, Petra Becker assisted in the keeping of the accounting records of the restaurant.)
[16] Petra Becker denied any deception and stated that throughout her tenure she advised the Appellant and the committee of the remittance problems for GST. Further, she said her direction from the Appellant and one other committee member (Brian Gray) was that payables were to be paid in accordance with a specified "hierarchy". Raw material suppliers were at the top of the list and GST was at the bottom of the list.
[17] Contrary to the evidence of the Appellant, Petra Becker said she did not hide the GST liability within Harring's accounting records. Moreover, the evidence of the Revenue Canada auditor who audited the corporation books in the Spring of l993 was to the effect that his review of the financial records of the corporation indicated nothing improper with the bookkeeping and accounting records.
[18] It is noted throughout the period under review, Petra Becker did not have signing authority for the corporation. All cheques had to be signed by one of the Appellant, a designated member of the management committee (Brian Gray) or a self employed Certified General Accountant employed outside the corporation (Carl Kingston).
[19] A review of the exhibits indicates GST liability was shown on a balance sheet for 1991 and GST liability was shown on a balance sheet for the Spring of l993. No other balance sheets were presented to the Court. The Appellant stated the balance sheets were non-existent whereas Petra Becker said they did exist and she filed them at each management meeting.
LEGISLATION
[20] The relevant sections of the Excise Tax Act (the "Act") are:
228(1) Calculation of net tax — Every person who is required to file a return under this Division shall in the return calculate the net tax of the person for the reporting period for which the return is required to be filed.
(2) Remittance — Where the net tax for a reporting period of a person is a positive amount, the person shall remit that amount to the Receiver General on or before the day on or before which the return for that period is required to be filed.
...
323(1) Liability of directors — Where a corporation fails to remit an amount of net tax as required under subsection 228(2), the directors of the corporation at the time the corporation was required to remit the amount are jointly and severally liable, together with the corporation, to pay that amount and any interest thereon or penalties relating thereto.
(2) Limitations — A director of a corporation is not liable under subsection (1) unless
(a) a certificate for the amount of the corporation's liability referred to in that subsection has been registered in the Federal Court under section 316 and execution for that amount has been returned unsatisfied in whole or in part;
(b) the corporation has commenced liquidation or dissolution proceedings or has been dissolved and a claim for the amount of the corporation's liability referred to in subsection (1) has been proved within six months after the earlier of the date of commencement of the proceedings and the date of dissolution; or
(c) the corporation has made an assignment or a receiving order has been made against it under the Bankruptcy and Insolvency Act and a claim for the amount of the corporation's liability referred to in subsection (1) has been proved within six months after the date of the assignment or receiving order.
(3) Diligence — A director of a corporation is not liable for a failure under subsection (1) 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.
ANALYSIS
[21] Where a corporation fails to remit an amount of net tax as required under subsection 228(2), subsection 323(1) provides that the directors of the corporation are jointly and severally liable, together with the corporation, to pay the net tax and any interest or penalties relating to that net tax. Subsection 323(3) allows a director a defence of due diligence from the liability for the corporation’s unremitted GST and any interest and penalties arising therefrom.
[22] Therefore, the Court need only determine whether the Appellant acted as a reasonably prudent person would have, in similar circumstances, in an attempt to prevent the failure of the corporation to remit the required GST. This will be a factual determination based upon the evidence brought before the Court by the Appellant.
[23] In A. Ted Ewachniuk v. Her Majesty the Queen, [1997] G.S.T.C. 29 (T.C.C.), Sobier J. found that the Appellant director did not demonstrate the requisite degree of care needed to prevent liability for the corporation’s unremitted GST. He found that the defence of due diligence requires that positive action has been taken to prevent the failure to remit tax. It is not sufficient to show that once the failure had been discovered, steps have been taken.
[24] In Ewachniuk (supra), Sobier J. found that although there were allegations of theft and embezzlement they were not material in any way to the issue in appeal, which was whether the Minister’s assessment under subsection 323(1) of the Act was correct. He stated that the outcome of the appeal rested on the interpretation of the operative words of subsection 323(3) "... the degree of care, diligence and skill, to prevent the failure". He then quotes from a decision of Rip T.C.J. in which an attempt to define the word "prevent" is made:
As Judge Rip of this Court said in Ho v. M.N.R., [1990] 2 C.T.C. 2623, 91 D.T.C. 76, at page 80:
The word "prevent" is defined in The Shorter Oxford Dictionary On Historical Principals [sic] as:
1. To act in anticipation of or in preparation for (a future event, or a point in time); to act as if the event or time had already come...b. To meet beforehand...3. To stop, keep or hinder from doing something....4. To provide beforehand against the occurrence of (something); to preclude, stop, hinder....6. To frustrate, defeat, bring to naught... 7. To use preventative measures....
In the French language, the word "prévenir" is used in subsection 227.1(3). Le Petit Robert I defines the word "prévenir":
1. Devancer (qqn) dans l'accomplissement d'une chose, agir avant (un autre)....2. Aller au-devant de (qqch.) pour hâter l'accomplissement....3. Aller au-devant pour faire obstacle; empêcher par ses précautions....
The words "prevent" and "prévenir" mean the same: to stop an event from happening before it happens. Once a failure to remit takes place, its prevention is no longer possible. Anything Ho, or Lawlor or Ho's counsel may have done after November, 1986 was too late to prevent the failures that had already occurred.
[25] Sobier J. found that the Appellant did not take any positive action to prevent the corporation’s failure to remit GST as the Appellant had never asked to see any of the corporation’s financial statements or reports other than some sales figures. Nor had the Appellant ever made any effort to see that the corporation’s GST was being remitted while it was operating the restaurant business. The action taken by the Appellant after he realized that the GST was not being remitted as required by the Act did not suffice in making out a defence of due diligence. Therefore, the Court found that the Appellant was jointly liable for the corporation’s outstanding GST owing.
[26] The decision in Soper v. The Queen, 97 DTC 5407, was a decision of the Federal Court of Appeal and in it Robertson J.A. analysed the requirements of the due diligence defence for directors attempting to avoid liability for unremitted source deductions under subsection 323(3) of the Act.
[27] Robertson J.A. characterized the test as an "objective-subjective" test. He stated at page 5417 that:
[I]t is difficult to deny that inside directors, meaning those involved in the day-to-day management of the company and who influence the conduct of its business affairs, will have the most difficulty in establishing the due diligence defence. For such individuals, it will be a challenge to argue convincingly that, despite their daily role in corporate management, they lacked business acumen to the extent that that factor should overtake the assumption that they did know, or ought to have known, of both remittance requirements and any problem in this regard. In short, inside directors will face a significant hurdle when arguing that the subjective element of the standard of care should predominate over its objective aspect.
[28] Robertson J.A., by categorizing directors as being either inside or outside directors, has seriously limited the subjective portion of the due diligence test for taxpayers that are involved in the day-to-day running of a company.
[29] Robertson J.A. also stated, at page 5418, with reference to an outside director, that:
[T]he positive duty to act arises where a director obtains information, or becomes aware of facts, which might lead one to conclude that there is, or could reasonably be, a potential problem with remittances. Put differently, it is indeed incumbent upon an outside director to take positive steps if he or she knew, or ought to have known, that the corporation could be experiencing a remittance problem. The typical situation in which a director is, or ought to have been, apprised of the possibility of such a problem is where the company is having financial difficulties.
[30] The Appellant in the present appeal states that there are several reasons for the cash flow problem that the corporation faced, including a manager that was misappropriating company funds, economic market decline, client bankruptcy and the eventual locking out of its business premises by the landlord of the building which ultimately led to the corporation ceasing operations. It is my opinion that these facts do not appear to be material to the issue under appeal and in no way affects the determination of whether the Appellant exercised the due diligence required by subsection 323(3) of the Act.
[31] It is clear that the evidence before the Court was full of conflict on the essential point of whether the Appellant knew of the GST remittance problem. All the Appellant's witnesses' evidence was contrary to the Respondent's witnesses', in particular Petra Becker's. Notwithstanding the conflicts of evidence, I conclude certain truths and conclusions emerge.
[32] The management committee was a relatively young group of individuals dedicated towards building the success of Harring. For each of their respective areas of responsibility they advanced their corporate needs and reports at each management meeting. This included the financial report of the office manager. However, there were basic realities that all members of the committee were aware of, namely, limited operating funds and the needs of the suppliers of raw materials in order to continue supplying were contingent in no small measure upon payment on account.
[33] The Appellant was an experienced businessman of many years standing and his wife was experienced in business. Both these businesses (Harring and the restaurant) were involved with GST. To operate a business and conclude GST was taken care of in a source deduction negotiation and not revisit this issue on a timely regular basis stretches credibility, especially when one is the sole director and shareholder.
[34] In order to plead the defence of due diligence the Appellant must do more on the evidence than to say I had someone in charge of the GST account and I was not aware of the remittance problem. On balance, I find on the evidence the unremitted GST was not a topic at every management committee meeting but I conclude that the Appellant was aware of the GST liability and must have chosen in consultation with the office manager to not pay the GST remittances as GST funds were needed to keep the business in business. At best, the efforts of Petra Becker in attempting to placate bankers and creditors and assisting to keep the company going did not discharge or satisfy the legislative remittance responsibilities of the Appellant. Moreover, the Appellant's retention of signing authority over the companies funds and Petra Becker's vigorous overt attempts to not have signing authority emphasize, as between Petra Becker and the Appellant, the ultimate responsibility over corporate expenditures lay with the Appellant.
[35] By taking this direction he did not take positive steps to prevent the failure to remit tax.
CONCLUSION
[36] I conclude 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.
DECISION
[37] The appeal is dismissed.
[38] The Respondent is entitled to costs.
Signed at Ottawa, Canada, this 13th day of February 1998.
"D. Hamlyn"
J.T.C.C.