Tax Court of Canada Judgments

Date: 19990126

Docket: 96-4802-GST-I

BETWEEN:

ASHTON RUTHERFORD HEVENOR,

Appellant

and

HER MAJESTY THE QUEEN,

Respondent.

Appeal heard on November 16, 1998 at London, Ontario by the Honourable Judge Gerald J. Rip

Reasons for judgment

RIP, J.T.C.C.

[1] Mr. Ashton Rutherford Hevenor, the appellant, appeals from an assessment issued by the Minister of National Revenue ("Minister") pursuant to section 323 of the Excise Tax Act ("Act") on the basis that the appellant was a director of 980250 Ontario Inc. ("Ontario") at all relevant times when the Corporation failed to remit to the Receiver General for Canada the net tax for reporting periods required by section 228 of the Act.

[2] This appeal asks the question whether a taxpayer can be said to exercise the degree of care, diligence and skill to prevent a corporation of which he is the sole director from failing to remit an amount of net tax under Part IX of the Act that a reasonably prudent person would have exercised in comparable circumstances when he had a limited education, was director of Ontario as a convenience to his son, was not involved in the business or the commercial activity carried on by Ontario, had no business experience and had no understanding of the responsibilities of a director.

[3] At time of trial Mr. Hevenor was 64 years of age. He was born on a family farm in Springfield, Ontario, where he still resides. He is the third generation of his family to live on this 74 acre farm. He attended a country public school and has a grade 10 education. After high school, he helped his father farm, worked as a garage mechanic and eventually became a welder and millwright, all the time living on the farm. He married in 1958 and has three children. Unfortunately, during the past few years his health has declined and he has had to retire early.

[4] Mr. Hevenor appears to be an honest, hardworking gentleman. He has no knowledge of accounting and business practices and, until recently, had no idea of what a corporation is and what the duties and obligations of corporate directors are.

[5] Bradley Hevenor ("Bradley") is the appellant's son. He is now 34 years of age and is a fourth-year apprentice welder and millwright. Bradley has a grade 11 education.

[6] In 1985, Bradley purchased a pizza business, Pud's Pizza, in Aylmer, Ontario which he operated until 1989. During this time the business made normal source deduction remittances to the Receiver General for Canada. In 1989, Bradley related, a developer purchased land contiguous to the pizza business and the developer intended to open a restaurant in the shopping plaza ("Plaza") it intended to develop. To protect his business, Bradley acquired a Pizza Delite franchise which he operated from the Plaza. Bradley incorporated a numbered corporation to operate the Pizza Delite franchise. The company borrowed $100,000 on a security of a mortgage on the farm owned by his father.[1] Bradley and his former wife were the shareholders of the numbered company. The appellant's accountant, a Mr. Denhander, was the accountant for Pud's Pizza and a Mr. Robert Deeleebeck was the accountant for the Pizza Delite business. Both were chartered accountants.

[7] At first the Pizza Delite business was very busy but after four months Bradley realized that there was insufficient cash coming into the business to cover expenses: a franchise fee to Pizza Delite of 6 percent of revenue, the costs of servicing the loan secured by the farm, Pizza Delite's investment in the business of $80,000 and a small business loan with the Royal Bank of Canada. Rent for the Pizza Delite premises was $4,000 a month, approximately $19.00 per square foot.

[8] Bradley attempted to obtain a reduction in his rent but the landlord refused. Eventually, in 1990 or 1991, the Royal Bank of Canada put the company operating the Pizza Delite business into receivership. The franchisor of Pizza Delite attempted to negotiate a settlement with the landlord. In the meantime Bradley continued to operate the franchise as manager. Eventually the Pizza Delite franchisor and the Royal Bank agreed to a settlement but the landlord refused to reduce the rent. Subsequently, a subsidiary of the landlord successfully negotiated an agreement with the receiver. The restaurant's name, among other things, was changed and Bradley was its manager. The restaurant was operated by a numbered company, the principal shareholder of which was Norton Builders Ltd. ("Norton"), the landlord, or a wholly-owned subsidiary of the landlord who owned the Plaza.

[9] In the meantime, Mr. Hevenor was still short the $100,000 borrowed by the numbered company.

[10] The Plaza itself was not successful. After about thirteen months, after Norton took over the restaurant, the Plaza's anchor store closed and other tenants moved out.

[11] Norton did not want to be in the restaurant business and in early 1992 offered to sell the restaurant to Bradley.

[12] At the time the company carrying on the Pizza Delite franchise was put into receivership, Bradley and his former wife were declared bankrupt. However, Bradley stated, when Norton made the offer to sell the business to him, he had been discharged from bankruptcy. In any event, Ontario was incorporated by Bradley to acquire the business from Norton. Bradley testified that he is under the impression that he was not involved in the incorporation of the corporation as a director or officer because of his earlier bankruptcy. Ontario acquired the restaurant for "about" $95,000.

[13] On incorporation, the only shareholder and director of Ontario was Mr. Hevenor, the appellant. Mr. Hevenor also invested $37,000 to pay to Norton on the purchase of the restaurant; he also signed a note for $66,000. The evidence is not clear as to whether Mr. Hevenor loaned the $37,000 to Ontario or paid the money to Norton. Similarly, it is not quite clear to whom the note was payable.

[14] The restaurant was now called "Pud's Pizza and Pasta Parlour" ("Pud's"). Mr. Hevenor was not involved in Pud's operation even though he was the Ontario's sole director and shareholder and financed the enterprise. From time to time, he acknowledged, he helped his son acquire some equipment and also went on some errands to pick-up some supplies for the restaurant. However, this was an infrequent and exceptional activity.

[15] Bradley managed Pud's. Bradley was the person who employed people to work in the business. Bradley was the person who dealt with Ontario's banker. Bradley was the person to whom the accountant sent financial statements. Mr. Hevenor stated he never saw any periodic financial statements although he may have seen the year-end financial statements.

[16] Bradley was also responsible for making all remittances and filings with the various government authorities. This included sending source deductions and Goods and Services taxes to the Receiver General for Canada. Ontario retained a part-time bookkeeper to prepare the various forms and documents for Revenue Canada and other government branches. The bookkeeper prepared the returns "and if money was available we would pay...", Bradley testified. He stated that Ontario's accountant was aware of Ontario's precarious financial situation. Bradley said he was not aware of his father's liability as a director pursuant to the Goods and Services Tax ("GST") provisions of the Excise Tax Act.

[17] I have no doubt that Bradley worked very diligently to make a go of the business. Unfortunately in 1994 Norton locked the restaurant's doors and Ontario's lease was terminated. Ontario was subsequently bankrupt.

[18] At no time was any meeting of shareholders or directors of Ontario held. This is not strange since Ontario had only one shareholder and one director.

[19] Bradley said that while Ontario did not pay the GST to the federal government, Ontario did remit Ontario Retail Sales Tax. Bradley stated that the GST arrears commenced immediately upon the start of the business in 1992. He also acknowledged that not "all source deductions" were remitted by Ontario. He said he never discussed with his father Ontario's failure to pay GST. Since his mother was extremely ill he felt he did not want to burden his father with other problems. Bradley "felt" he could work his way out of the situation by himself.

[20] Bradley said that when things were going well, for example, when the business had a good week, he would inform his father that things went well that week. But, again, he did not inform his father when things were not going well. Bradley blames the failure of the business on the recession that was taking place in the early 1990s. He said his father realized that when Ontario acquired the business in 1992 there was a recession, but his father had faith in him and believed that he was capable of running a successful restaurant business. His father thought "I could turn it around". He thinks his father knew that times were bad but he was not "overly-concerned...he trusted me...".

[21] Mr. Hevenor stated that other than assisting his son in incorporating Ontario he had nothing to do with the business carried on by Ontario or with Ontario itself. He said that he had no reason to believe that Ontario was not doing well. He said he was never aware of Ontario's serious financial difficulty. It was only when he received a letter, dated December 6, 1994, from Revenue Canada did he first realize there was a problem. This letter advised him that as a director of Ontario he was potentially liable for the corporation's defaults in not remitting GST. He stated that before receiving this letter he was "not aware of the liability". He stated that he gave the letter to Bradley who took the letter to lawyers.

[22] Mr. Hevenor explained in cross-examination that "when the corporation was incorporated, the lawyer incorporating the company explained very little to me". The lawyer told him he would have "very little to do". The lawyer knew, according to Mr. Hevenor, that he had no restaurant experience. In any event, he did not realize what the lawyer was trying to explain to him. Mr. Hevenor stated that he "honestly thought I'd have nothing to do with the company...that Bradley would operate it...". When Ontario was incorporated, the lawyer told Mr. Hevenor a corporation required a director and president and "I was it". Mr. Hevenor did not ask what his role as director and president would be and he was not told. He said that he had no reason to do anything with the company. He never asked to see financial statements or records of Ontario notwithstanding his loan to Ontario when it purchased the business from Norton.

[23] Mr. Hevenor did acknowledge that at one time he knew a monthly payment to the Royal Bank of Canada had not been made. He said this was "probably within a few months of the company going down". He stated he asked Bradley if he would be making payments and Bradley said "he would do what he could do".

[24] On these facts, then, is Mr. Hevenor liable under section 323 of the Act to pay the amount of tax and interest that Ontario failed to remit to the Receiver General for Canada in accordance with section 228 of the Act? Subsection 323(1) states that:

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.

However, subsection 323(3) provides that:

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.

[25] Robertson, J.A., in Soper v. The Queen,[2] reviewed in detail the statutory and common law affecting the responsibilities of directors. He summarized his findings in respect of subsection 221.1(3) of the Income Tax Act, a provision that mirrors subsection 323(3) of the Act, at page 5416:

...The standard of care laid down in subsection 227.l(3) of the Act is inherently flexible. Rather than treating directors as a homogeneous group of professionals whose conduct is governed by a single, unchanging standard, that provision embraces a subjective element which takes into account the personal knowledge and background of the director, as well as his or her corporate circumstances in the form of, inter alia, the company's organization, resources, customs and conduct. Thus, for example, more is expected of individuals with superior qualifications (e.g. experienced business-persons).

The standard of care set out in subsection 227.1(3) of the Act is, therefore, not purely objective. Nor is it purely subjective. It is not enough for a director to say he or she did his or her best, for that is an invocation of the purely subjective standard. Equally clear is that honesty is not enough. However, the standard is not a professional one. Nor is it the negligence law standard that governs these cases. Rather, the Act contains both objective elements—embodied in the reasonable person language—and subjective elements—inherent in individual considerations like "skill" and the idea of "comparable circumstances". Accordingly, the standard can be properly described as "objective subjective".

[26] In the appeal at bar, we are presented with a situation where a father with limited education and no business experience seeks to assist his son in a business endeavour. He does what many parents do: he helps fund the business. Perhaps due to an error by the lawyer who incorporated Ontario and who may not have realized that a discharged bankrupt is eligible to be a corporate director, the appellant, almost by default, became Ontario's sole director. And while the lawyer may have tried to explain to Mr. Hevenor the duties of a director, it is questionable if he understood what was being said. All Mr. Hevenor understood was that he would have nothing to do and he was only helping his son.

[27] Mr. Hevenor's son ran the business. Mr. Hevenor was an outside director not at all involved in Ontario's operations. As far as he was concerned, it was Bradley's business. He trusted Bradley and had faith in him, whether or not the faith was merited. Mr. Hevenor was a father, after all.

[28] Bradley would tell Mr. Hevenor when things went well but was silent when there were problems, and problems there were.

[29] In these circumstances, what could Mr. Hevenor have done to prevent Ontario's failure to remit? In Soper, supra, Robertson, J.A., at p.5418, stated:

In my view, the 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 fact that a corporation's monthly balance bears a negative figure, Robertson, J.A., noted, does not necessarily indicate it is in serious financial difficulty:[3]

...it will be for the Tax Court Judge to determine whether, based on the financial information or documentation available to the director, the latter ought to have known that there was a problem or potential problem with remittances. Whether the standard of care has been met, now that it has been defined, is thus predominantly a question of fact to be resolved in light of the personal knowledge and experience of the director at issue.

[31] There was no suggestion at trial that even if Mr. Hevenor had been presented with periodic financial statements, he would have understood the statements and have realized Ontario's severe financial situation at the time. No doubt he would have realized the business was losing money; however, whether this would have convinced him that Ontario had no hope of success is another question. The "reasonably prudent person in comparable circumstances" in subsection 323(3) may be, as Robertson, J.A. explains in Soper[4], an unskilled person. "It is correct to distinguish between a reasonably prudent person and a reasonably skilled person...". He added, at p. 5415;

...in the event that the reasonably prudent person is unskilled..., the statute requires only the exercise of a degree of care which is commensurate with that person's level of skill...

[32] What Mr. Hevenor did—finance his son's business—is a common and acceptable practice in Canada. That he became a director—the sole director—of a corporation he had absolutely no interest in, except as a creditor, was due to special circumstances. Had Mr. Hevenor been more experienced in business, had he even suspected the legal exposure of a director, or a director's duties and responsibilities, had he not been blinded by his devotion to his son, then, perhaps, he may have paid more attention to Ontario's operations and financial situation. But, then, this degree of care would be limited by his lack of skill. And these are all subjective traits Mr. Hevenor shares with other parents.

[33] The facts at bar are not similar to those in Black v. The Queen[5]. Mr. Black was not unsophisticated in business matters. And, unlike Mrs. Hanson,[6] Mr. Hevenor was not directly involved in the acquisition of the restaurant business. He did not own directly or indirectly shares in the subject corporation and he did not participate in decisions. Appeals such as Stuart v. M.N.R.[7]were decided before Soper, supra. In my view Mr. Hevenor acted as one would have reasonably expected him to act when he was made the sole director of Ontario.

[34] I do not suggest that the mere fact one becomes a director in a family corporation is sufficient to permit a director to ignore the affairs of the company. On the contrary, a director who is a family member in this context has the same responsibilities as any other director. On the facts before me, however, Mr. Hevenor was a sole director who was placed in a situation for which he had no experience or skill.

[35] Therefore, on the facts before me, the appeal is allowed with costs.

Signed at Ottawa, Canada this 26th day of January 1999.

"Gerald J. Rip"

J.T.C.C.

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