Date: 20000419
Dockets: 1999-2182-IT-I; 1999-2184-IT-I
BETWEEN:
DALE HOLMES, BEVERLY HOLMES,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent,
Reasons for Judgment
Bowman, A.C.J.
[1] These appeals were heard together. They involve assessments of Mr. and Mrs. Holmes under section 227.1 of the Income Tax Act.
[2] Under subsection 227.1(1) of the Act where a corporation has failed to deduct and withhold taxes on wages and salaries paid to employees, or has failed to remit them to the Receiver General, the directors are jointly and severally liable with the corporation for the amount the corporation has failed to deduct, withhold, remit or pay together with related interest and penalties.
[3] A director is not liable for a corporation's failure under subsection 227.1(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.[1]
[4] On January 27, 1998 the Minister of National Revenue assessed each of the two appellants for $19,921.55. The liability is joint and several and the amount assessed included amounts payable under subsection 227.1(1) of the Income Tax Act, section 38 of the Ontario Income Tax Act, section 22.1 of the Canada Pension Plan and subsection 54(2) of the Unemployment Insurance Act. The Canada Pension Plan ("CPP") and the Unemployment Insurance Act ("UI Act") permit the assessment of corporate directors for failure by the corporation under the corresponding provisions of those acts. The same defences are available to directors as under the Income Tax Act and there is a right of appeal. This court has no jurisdiction over assessments of tax under the provincial act. Under section 22 of the Ontario Income Tax Act, section 165 of the federal act applies, with the result that a notice of objection filed under the federal Income Tax Act is a valid objection for provincial purposes. However an appeal to the court beyond that level requires the filing of a notice of appeal to the Ontario Court which has a certain limited jurisdiction, including, specifically, a director's liability under section 38 of the Ontario act, which corresponds to section 227.1 of the federal act. I note that the notifications of confirmation refer only to the federal assessments of income tax. The result of this is that any variation in the federal assessments of tax can be automatically reflected in a varied assessment of provincial tax by the Minister of National Revenue acting in the capacity of agent for the provincial Minister.
[5] So far as the CPP and UI (or EI) assessments are concerned the situation is a little complex. Subsection 54(1) of the UI Act corresponds to subsection 227.1(1) and subsections 227(2) to (7) of the Income Tax Act apply, mutatis mutandis. A director has the same rights as an employer under subsection 54(3). One of those rights is the right under subsection 61(2) to request a reconsideration of an assessment and a right of appeal to the Tax Court of Canada under section 70. The same statutory regime applies under sections 83, 92 and 103 of the Employment Insurance Act and under section 21.1, subsection 27(2) and section 28 of the CPP.
[6] No form is prescribed for an appeal to the Minister for reconsideration of an assessment under subsection 61(2) of the UI Act and I should think that a notice of objection to an assessment that purports in one document to assess tax under three federal statutes would be sufficient compliance with the three statutes particularly where, as here, the notice of objection refers to the assessment by date and number. The same is true of a notice of appeal to this court. I note that Joyal J. in a trial de novo from a judgment of Rip J. held that a piece of paper emanating from the Department of National Revenue listing four statutes and one global amount was a valid notice of assessment (The Queen v. Leung, 93 DTC 5467).
[7] If the Minister can fulfil his statutory obligation under four statutes to notify a taxpayer of his assessments with one piece of paper it would be unconscionable if the taxpayer could not likewise notify the Minister of his objection to the assessments and of his appeal by sending a single notice of objection or appeal. Although under the rules of this court there are prescribed forms for appealing from an EI assessment or CPP assessment, under section 32 of the Interpretation Act substantial compliance is sufficient. Otherwise the objection and appeal process under these omnibus assessments could become a minefield for the unwary.
[8] Before I leave these procedural questions one further rather technical point should be mentioned. Under section 169 of the Income Tax Act where the taxpayer has served a notice of objection, an appeal may be taken to the court 90 days after confirmation or reassessment or 90 days after serving the notice of objection if the Minister has not responded by way of reassessment or confirmation. No similar right to appeal is conferred under section 70 of the UI Act or section 28 of the CPP where the Minister has failed to respond to the appeal. Since the notice of confirmation refers to the omnibus assessment, even though it does not mention the UI Act or the CPP, it is evident that the assessments under all three federal acts have been confirmed.
[9] I turn now to the question whether the appellants have met what has come to be called the "due diligence" test under subsection 227.1(3). This provision has been the subject of a great deal of litigation in this court. The most recent decision of the Federal Court of Appeal of which I am aware is Soper v. R., [1997] 3 C.T.C. 242, which sets out in some detail the tests to be applied under subsection 227.1(3).
[10] Essentially, however, whether a director meets the test under subsection 227.1(3) is a question of fact.
[11] It is obvious from the many cases that have been decided under section 227.1 of the Income Tax Act and the corresponding section of the Excise Tax Act, section 323, that each case must be decided on its own facts, and no single factor predominates, nor can one test apply that fits all circumstances. For example, we know from Soper that although inside directors may find it more difficult to meet the due diligence test than outside directors, not every inside director will be found liable. Similarly, a director may not escape liability under section 227.1 by remaining wilfully blind to a deteriorating financial condition in a corporation, or by claiming ignorance of his or her obligations as a director. However, directors have been held not liable for a corporation's failure to remit source deductions where economically it was impossible to ensure that the required remittances be made (Fancy v. M.N.R., 88 DTC 1641) or where the directors were completely excluded from the affairs of the corporation by an autocratic and domineering owner of all of the shares of the corporation (Fitzgerald et al. v. The Queen, 92 DTC 1019).
[12] Here the appellants were the sole directors and shareholders of a corporation, Dale Holmes Ltd., which operated a grocery store in Bridgenorth, Ontario under the name Dales Freshmart from August 24, 1977 to November 20, 1993, under franchise from National Grocers Co. Ltd. They fell behind with payroll remittances in 1992 but in the course of the year 1993 according to the schedule attached to the replies to the notices of appeal, they made up the shortfall.
[13] Paragraph 6(f) sets out the following assumption on which the assessment was based.
f) for the periods January 28, 1993, July 28, 1993, November 18, 1993 and May 26, 1995, the Corporation failed to remit source deductions from the said payroll account in amounts as set out in Appendix A attached.
(A date is not a period. These appear to be the dates upon which the remittances for moneys withheld for the prior period had to be made.)
[14] This assumption is simply wrong as a basis for the assessment. There was a failure to remit tax (federal and provincial), and CPP and UI premiums, on January 28, 1993 but this was paid off over the year. The same is true of July 28, 1993. The amount that the corporation failed to remit on that date was paid off in August of 1993.
[15] The respondent's own schedule shows that the failure to remit upon which the assessment was based did not occur until November 18, 1993. At that point National Grocers had come in and taken over the store and the corporation ceased operations. Between the time of the payment to the employees of wages net of withholding and the time the remittance of the withholding was due the corporation was stripped of its power to effect the remittance. The corporation paid its employees but it could not afford to pay the withholding amounts. It simply did not have the money to do so and the manner in which National Grocers controlled the most minute details of its business made it impossible for it to pay the Government of Canada. This was not a case of paying the employees, withholding tax and CPP and UI premiums and using that amount for other corporate purposes. It was a case of paying the employees and having nothing left for any other purpose. At the time the deficiency arose National Grocers was completely in control of the business. There was nothing either the corporation or its directors could have done. The alternative would have been to breach the corporation's legal obligation to the employees.
[16] The impossible situation in which the corporation and the appellants found themselves is set out at tab 6 of exhibit R-1.
However, due to the competitive nature of our business, the fact that we were bound by a Franchise Agreement, that we operating with an overdraft, and that over the years our Franchisor (National Grocers) had, gradually, taken control of our business affairs and by 1992 the Recession hit us hard and cash-flow was severely affected.
Our position at this point in time was to keep our Business going, even though we were slipping behind in three areas, with our Franchisor and main supplier, the Bank, in maintaining our line of credit and keeping our direct suppliers paid, as well as our responsibilities to Gov't agencies, not to mention keeping up with utility payments (hydro heat and telephone). Because we were getting behind with our account with National Grocers (the Franchisor) they, without warning, in June of 1992 put us on C.O.D. with all of our direct suppliers. This meant that while we were still paying for goods delivered prior to C.O.D. notification, we had to find the cash to pay for current direct deliveries which frustrated our cashflow situation to an amount of approx. $30,000.00.
At the end of 1992, we were in arrears with Revenue Canada and had lost $98,000.00 for the year. In January of 1993 Revenue Canada did a payroll audit and with interest and penalty we owed $25,475.28.
By July of 1993, we paid the $25,475.28 in tax arrears, at the rate of $500.00 per week from January 1993 to April 30 1993 and $1,400.00 from May 7 1993 to the end of June, without default as well we kept up with current payments.
...
By October without National's help I felt that we would finish the year while still in the red but not as bad as 1992 had been, for one thing, while we had gotten behind with Revenue Canada there would be no problem catching up by the end of 1993, and without a $25,000.00 pay back in 1994, 1994 should be a turn-around year.
On Tuesday [Nov. 16] morning a representative from National Grocers entered our store and handed me an eviction notice giving me until Sat Nov 20 1993 to leave the premises. This came as a complete surprise and put me in a very difficult position since the terms of this notice were very specific. As you will note all shipping lanes were closed, meaning that no further deliveries of goods would be shipped, not even Produce while we were expected to function as normal.
Bridgenorth, being a small community, word travels very quickly and that particular week was no exception and business suffered as a result. As well all doors of support closed very quickly. The Bank of course refused to honour all outstanding cheques. Deposits were made up of cheques only given to us by our customers, cash on the other hand was used to buy Produce, to pay direct suppliers (perishables only) and other expenses including Payroll.
[17] I set out in Cloutier et al. v. M.N.R., 93 DTC 544 (at pages 545-6), my approach in these cases.
The question therefore becomes one of fact and the court must to the extent possible attempt to determine what a reasonably prudent person ought to have done and could have done at the time in comparable circumstances. Attempts by courts to conjure up the hypothetical reasonable person have not always been an unqualified success. Tests have been developed, refined and repeated in order to give the process the appearance of rationality and objectivity but ultimately the judge deciding the matter must apply his own concepts of common sense and fairness. It is easy to be wise in retrospect and the court must endeavour to avoid asking the question "What would I have done, knowing what I know now?" It is not that sort of ex post facto judgement that is required here. Many judgement calls that turn out in retrospect to have been wrong would not have been made if the person making them had the benefit of hindsight at the time.
Section 227.1 is an example. That section imposes a standard of care on directors that requires reasonable prudence and skill in ensuring that the money raised through the SRTC program be in fact used for scientific research or else that the Part VIII tax be paid either out of the money so raised or otherwise. In determining whether that standard has been met one must ask whether, in light of the facts that existed at the time that were known or ought to have been known by the director, and in light of the alternatives that were open to that director, did he or she choose an alternative that a reasonably prudent person would, in the circumstances, have chosen and which it was reasonable to expect would have resulted in the satisfaction of the tax liability. That the alternative chosen was the wrong one is not determinative. In cases of this sort of failure to satisfy the Part VIII liability usually results either from the making of a wrong choice in good faith, or from deliberate default or wilful blindness on the part of the director.
[18] I find as a fact that there is nothing that Mr. and Mrs. Holmes could reasonably have done to prevent the failure. They struck me as decent, honourable people who did all they could to ensure that the corporate obligations were fulfilled, but the economic circumstances rendered that impossible.
[19] Counsel for the respondent argued that in November of 1993 when they knew the business was going to be closed down by National Grocers they could have paid the Department of National Revenue but chose not to do so. This is simply wrong as a matter of fact. They could not have done so and they had no choice.
[20] Counsel for the respondent suggested three things that he says the appellants could have done.
(a) Better internal control. Internal control had nothing to do with the problems here. The difficulty here did not come about through inadvertence. It came about through economic circumstances beyond the appellants' control and through an extremely restrictive relationship with the franchisor who, among other things, insisted on receiving blank signed cheques for supplies in advance.
(b) Setting aside cash for the government. As is abundantly clear from the evidence this was impossible.
(c) Getting an enforceable undertaking from the bank to honour all cheques to the Government of Canada. This interesting suggestion, while it deserves full marks for imaginativeness, must exist in some Alice-in-Wonderland country of benign banking practices with which I am unfamiliar.
[21] As I noted above Mr. and Mrs. Holmes are honourable and decent people whose corporation has run into difficulties that are beyond their control. They have had no trouble with payroll deductions for over fifteen years. In the circumstances that prevailed in 1993 there is nothing that they could reasonably have done to ensure that the Government of Canada be paid the amount claimed under these assessments.
[22] The appeals are allowed and the assessments under section 227.1 are vacated.
[23] The appellants are entitled to their costs, if any.
Signed at Ottawa, Canada, this 19th day of April 2000.
"D.G.H. Bowman"
A.C.J.