Tax Court of Canada Judgments

Date: 20010516

Docket: 98-9316-GST-I

BETWEEN:

NICOLA DILORENZO,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

McArthur J.T.C.C.

[1]            This appeal involves the liability of the Appellant as a director of 819636 Ontario Inc. (the Corporation) for unremitted goods and services tax for the periods April 1, 1993 to June 30, 1993 and January 1, 1994 to March 31, 1994 in the amount of $66,442 including interest and penalties. Presentation of the evidence at trial took three days in April and June 2000 and closing submissions were not heard until January 2001, having awaited the Federal Court of Appeal decision in Worrell v. The Queen, [2000] F.C.J. No. 1730.

[2]            The issues are whether the Appellant had an obligation to remit goods and services tax under subsection 321(1) of the Excise Tax Act and if so, did the Appellant exercise the degree of care, diligence and skill to prevent the failure of the Corporation to remit GST that a reasonably prudent person would have exercised in comparable circumstances pursuant to subsection 323(3) of the Act.

Facts

[3]            I will first deal with the facts, which I accept, as presented by the Appellant and his witnesses. The Appellant immigrated to Canada from Italy at the age of 16 in 1957 when he commenced working in the construction industry in the Toronto area. He has little formal education but quickly rose in the industry. In the 1960s, with his brothers, he managed 3,700 men. He repeated throughout his evidence that he never got involved in paperwork but hired accountants, lawyers and office workers while he did the outside work.

[4]            The Appellant and a friend, Charles O'Hara (O'Hara) planned the construction of a senior citizen home in Ajax, Ontario through the Corporation of which both were directors. I will refer to it as the Project. He and O'Hara had several other projects at various stages which are not the subject of this appeal. The Appellant was the outside man and O'Hara was the administrator. The Appellant's responsibilities were to overlook the trades, deal with the architects and assure the construction progressed properly. The Corporation hired Philip Weinstein (Weinstein), a chartered accountant, to administer the total financial area. The witnesses, O'Hara and Weinstein, confirmed that the Appellant's responsibilities were out in the field and not in the office.

[5]            Financing was arranged through Royal Life Insurance Company for which Zurich Indemnity Company was the surety or guarantor. Pursuant to its contractual rights on April 26, 1991, Zurich appointed monitors to take over the Project's finances and take control of the Corporation's bank accounts. The monitors received all of the advances to the Corporation and retained control throughout the assessed period to the exclusion of the Appellant, O'Hara and Weinstein. It was obvious the Project was undercapitalized and Zurich was concerned with the loan it had guaranteed and wanted control of the flow of funds. The Appellant had no control over the Corporation's banking. The monitors did not pay the remittances in question although they were on occasion, asked to do so by Weinstein. He would present cheques made payable to the Receiver General to the monitors for signature and remittance but these cheques were ignored.[1] The monitors received approximately $7.5 million in advances from the Project which clearly had a GST component yet they did not remit the GST amounts to the Receiver General. From July 1992, no cheques issued by the Corporation were signed by the Appellant, nor did he have authority to do so. Both the Appellant and O'Hara transferred their ownership in the Corporation to Zurich. All of the monies went into the monitor's account. The monitor consisted of three or four individuals appointed by Zurich.

[6]            The Corporation passed a banking resolution in June 1992 approving Zurich's appointment of a monitor to be the only signing authority with respect to all banking. During the relevant periods, Weinstein continued to do the accounting for the Project and made the requests to Ajax Municipal Housing Corporation for progress advances or draws. He calculated the amount of the draws including the requisite amount for GST. The draw proceeds would go into the bank account over which Zurich, through the monitor, had complete control. The last deposit from the Project to the Corporation's account was in September 1993. All draws went into the one Bank of Montreal account. These draws included GST. The security agreement provided that all taxes were to be paid by the monitors but this provision was ignored by them. It would appear that Zurich paid those debtors who were a threat to shutting down the Project and the cash flow. The Appellant and O'Hara abandoned the Corporation's construction contract with Ajax Municipal Housing Corporation in September 1993 before its completion. The first indication the Appellant received that GST had not been paid was in 1996. For the period after December 1993, the Appellant was off the Project having abandoned it.

[7]            The Respondent's counsel introduced facts under his theme of "responsibility" that casts a shadow over the simplicity of the foregoing. I accept the following further facts. In addition to extensive cross-examination of the Appellant, O'Hara and Weinstein, the Respondent called on one of the monitors to testify.

[8]            The Appellant and O'Hara had four companies referred to as the Dilhara Group which Group intended to build four projects. The Ajax senior citizen project was projected to cost $10 million of which $700,000 was for GST. Weinstein agreed that the Corporation was to receive $10 million from the Project. The Corporation subcontracted the construction for $7 million. Had the Corporation not carried the debt loan of its three related Corporations, there would have been no need for the monitors and there would have been sufficient funds to pay GST.

[9]            One of the four corporations, 698375 Ontario Limited, may have been in default of unremitted GST in January 1991 but not on the Project in question. The evidence in this regard lacked clarity and certainty and I give it no weight.

[10]          Roderick Dougherty, one of the monitors, gave evidence on the Respondent's behalf. During the relevant period, he was an employee of an insurance brokerage company that had arranged financial guarantees and bonding for the Dilhara Group. He was also the president of Surety Monitors Limited which assumed a monitoring role on behalf of Zurich for these projects. He did not recall being asked by the Appellant or anyone else to pay GST.

[11]          The Appellant was not prevented from reviewing the Corporation's records. The Corporation may have had some control over a very small amount of Project funds. There were isolated incidents when the Appellant was able to interfere with some monies going to the monitor. In October 1993, the Appellant was able to direct the amount of $8,183 to be paid for the benefit of Weinstein. The Respondent submits that $300,000 relating to the land and soft costs was not properly accounted for. The accounting in this regard was not clear and I give this evidence very little weight.

[12]          The Appellant was a director and secretary-treasurer of the Corporation; he guaranteed the financial transactions of the Dilhara Group; was involved in the construction; attended some site and draw meetings; signed statutory declarations stating that the Corporation was current on its liabilities; and directed money from the Project to pay some minor receivables.

Position of the Appellant

[13]          In his Notice of Appeal, the Appellant sets out the following defences: (i) he had no control over the funds received by the monitors of Zurich as a result of the sales of the non-profit units; (ii) he was not a trustee of the funds under the circumstances; (iii) he directed the monitor to remit the tax, however, could not secure such remittance; (iv) the trust funds sought by the Minister were in the hands of Zurich and the Appellant had no signing authority over the Corporation's account during the relevant periods of assessment; and (v) the Appellant was not a de facto director of the company at the relevant time periods and the Minister did not properly exercise its proper and fair discretion when this matter was determined.

[14]          The Appellant's counsel stated that the appeal was two-pronged: (i) it is our position that the obligation under subsection 323(1) did not arise because there was no control whatsoever over the funds that generated the liability; and (ii) the Appellant did everything he possibly could, or could not have been accused of not having exercised due diligence based on his background and his position in the Corporation and the information he had provided to him and the way that the monies moved throughout these projects.

Position of the Respondent

[15]          The Respondent stated that the first project of the Dilhara Group "seems to have been behind between $300,000 in GST remittance". The evidence that the Appellant was unaware of a GST problem until 1996 is undermined by this. The Appellant wilfully blinded himself to the financial and administrative side of the Corporation. The Appellant cannot make his own shortcoming into his defence. He was the secretary-treasurer of his own company. He signed most of the key documents. When it suited him, he interfered with payables by directing that monies from Ajax Municipal Housing Corporation be paid to his friend Weinstein.

[16]          The Appellant set up the situation for the Zurich/monitors take-over by entering into a highly risky arrangement. The Respondent's premise is first, responsibility and second, the Corporation and the Appellant acquiesced in the monitor's misuse of the GST funds. They were the ones who were telling the monitors how to misuse the money. The monitors are not on trial. If the Corporation acquiesced and instructed the monitors how to act, how can it possibly be said that monitors acted to prevent the Corporation from paying GST as and when it was due?

Analysis

[17]          I am assisted by the decision of the Federal Court of Appeal in Soper v. The Queen, 97 DTC 5407. The starting point is to classify the Appellant as an inside or outside director. I have no difficulty in finding that the Appellant was an inside director. In Soper, Robertson J.A. stated that inside directors are those involved in the day-to-day management of the Corporation. The Appellant was such a person. He was involved in the day-to-day construction. While the construction work was subcontracted and not actually carried on by the Corporation, the Appellant supervised the construction process to be assured that the contract was being fulfilled. I find the Appellant was not passive. He hired Weinstein, a chartered accountant, on a full-time basis and relied on the expertise of O'Hara.

[18]          I cannot accept the Appellant's position that there is no need for a due diligence analysis because the Appellant lacked control and, therefore, subsection 321(1) was never triggered. Evans J. in Worrell found the contrary. The fact that the money lender has control is not sufficient to relieve a director from demonstrating due diligence under the legislation. I find that the Appellant was a director and an inside director as described in Soper and the fact that the monitor took control does not relieve the Appellant from demonstrating due diligence.

[19]          At paragraphs 51, 56 and 61 in Worrell, Evans J. stated:

... However, despite some broad statements by Addy J.,[2] in my opinion this case cannot be regarded as authority for the general proposition that once a bank exercises control over the cheques written by a company, the directors are not vicariously liable for source deductions not remitted to Revenue Canada.

With all respect to those who have taken a different view, in my opinion it is inappropriate to import into subsection 227.1(1) a requirement that it is only engaged if the directors have de facto control over the financial operation of the company, particularly the payment of its bills.

Therefore, in my respectful view, the decision of McArthur J.T.C.C. that the directors of Abel were not liable for the unremitted source deductions and GST cannot be supported on the ground that subsection 227.1(1) was not triggered because the bank's insistence that it approve any cheques written by the company deprived the taxpayers of control of the company's finances.

Due Diligence

[20]          This brings me to the Appellant's second argument that he is not liable pursuant to subsection 323(3) of the Act which reads:

323(3)      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.

While the Appellant gave up control of the finances to Zurich, he remained a director of the Corporation and continued to supervise the Project. This puts him within the situation in Worrell.

[21]          In summary, the Respondent's four points are: (i) the Appellant was a fairly sophisticated business person; (ii) his company was undercapitalized; (iii) the monitors never interfered with the payments of receivables to Revenue Canada; and (iv) the whole issue of control is completely irrelevant. The Corporation demonstrated a pattern of indifference and neglect which undermines the availability of the due diligence defence, especially when that neglect contributed to the failure to remit.

[22]          All draws from the Ajax Project went into a bank account over which the Appellant had no control - only the monitors had signing authority. The advances were inclusive of GST yet the GST was not paid. The monitors paid the amounts necessary to keep the construction producing advances and paid its own fees. Now the Appellant is being called upon to pay Revenue Canada the GST which was collected but not remitted. I believe a strong argument can be made to the effect that the GST component over which the monitors had control is trust money that cannot be paid to anyone other than Revenue Canada.[3] Be that as it may, the monitor had no legal obligation to remit the GST collected. A monitor, Mr. Doughtery, stated no one told them to remit the GST to Revenue Canada, yet the agreement under which they were working stipulated that the monitor was to pay taxes. I agree that the monitor is not the subject of the assessment and I should not be side-tracked into blaming the monitor. The question is whether the Appellant acted reasonably to assure that GST collected was remitted as envisaged in subsection 323(3). There is no evidence that the Appellant was made aware that there was a GST problem. What proactive steps were undertaken by the Appellant to take him out of the totally passive mode? The Appellant's answer was "I'm not a paper man, I relied absolutely on my chartered accountant, Mr. Weinstein".

[23]          Is this due diligence? I believe it is. What more could have been done? He had hired a highly experience chartered accountant and he had no control over the bank account into which the draws were deposited. In December 1993 when the building was substantially completed, the Appellant and O'Hara notified the Ajax Municipal Housing Corporation that they could no longer honour their contract. There is an assessment for the period from January 1994 to March 1994 when the Appellant no longer was involved in the completion of the Project.

[24]          There is insufficient evidence that the Corporation was in GST remittance arrears prior to the take-over of the draws by the monitors. There is no evidence that the Appellant was aware of any such arrears. A distinguishing factor with this case from Worrell and many others is that in Worrell, the directors knew of the default to remit. The Appellant did not. In order to obtain financing, he entered into an agreement wherein the finances were taken out of his Corporation's control.

[25]          In Worrell, Rothestein J.A. in his brief concurring reasons at page 6605 stated:

... I wish to emphasize that whether the due diligence defence will be successful is fact-driven in each case, i.e. always comparing what the directors did to prevent the failure with what a reasonably prudent person would have done in comparable circumstances. I agree with Evans J.A. that the due diligence defence is established on the facts of this case. ...

Evans J.A. had stated at paragraph 77 of his reasons (at page 6604):

                Given the limitations placed upon them by the bank's de facto control of the company's finances, I am satisfied that, on the facts of this case, the directors exercised the degree of care, diligence and skill to prevent failures to remit that would have been shown by a reasonably prudent person in comparable circumstances. ...

[26]          In conclusion, I find that the Appellant did exercise the degree of care, diligence and skill to prevent failures to remit that would have been shown by a reasonably prudent person in comparable circumstances. The appeal is allowed.

Signed at Ottawa, Canada, this 16th day of May, 2001.

"C.H. McArthur"

J.T.C.C.

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