Tax Court of Canada Judgments

Date: 20001130

Dockets: 98-2304-GST-I; 98-2305-GST-I

BETWEEN:

VITO CIRIELLO, ROSA CIRIELLO,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Rip, J.T.C.C.

[1]            During the periods between May 1, 1991 and October 31, 1991 and between February 1, 1992 and April 30, 1994, R. & V. Insulating Glass Co. Ltd. ("R & V") failed to remit to the Receiver General for Canada net tax aggregating $69,295.28 as required by subsection 228(1) of the Excise Tax Act ("Act"). R & V was also assessed interest and penalties. On or about June 25, 1994 R & V made an assignment under the Bankruptcy and Insolvency Act and the Crown's claim for the net tax, interest and penalties was proved.

[2]            At the times R & V failed to remit the net tax to the Receiver General, Vito Ciriello and Rosa Ciriello, his wife, were directors of R & V and the Minister of National Revenue ("Minister") by notices of assessment dated February 27, 1997 assessed each of Mr. and Mrs. Ciriello under subsection 323(1) of the Act. Mr. Ciriello appeals the assessment on the basis he exercised the degree of care, diligence and skill to prevent the failure of R & V to remit the tax that a reasonably prudent person would have exercised in comparable circumstances as required by subsection 323(3) of the Act.

[3]            Mr. Ciriello also claims that the Minister did not give credit to R & V for bad debts. No evidence was led by the appellant with respect to the bad debts. For R & V to receive a refund or adjustment of tax subsection 231(1) of the Act requires that not only must the taxpayer have made a taxable supply in the course of a commercial activity and for consideration, but also that the taxpayer have filed a return accounting for and remitting tax under Division II in respect of that supply; finally, the consideration and tax must have become a bad debt. There is no evidence to satisfy the requirements of the statute for an adjustment of tax.

[4]            Mr. Ciriello also argues that R & V "ceased to carry on business as at June 25, 1994 . . ." [and] "to the knowledge of the Minister, the Appellant ceased to be a director or understood that he was no longer a director as at the date of June 25, 1994". Since the notice of assessment against Mr. Ciriello was issued, more than two years after he ceased to be a director, the assessment is statute barred: subsection 323(4).

[5]            Mrs. Ciriello claims she is not liable for the failure by R & V to remit tax since, amongst other things, she was only a nominal and passive director of R & V who did not participate in any decisions and had no knowledge of the financial status of the corporation. Mrs. Ciriello claims she exercised the due diligence required by subsection 323(3) of the Act to prevent R & V's failure to remit the tax and also states she ceased to be a director of R & V more than two years before the assessment against her was issued.

[6]            The appeals of Mr. and Mrs. Ciriello were heard together on common evidence.

[7]            Mr. Ciriello has a grade 6 education. He immigrated to Canada from Italy. He incorporated R & V in 1982. From about 1960 to 1982 he was employed as a plant foreman for an insulating glass company. R & V assembled and installed thermopane windows.

[8]            The only person to make business decisions for R & V was himself, Mr. Ciriello asserted. He stated that Mrs. Ciriello's name was used as a director and secretary of R & V because when the corporation was incorporated he was told the corporation required a president and secretary. Mr. Ciriello explained that he had been informed by his lawyer when R & V was incorporated that the company required two officers. As president he was responsible for all business and financial decisions. He appears to have had sole cheque-signing authority. He insisted he was not advised nor informed by anyone, including his lawyer at the time, of the responsibilities of an officer or director. Mr. Ciriello had no previous formal training on how to run a business. There were no meetings of directors of R & V.

[9]            Mr. Ciriello had never been an officer or director of a corporation before. He had always been an employee. He readily admitted that he made all decisions concerning which creditors would get paid and which creditors would not get paid.

[10]          R & V employed a secretary and bookkeeper to record the company's accounts. An accountant attended at R & V to "verify the system". Since 1988 R & V had a computerized accounting system. Mr. Ciriello said he did not interfere in the security process and let "the employees do their jobs".

[11]          The GST returns were signed by a Mrs. Thompson who was the secretary and bookkeeper of R & V. Mr. Ciriello did not review the returns. Mr. Ciriello said that the company's accountant would look over the Goods and Services Tax ("GST") returns and "there was no need for me to do so". Mr. Ciriello also stated that at the end of each month he was given a general ledger sheet with R & V's receivables and payables.

[12]          From the time R & V started in business to about 1990 the business was holding its own, according to Mr. Ciriello. R & V constructed a building in 1987 in which to carry on its business. However, Mr. Ciriello complained that the economic recession in 1990 severely affected the business. R & V's business was seasonal and if there was no construction taking place, there was no business going to R & V. By 1990 it was becoming more difficult for R & V to collect its receivables. At the same time R & V started to get behind in paying provincial sales tax to the Ontario government and started to default in remitting source deductions and GST to the Receiver General, although Mr. Ciriello said R & V did make some GST payments.

[13]          In 1990 or 1991 - the exact date is not clear from the evidence - R & V's banker demanded payment on the credit it had advanced to the company.

[14]          R & V was also facing threats from the Municipality of Etobicoke that its building would be sold due to tax arrears. In 1992 R & V sold one-half interest in the building it had acquired in 1987 for less than its cost. The proceeds of sale were applied to outstanding real estate taxes. Earlier, the bailiff had repossessed one of R & V's trucks which, Mr. Ciriello said, was required for business. He was also being threatened with the seizure of another truck.

[15]          In 1991, the appellants secured a loan from Shoppers Trust Company on the security of a mortgage on their home. The amount advanced was $250,000, less an interest adjustment of $770.55. R & V made payments on the mortgage.[1] It appears from Mr. Ciriello's evidence on cross-examination that the mortgage funds were used to repay the bank loan and then he was able to obtain a $50,000 line of credit from another branch of the same bank.

[16]          R & V arranged for a factoring company for the collection of its receivables for the consideration of $50,000.

[17]          Mr. Ciriello could not recall if any money he received from the mortgage of his home, the bank or the factor was remitted for GST, even though R & V was paying its suppliers. The factoring company was used because the mortgagee of R & V's building required a $50,000 security deposit to renew the mortgage. R & V had been late with payments in the past. This was before R & V sold one-half of its interest in the building.

[18]          Unfortunately, the efforts to finance the company were not successful and in May 1994 the Treasurer of Ontario commenced to garnish amounts owing to R & V for failure to remit Ontario Retail Sales Tax. This, Mr. Ciriello stated, was the "last straw". Suppliers no longer wished to supply R & V. At the same time R & V had used up its line of credit with the bank. In June 1994 the company made an assignment under the Bankruptcy and Insolvency Act.

[19]          The trustees in bankruptcy made attempts to collect R & V's receivables which, at time of the bankruptcy, was $189,049. The trustee collected $55,176 of receivables. I do not know if the trustee made any payments to the Receiver General from the amounts he collected.

[20]          At its peak R & V employed 16 people during its high season from June to December. Mr. Ciriello would lay off employees during the slow season although he did keep approximately 8 to 10 key employees, including himself, Mrs. Ciriello, the foreman, a truck driver and the secretary. He and Mrs. Ciriello were the only family members in the employ of R & V.

[21]          In cross-examination Mr. Ciriello acknowledged that before 1992 receivables were slow in coming in but at any given time the payables and the receivables were "not a problem".

[22]          In 1992, R & V first received its notice of GST arrears. Mr. Ciriello acknowledged that he knew the company was in arrears since there was a recession. He did not know of the statutory requirement that GST funds were to be kept in an account separate from other funds of the company. He did say that whenever R & V collected money from its creditors, GST was paid.

[23]          It was Mr. Ciriello's position that it was "between the bookkeeper and the accountant" to pay or not to pay GST. Mr. Ciriello stated that he had nothing to do with this decision.

[24]          During the time of financial difficulty R & V paid no salary to Mr. Ciriello and paid to Mrs. Ciriello only her normal salary of $600 a week.

[25]          In re-examination Mr. Ciriello advised that he made arrangements in February of 1994 to pay GST arrears by forwarding the post-dated cheques to Revenue Canada. He believes one cheque may have been cashed and another one may have been returned for insufficient funds. He testified that once the provincial government garnished R & V's receivables "it made no difference to me who got paid".

[26]          Mrs. Ciriello testified that she immigrated to Canada in 1966 and after raising her three children, started to work at R & V. She received a grade 5 education in Italy. When R & V was incorporated she and her husband attended at the offices of a lawyer and the lawyer told them that she should be included as a director of the company "in case something happened to my husband". In fact, she has never acted as a director and she has never participated in the operations of the company's business except as an unskilled employee. She has never seen financial records of the company and has never discussed the corporation's affairs with Mr. Ciriello.

[27]          Mrs. Ciriello was alert enough to realize that once the recession took hold the company's business was not as busy as before. Consequently, she agreed to mortgage their home for the line of credit because "if we lose business, we lose everything". She recalled that when R & V started in business she and her husband obtained a $30,000 loan on the security of their home in order to finance R & V's business. She hoped the new financing would help R & V.

[28]          I will deal with Mrs. Ciriello first. Mrs. Ciriello has a limited education in Italy. She testified she had absolutely nothing to do with the management and administration of R & V and that she was named a director at the suggestion of the corporation's lawyer when R & V was incorporated. She was a director in name only. There was no evidence to contradict Mrs. Ciriello's testimony and her evidence coincided with that of her husband: it was Mr. Ciriello who ran R & V.

[29]          Mrs. Ciriello consented to the mortgage of the family home to keep the business. The home was mortgaged to help finance R & V when it first started in business and she believed that additional financing would assist it in overcoming its financial problems in 1991. However, she had no knowledge of R & V's failure to remit GST and was not in a position to do anything about it even if she had known since her husband had total control. In Robitaille v. The Queen,[2] the taxpayer was made a director to comply with a statutory requirement that a corporation had to have at least three directors. She played no active role in the company and learned of its financial difficulties after the bank assumed de facto control of the company's affairs. In Robitaille, the trial judge was greatly influenced by the fact the bank exercised control of the company.

[30]          In Soper v. The Queen,[3] Robertson J.A., set forth the "objective-subjective" test in determining whether a director exercised the "due diligence" required by subsection 227.1(3) of the Income Tax Act, which is similar to subsection 323(3) of the Act. In Worrell v. Canada,[4] Evans J.A. explained that the court must take into account the characteristics of the director whose conduct is in question, including her level of relevant skill, experience and knowledge. The court must then ask whether, if faced with similar circumstances, a reasonably prudent director, with comparable levels of skill, experience and qualifications would have acted in the same way as the director in question.

[31]          To my mind Mrs. Ciriello lacked the skill and experience to recognize any default by R & V in failing to remit GST to the Receiver General and any person with her level of skill, experience and qualifications, or lack of them, would have acted, or more precisely, not acted, in the manner as did Mrs. Ciriello. On the basis of the "objective-subjective" test, Mrs. Ciriello exercised the required "due diligence" and her appeal ought to be allowed.[5]

[32]          Mr. Ciriello is in a different set of circumstances than his wife. He, too, has a public school education but over the years he gained experience by managing R & V's business. Before 1991, R & V had remitted source deductions to the Receiver General and Mr. Ciriello was aware, once Part IX of the Act came into force in 1991, that R & V had to remit GST as well.

[33]          In Worrell, supra, Evans J.A. opined that "it is essential to keep in mind the relevant question in this appeal: did the directors exercise due diligence to prevent the company's failure to remit?"[6] He added that:

[I]n order to avail themselves of the defence provided by subsection 227.1(3) directors must normally have taken positive steps which, if successful, could have prevented the company's failure to remit from occurring. The question is whether what the directors did to prevent the failure meets the standard of the care, diligence and skill that would have been exercised by a reasonably prudent person in comparable circumstances.

[34]          Carrying on the business knowing that the company will fail to remit on time but hoping the company's fortunes would be revived does not normally help the director's defence. The director, in such circumstances, assumes the risk the company subsequently will be able to make payments.

[35]          Appellants' counsel submitted that Mr. Ciriello could not do more than he did since only by keeping R & V's business in operation would R & V be in a position to pay the GST. Unfortunately R & V (and the appellant, Mr. Ciriello) were overtaken by events. Counsel relied on the reasons for judgment in Soper, and in particular the "objective-subjective" test.[7]

[36]          R & V had at least one day-to-day employee whose responsibilities included the remission of GST to the Receiver General. However, Mr. Ciriello knew the company had to remit, but did not remit, GST and he appears not to have done much to solve the problem. He knew the company was in financial difficulty. His energies were focussed on ensuring his suppliers were satisfied. To ensure the suppliers dealt with R & V, Mr. Ciriello mortgaged his home, factored accounts receivable and borrowed money from the bank. There is no evidence that any significant portion, if any, of the funds received from these sources were applied to R & V's debt to the Receiver General.

[37]          There is no evidence before me, as in Fancy v. The Queen,[8] for example, that R & V's banker prevented Mr. Ciriello from causing R & V to remit GST. In any event, there is no evidence Mr. Ciriello did anything to prevent the defaults by R & V that were clearly foreseeable as the business continued.

[38]          Mr. Ciriello claims he ceased to be a director of R & V once the corporation made an assignment in bankruptcy on June 25, 1994 and is therefore freed of the liability under subsection 323(1).

[39]          This is not the first occasion that a director of a bankrupt corporation took the position that he ceased to hold the position for purposes of subsection 227.1(4) of the Income Tax Act, which is analogous to subsection 323(5) of the Act, when a trustee in bankruptcy is appointed and is therefore not vicariously liable for the default of the corporation.[9]

[40]          The Federal Court of Appeal allowed the Crown's appeal from this court in Kalef. The Court of Appeal reviewed the domestic corporate statute under which the subject corporation was incorporated. Subsection 121(1) of the Ontario Business Corporations Act states that a director of a corporation ceases to hold office on death or resignation, removal or disqualification. The Income Tax Act, like the Excise Tax Act, is silent as to when a person ceases to be a director and therefore one must refer to the incorporating statute. The Court of Appeal held that Mr. Kalef did not cease to be a director by virtue of the appointment of a trustee in bankruptcy and did not meet any of the requirements for ceasing to be a director established by the Ontario Business Corporations Act. Therefore, the time limit found in subsection 227.1 of the Income Tax Act did not bar the reassessment against Mr. Kalef.[10]

[41]          In Wheeliker v. The Queen,[11]the Federal Court of Canada relied on Kalef and stated that there was no need to look at common law because statutory law determined when a person ceased to be a director.

[42]          A corporation continues to exist when it makes an assignment in bankruptcy or is petitioned in bankruptcy and a trustee in bankruptcy is appointed. The directors may no longer be operating the bankrupt corporation but they are still directors.[12]

[43]          I am bound by the Federal Court of Appeal decision in Kalef. Mr. Ciriello did not cease to be a director on or about June 25, 1994.

[44]          Mr. Ciriello's appeal will be allowed but only to refer the assessment to the Minister of National Revenue for reconsideration and reassessment to determine if the trustee in bankruptcy made any payments for GST to the Receiver General and, if so, to reduce the amount of the assessment accordingly. In all other respects, the appeal is dismissed.

Signed at Ottawa, Canada, this 30^th day of November 2000.

"Gerald J. Rip"

J.T.C.C.

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