Date: 20020419
Docket: 2001-1327-IT-I
BETWEEN:
SHELDON WISEMAN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor Judgment
Lamarre, J.T.C.C.
[1] This is an appeal from an assessment dated January 14, 2000 that was made by the Minister of National Revenue ("Minister") pursuant to section 227.1 of the Income Tax Act ("Act") in respect of unremitted income tax deductions, interest and penalties payable by Lacewood Studios Ltd. ("Lacewood Studios"), a corporation that was incorporated under the Ontario Business Corporations Act on March 25, 1993 and was owned by Lacewood Television Productions Inc. ("LTPI"). These two corporations were part of a group of corporations ("Lacewood Group"), all of them owned by the appellant and his wife, that were involved in the media and film animation industry. The appellant was the sole director, and also the president, treasurer and secretary, of each of the corporations in the Lacewood Group, which were petitioned into bankruptcy on May 9, 1997.
[2] For the period from March 16, 1997 to April 30, 1997, Lacewood Studios failed to remit federal income tax to the Receiver General, hence the assessment under appeal, for a total amount of $15,522.52. At the hearing, counsel for the respondent acknowledged that this amount should be reduced by $1,883.75 because an amount of $170.28 was not established by a proof of claim as required by paragraph 227.1(2)(c) of the Act, while the balance of $1,713.47 related to amounts not remitted during the post-bankruptcy period. The total amount at issue is therefore $13,638.77.
[3] The appellant is challenging the assessment on two grounds. He first alleges that no action or proceeding to recover any amount payable by him under subsection 227.1(1) was commenced within two years after he last ceased to be a director of Lacewood Studios, as required by subsection 227.1(4) of the Act. The appellant claims that he resigned as a director of Lacewood Studios between May 1997, when the corporation was petitioned into bankruptcy, and July 1997, when it was put into receivership. The Minister assessed the appellant by a notice of assessment dated January 14, 2000, which was more than two years after he ceased to be a director of the corporation. The Minister responds that the appellant never ceased to be a director of Lacewood Studios and that, therefore, the limitation period provided for in subsection 227.1(4) never started to run.
[4] In the alternative, the appellant relies on subsection 227.1(3) and submits that he is not liable for a failure under subsection 227.1(1) because he exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. The respondent takes issue on this point.
Legislative Provisions
SECTION 153: Withholding.
(1) Every person paying at any time in a taxation year
(a) salary, wages or other remuneration, other than amounts described in subsection 212(5.1),
. . .
shall deduct or withhold from the payment the amount determined in accordance with prescribed rules and shall, at the prescribed time, remit that amount to the Receiver General on account of the payee's tax for the year under this Part or Part XI.3, as the case may be, and, where at that prescribed time the person is a prescribed person, the remittance shall be made to the account of the Receiver General at a designated financial institution.
SECTION 227.1: Liability of directors for failure to deduct.
(1) Where a corporation has failed to deduct or withhold an amount as required by subsection 135(3) or section 153 or 215, has failed to remit such an amount or has failed to pay an amount of tax for a taxation year as required under Part VII or VIII, the directors of the corporation at the time the corporation was required to deduct, withhold, remit or pay the amount are jointly and severally liable, together with the corporation, to pay that amount and any interest or penalties relating thereto.
4227.1(2)3
(2) Limitations on liability. A director 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 223 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 that subsection 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 that subsection has been proved within six months after the date of the assignment or receiving order.
4227.1(3)3
(3) Idem. A director 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.
4227.1(4)3
(4) Limitation period. No action or proceedings to recover any amount payable by a director of a corporation under subsection (1) shall be commenced more than two years after the director last ceased to be a director of that corporation.
Facts
[5] On April 17, 1995, LTPI entered into a consulting agreement with the Lacewood Group's international distributor, Paragon Entertainment Corporation ("Paragon"), a publicly traded corporation in Toronto, pursuant to which a joint-venture corporation called Lacewood Animation Productions Inc. ("LAPI"), in which the two partners held equal shares, was created to undertake all the activities of the Lacewood Group. Under that agreement, Paragon was to advance working capital to cover the general and administrative expenses incurred by LTPI for LAPI, and those advances were to be repaid by LTPI or LAPI out of excess earnings, if any. A senior financial executive was retained to manage the day-to-day financial operations of both entities with respect to projects undertaken under the consulting agreement. The financial executive's responsibilities included the establishment and maintenance of separate bank accounts for every LTPI production connected with the consulting agreement, and the maintenance of proper reporting procedures of a financial nature. The financial executive had co-signing authority with the appellant for everything related to those projects.
[6] According to the appellant's testimony, that senior financial executive was appointed by Paragon. His name was Steve Jarosz and he was the vice-president of finance at Paragon. From that time, he started interacting on a regular basis with the bookkeeping department of the Lacewood Group, its staff and the appellant. In the appellant's words, a cash-flow deficiency was created by the new activity undertaken by Paragon, which was funding the gross operational requirements on a weekly or bi-weekly basis.
[7] In the fall of 1996, Paragon showed its interest in becoming a part owner of the entire Lacewood Group. From that moment, according to the appellant's testimony, although there was no official change, the Lacewood Group's bookkeeping staff started to report to Steve Jarosz for day-to-day financial matters.
[8] According to the appellant, an agreement was worked out by the end of 1996 (although the agreement was not filed in evidence) under which Paragon intended to become the owner of 75 per cent of the Lacewood Group; the appellant and his wife would have kept only 25 per cent. After that, Paragon sent people to the Lacewood Group's facilities in Ottawa to photocopy all its files. The appellant testified that the people from Paragon started from that moment to act as if they were in control of the Lacewood Group even though no deal had been closed yet. At the same time, Paragon prepared an offering memorandum relating to the offer and sale of special warrants of Paragon to the public in order to raise approximately $10,000,000. One of the purposes of the offering memorandum, as indicated therein (see Exhibit A-3 at pages 3-4), was for Paragon to raise funds to acquire all the assets of LAPI and certain assets of related entities thereof.
[9] In this context, Paragon analyzed the Lacewood Group's operations and addressed some financial issues related thereto. In a letter sent by Richard Borchiver, the president of Paragon, to the appellant on March 19, 1997 (Exhibit A-2), Mr. Borchiver stated that there were several problems relating to Lacewood's operations and he indicated that he had some concerns with the non-viability of the current business plan. Mr. Borchiver addressed the question of Lacewood's substantial debts and liabilities. He suggested that he and the appellant "work together to establish pre-approved parameters for production for future deals" and that a system of cheque signing and daily approvals be instituted for all productions and corporate matters. By the same token, he expressed his will to discuss the proper governance of these important business matters with the appellant and Jonathan Slan, Paragon's chief executive officer, every two weeks.
[10] In cross-examination, the appellant explained that Mr. Borchiver was speaking in that letter (Exhibit A-2) of the non-viability of the plan initially proposed by Paragon in relation to Lacewood's projected activities should Paragon acquire an interest in the Lacewood Group. He acknowledged however that the Lacewood Group's operations subsequent to the joint venture agreement with Paragon were unsustainable without injections of working capital from Paragon. With respect to the specific financial issues raised by Mr. Borchiver (in relation to Lacewood's substantial debts), the appellant commented that those issues did not stand in the way of closing the deal with Paragon. In his view, Paragon was only seeking information and details to find out how and in which period their investment in the Lacewood Group would be recouped. With respect to Mr. Borchiver's request to implement a system by which cheques would be approved regularly, the appellant stated that this was a normal request since Paragon was advancing working capital to the Lacewood Group.
[11] Finally, Paragon was able to raise approximately $10,000,000 through its public offering by the end of March 1997. Nevertheless, it never closed the deal with the Lacewood Group. Instead, in the appellant's words, Paragon resorted to bankruptcy proceedings to take over the Lacewood Group (including Lacewood Studios, which was owned by LTPI). According to the appellant's testimony, this move took him completely by surprise.
[12] In 1996, Lacewood Studios employed approximately 50 employees. In 1997, there was a significant decline in the number of employees to approximately 27. The appellant testified that a separate trust account was never set up for source deductions from the employees' salaries. He acknowledged that, although Paragon was advancing the funds in that period, the cheques were still issued by the Lacewood Group and he had to sign them to give his approval, too. Although the appellant signed each and every cheque drawn from Lacewood Studios' account, and verified each of them to ensure that it was properly authorized, he could not recall signing cheques made out to the Receiver General for source deductions in March and April 1997.
[13] The appellant explained that when Paragon became involved in the Lacewood Group in 1995, and even more so at the end of 1996 when it was planning to acquire 75 per cent of the Lacewood Group, it took over control of the Lacewood Group. It is worth saying here that Lacewood Studios had been operating since 1993 and that the appellant had always overviewed and controlled the management and finances of the Lacewood Group since its inception. When Paragon came into the picture, it deposited sufficient funds in Lacewood's account on a weekly basis to cover gross operational requirements, including all remittances of source deductions to the Receiver General. The appellant therefore assumed and expected that the control put in place under Paragon's jurisdiction would ensure that cheques were remitted properly with respect to source deductions. It was in fact always done properly up until mid-March 1997, at which point Lacewood Studios failed to remit the source deductions for three periods in a row (from mid-March 1997 to the end of April 1997).
[14] The appellant said that during the period when Paragon was in control, he was provided with cash flow statements and cheque registers (which included the cheques for remittances to the government) and that it did not come to his attention that the source deduction remittances were not made in March and April 1997. Nothing occurred that was out of the ordinary or that appeared different so as to make him suspect that this was happening. He testified that Paragon controlled the financial management of the Lacewood Group and that he was excluded from that control. Paragon was the source of cash financing, its board of directors was prestigious and the Lacewood Group was at its mercy. In his view, he could have done no more to prevent the failure to make the remittances than what a reasonably prudent person would have done in the circumstances.
I) First argument: Limitation period under subsection 227.1(4) of the Act
[15] Subsection 227.1(4) provides that no action or proceedings under subsection 227.1(1) for recovery of an amount payable by a director may be commenced more than two years after the director last ceased to be a director of the corporation. The question here is when, if ever, the appellant last ceased to be a director of Lacewood Studios.
[16] It is necessary to look at the applicable incorporating legislation to determine whether a director has ceased to be a director even though a trustee in bankruptcy has assumed control of the bankrupt company. (See The Queen v. Kalef, 96 DTC 6132.)
[17] In the instant case, Lacewood Studios was incorporated under the Ontario Business Corporations Act. Its relevant provisions read as follows:
SECTION 121
When director ceases to hold office
121.—(1) A director of a corporation ceases to hold office when he or she,
(a) dies or, subject to subsection 119 (2), resigns;
(b) is removed in accordance with section 122; or
(c) becomes disqualified under subsection 118 (1).
Idem
(2) A resignation of a director becomes effective at the time a written resignation is received by the corporation or at the time specified in the resignation, whichever is later. R.S.O. 1990, c. B.16, s. 121.
[18] The appellant testified that he sent a letter of resignation to Paragon at a certain date between May 1997 and July 1997. He testified that he sent the letter to Paragon because it was exercising de facto control over the Lacewood Group at the time. He did not want to send the letter to himself, as he was the sole director. He added that he submitted his resignation after the petition in bankruptcy was filed, in the hope that Paragon would reconsider its position. The appellant further claimed that his copy of the letter of resignation was lost when the receiver-manager, Deloitte & Touche, took possession of the Lacewood Group's files in July 1997.
[19] The respondent filed, as Exhibit R-4, a letter from the appellant dated September 21, 1999 in which, at paragraph 10, the appellant stated that, "[a]s a result of Paragon's actions, Deloitte & Touche was appointed Receiver/Manager of the company on or about May 9, 1997, at which time I resigned as an Officer and Director of the company". In his testimony, the appellant said that he had resigned after May 9, 1997. He said that there was confusion in relation to the date shown in Exhibit R-4 due to the fact that a court order delivered in July 1997 made the bankruptcy effective on a retroactive basis to May 9, 1997. Although the appellant claimed that he was still acting as a director for the Lacewood Group after May 9, 1997, he asserted that he must have resigned before it was put into receivership in July 1997.
[20] The respondent also filed the statement of affairs of Lacewood Studios dated August 8, 1997 (see Exhibit R-5). On the second page of this document, the appellant purported to certify the accuracy of the statement of affairs under oath in his capacity as president of Lacewood Studios. The respondent also filed, as Exhibit R-6, a letter dated December 10, 1997 that was sent by the appellant to Mr. Saunders at Deloitte & Touche. By this document, the appellant purported to resign as officer and director of various companies of the Lacewood Group, not including Lacewood Studios. Mr. Saunders, a trustee in bankruptcy employed by Deloitte & Touche, testified at trial that, to his knowledge, this letter to him from the appellant dated December 10, 1997 was the only letter of resignation the appellant sent.
[21] Thus, the appellant's version was contradictory, as pointed out above by the respondent, and no evidence other than the appellant's own self-serving testimony was presented to support the credibility of the appellant's claim that he had ceased to be a director of Lacewood Studios in the period between May and July 1997.[1] The appellant is a lawyer and Exhibit R-6 demonstrates that he is well aware of the proper method for delivering a resignation letter. Based on the above, as well as on the rule in Kalef, supra, the appellant has failed to show that he ceased at any time to be a director of that corporation pursuant to section 121 of the Ontario Business Corporations Act. Therefore, the limitation period provided for in subsection 227.1(4) never started to run.
II) Second argument: Due diligence
[22] Subsection 227.1(3) provides that a director will not be liable 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". The standard of care, diligence and skill required by subsection 227.1(3) was defined as follows by Robertson J.A. in Soper v. The Queen, 97 DTC 5407 (F.C.A.) at page 5416:
. . . The standard of care laid down in subsection 227.1(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".
[23] Specifically, with respect to the duty to act, Robertson J. stated at page 5418 that in his 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.
[24] In the present case, the appellant is a professional with significant business acumen. It has been held that a person who is experienced in business and financial matters is likely to be held to a higher standard than a person with no business experience. (See Smith v. The Queen, 2001 DTC 5226 (F.C.A.) at paragraph 10.)
[25] Although the appellant testified that he was under the impression that Paragon was exercising de facto control over the Lacewood Group, which I do not find to be substantiated by the documentary evidence, this would not be sufficient to discharge the appellant from his responsibilities as a director. Indeed, it was stated in A.G. of Canada et al. v. McKinnon et al., 2000 DTC 6593, that even if "a bank exercises control over the cheques written by a company, [this does not mean that] the directors are not vicariously liable for source deductions not remitted to Revenue Canada" (paragraph 51).
[26] In the instant case, the appellant was still active in the Lacewood Group at the time of the failure to remit source deductions. Even though Paragon had been advancing working capital to the Lacewood Group over the preceding two years and was supervising the Lacewood Group's operations, the appellant not only stayed on as a director, but had to approve and sign all cheques drawn from the Lacewood account. Furthermore, it is clear from the letter sent by Mr. Borchiver, Paragon's president, in March 1997 (Exhibit A-2) that the appellant was to be included on a regular basis in discussions on decisions to be taken in relation to the operations of the Lacewood Group. It is difficult in the circumstances for the appellant to argue that he was excluded by Paragon from management and financial decisions relating to the Lacewood Group of corporations, which he still owned.
[27] The appellant testified that he relied on Paragon to manage the Lacewood Group's operations. But in order to escape liability as a director, he had to show that he took positive action to prevent the failure. As a co-signer of cheques, he ought to have noticed that no cheque was made to the Receiver General in the middle of March 1997, as the remittances were always made on a bi-monthly basis. The same can be said for the month of April 1997.
[28] I agree with respondent's counsel that the control of the company's finances by a third party, if there was in fact control, did not absolve the appellant, as a director of Lacewood Studios, of the duty to remain informed as to the financial condition of the company and to act, as regards its financial obligations, in accordance with the Act.
[29] In my view, it was possible for the appellant to suspect that the corporation had failed to remit the source deductions in accordance with the Act, and he failed to exercise adequate control over the obligations of Lacewood Studios. A reasonable person in the same situation with the same degree of knowledge and experience would in my view have acted otherwise.
[30] For these reasons, the appeal is allowed and the assessment is referred back to the Minister for reconsideration and reassessment, but only to take into account the amounts conceded by the respondent that are mentioned in paragraph 2 of the present reasons.
Signed at Ottawa, Canada, this 19th day of April 2002.
"Lucie Lamarre"
J.T.C.C.
COURT FILE NO.: 2001-1327(IT)I
STYLE OF CAUSE: Sheldon Wiseman v. The Queen
PLACE OF HEARING: Ottawa, Ontario
DATE OF HEARING: December 14, 2001
REASONS FOR JUDGMENT BY: The Honourable Judge Lucie Lamarre
DATE OF JUDGMENT: April 19, 2002
APPEARANCES:
Counsel for the Appellant: Harold J. Feder
Counsel for the Respondent: Rosemary Fincham
COUNSEL OF RECORD:
For the Appellant:
Name: Harold J. Feder
Firm: BrazeauSeller LLP
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2001-1327(IT)I
BETWEEN:
SHELDON WISEMAN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on December 14, 2001, at Ottawa, Ontario, by
the Honourable Judge Lucie Lamarre
Appearances
Counsel for the Appellant: Harold J. Feder
Counsel for the Respondent: Rosemary Fincham
JUDGMENT
The appeal from the assessment made under section 227.1 of the Income Tax Act, notice of which is dated January 14, 2000 and bears number 06031, is allowed, without costs, and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment, but only to take into account the amounts conceded by the respondent, on the basis that the appellant is jointly and severally liable, together with Lacewood Studios Inc., to pay an amount of $13,638.77.
Signed at Ottawa, Canada, this 19th day of April 2002.
|
"Lucie Lamarre" |
J.T.C.C.
[1] See Lino Mastromonaco v. The Queen, 2000 DTC 1539, aff'd 2001 DTC 5298 (F.C.A.), where it was said that it is open to the trial judge to rely on the lack of documentary evidence to measure his or her appreciation of the taxpayer's credibility.