Date: 20011214
Docket: 1999-730-GST-G
BETWEEN:
DOUGLAS SCOTT COCHRAN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor Judgment
Campbell, J.
[1] This appeal is from an assessment under section 323 of the Excise Tax Act (the "Act"), against the Appellant who was a director of Eco Superwood B.C. Ltd. ("Eco") during the relevant period August 1, 1991 through April 30, 1995. The Minister assessed the Appellant for the unremitted Goods and Services Tax ("GST") on the basis that the Appellant, in his capacity as director, failed to exercise the requisite care, diligence and skill to prevent Eco's failure to remit the net tax.
[2] Subsection 323(1) of the Act imposes liability on directors of a corporation for failure by the corporation to remit amounts of net GST. Subsection 323(3) provides a defence of due diligence to a director as follows:
Diligence — 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.
[3] As a result of Eco's failure to file GST returns, an audit was commenced in October 1995 and a subsequent report completed in January 1996. The report served as the basis for the assessment against Eco for unremitted tax. A British Columbia Supreme Court order deemed Eco to have made an assignment in Bankruptcy as of January 18, 1996. At the completion of the administration of Eco's bankruptcy, there were no available funds to remit the tax.
Preliminary Matter:
[4] During the proceedings, the Appellant raised the issue of whether a portion of the period was statute barred and therefore could not be pursued by the Minister. Respondent counsel conceded that it did not have sufficient evidence to meet the required burden of proof and would not be pursuing the period, August 1, 1991 through October 31, 1991. The period under consideration is therefore October 31, 1991 through April 30, 1995.
The Facts:
[5] The Appellant is a lawyer practicing in the areas of family, criminal and personal injury law. Not only was the Appellant a director of Eco but he was also a director of Eco's parent company, MPI Metal Plast Inc. ("MPI"). In addition he was Vice-President of Eco and Chairman of its Board of Directors. His involvement began at his brother's request. The brother, Thane J. Cochran, had founded Eco and initially requested the Appellant to provide legal advice.
[6] Eco was involved in the business of manufacturing and selling a product known as "Superwood", which was a lumber substitute made from recycled waste plastics. Initially the company had 50 investors and raised sufficient funds to purchase two extruder machines from Ireland. Eco had five directors, one being the Appellant. It started operations in British Columbia in 1991 and commenced GST reporting in 1991. Shortly after this, it became involved in litigation with a multi-national corporation, which lasted one and one-half years. Although Eco was successful in the litigation proceedings, it was forced to shut down the company's operations for this period. The company commenced business again in late 1992.
[7] In January 1993, Eco approached a company called Lease West Financial and offered to sell its equipment to this company and lease it back. This would have provided some capital to Eco but it failed to materialize.
[8] On January 12, 1993, the Appellant entered into a loan agreement with MPI and Eco, under which he agreed to lend $200,000.00 to MPI until January 31, 1995 (the "loan agreement"). In consideration for the loan, the Appellant received shares in MPI and obtained security over all of MPI and Eco's present and after acquired property. Interest payments were to be issued monthly to the Appellant. The Appellant put a second mortgage on his home to provide the requisite loan funds.
[9] In February 1993, Gordon Smith was elected a director of Eco. He testified that one of his first actions undertaken, as a new director was to propose a resolution that payment of taxes be given priority. This resolution was unanimously passed by all directors including the Appellant. Mr. Smith's evidence was that regular reports were provided at subsequent director's meetings and indicated that necessary corporate payments were always made when due and that with respect to the GST reporting, the history always showed a credit up to the filings of September 1995.
[10] Throughout 1993 and 1994, the company continued to explore additional avenues that might generate capital. Efforts were made to have MPI listed on the Vancouver Stock Exchange commencing in 1993. A reverse takeover was negotiated with Protected Technologies Inc. but the plans stagnated sometime in 1995. The listing never materialized and the company did not proceed to go public. In 1994, concerted efforts were also made to raise capital for Eco through Eco's shareholders. A newsletter dated May 31, 1994 was sent to all shareholder investors for additional funds. Although the other corporate investors were approached for funding, it was largely unsuccessful and the Appellant contributed the majority of the money necessary to keep the company operating. By October 20, 1995, he had loaned the company a total of $295,000.00. On January 31, 1995, the original loan agreement was amended to reflect these additional advances made by the Appellant. The repayment date was extended to July 31, 1995.
[11] In February 1995, Eco applied for a Scientific Research and Experimental Development ("SRED") tax credit. The SRED funds, according to the evidence, would have been sufficient to pay all corporate accounts and help keep Eco afloat.
[12] According to Gordon Smith's evidence, he became directly involved in efforts to raise money for Eco in June 1995, when Eco's financial difficulties became extremely serious. Mr. Smith's testimony was that he became actively involved in pursuing the government SRED credit on behalf of the company and at the request of the Board of Directors. He also contacted a Revenue Canada official to work out a payment schedule for any potential arrears of unpaid remittances. The SRED credit was to be used to cover any overdue payments. Until Mr. Smith became involved in pursuing the SRED credit, the company had retained a firm of accountants to process the grant application. Mr. Smith testified that Eco had attempted unsuccessfully to raise money through various other avenues.
[13] The Appellant's evidence was that he became aware of the necessity of filing GST returns in June 1995. He stated that the accountant informed the directors that returns had to be filed before obtaining the SRED credit. Correspondence requesting GST filing had actually been sent in November 1994, to the company accountant, Dan Huber although not communicated to Eco until June 1995. It was the evidence of the Appellant supported by testimony of both Gordon Smith and Thane J. Cochran, the Appellant's brother, that Mr. Huber's communication of information to the company was sporadic at best. This may have accounted for Mr. Huber's delayed communications to Eco's directors of the GST filing request until June 1995. Sometime prior to the November 1994 request for filing, Eco had received correspondence advising that their GST account had been closed. Until this correspondence, the company had been in a credit position in respect to GST liability. The Appellant stated that in his mind this meant:
... if we wanted to get some money for a credit we'd have to apply for it but otherwise we didn't need to keep reporting because we were never generating any surplus GST.
The Appellant stated that his brother, the President of Eco, was in charge of remitting GST and source deductions. It was also his brother who dealt with the accountant on these matters. He testified that his brother would call him to obtain funds to cover payments as they arose, including source deductions. His brother's evidence supported this arrangement. Based on the financial statements, provided to the Appellant, he did not believe that any GST was owed. In fact, the Appellant stated in his evidence that:
... in my mind at all times was that we were .. we were having a surplus of money coming in terms of GST rather than money owing.
The Appellant introduced consolidated financial statements for MPI, including a balance sheet for 1993 and 1994, which included an asset described as GST recoverable. Throughout the relevant period he believed that Eco's input tax credits (ITCs) would more than offset any GST owing. He introduced into evidence a summary of the history of reported GST returns. For the first period until the company entered litigation proceedings and temporarily suspended its operations, a credit showed. After the company commenced operations again in the fall of 1992, the first sequence of returns were submitted on the same date in November 1993 and showed a surplus of input tax credits over GST and all showed a refund. The Appellant's evidence was that this was consistent with the money he injected into the company during its operations for setting-up costs, repair and maintenance on equipment and other expenses in relation to its sales.
[14] In August 1995, Mr. Smith realized "...the company was going to go under". He stated that he contacted Greg Looey of Revenue Canada and urged him to put a claim against the SRED credit for any money owed by the company. Mr. Smith's understanding was that the company's GST account had been closed but on Mr. Looey's suggestion Mr. Smith contacted the GST department. When he contacted the department, he was advised that an audit would have to be completed. Mr. Smith testified that Shashi Jaswal, the auditor, was also advised to put a claim against the SRED credit. Ms. Jaswal had no such recollection. I accept Mr. Smith's recollection of these events. He has no personal interest in the outcome of the Appellant's appeal and he has recently been involved with his own ongoing appeal in respect to these very same facts.
[15] In July 1995, a Financial Recovery Plan ("Plan") was tendered to shareholders. The Plan called for a capital injection of $50,000.00. The Plan itemized an estimated $15,000.00 GST liability.
[16] On August 25, 1995, the Appellant resigned as director of Eco and MPI. He demanded payment pursuant to his Loan Agreement, which had been subject to a second amendment in July 1995 to reflect further advances by the Appellant. On October 20, 1995, the Appellant enforced his security through seizure of the assets of Eco and MPI. The assets seized were appraised at $92,500.00.
[17] In September 1995, GST returns signed by the Appellant's brother, Thane J. Cochran, were filed for three reporting periods from November 1, 1993 through July 31, 1994 but no tax was remitted. The total GST reported as owing in these returns was $8,278.46 with penalties and interest raising the total owing to $10,168.17. These returns were submitted after the Appellant resigned as director of Eco. The Appellant stated that he felt these returns were incorrect as they did not make sufficient allowance for export sales.
[18] From October 1995 through January 1996, Ms. Jaswal conducted a GST audit of Eco at the former business premises of the company. Again Mr. Smith's evidence was that he advised Ms Jaswal that if any money was owed, she should ensure it was paid from the SRED credit. In this he was quite adamant of his recollection of events.
[19] It was in December 1995, after Eco had ceased operations, that the SRED credit in the amount of $66,000.00, after some deductions, was issued. The Appellant seized this cheque on the argument that this amount formed part of Eco's assets and was covered by his security.
[20] By order of the British Columbia Supreme Court, Eco was deemed to have made an assignment in Bankruptcy as of January 18, 1996. Eco's Trustee in Bankruptcy, Campbell & Saunders Ltd., obtained an order declaring the Appellant's security over the assets of Eco void and unenforceable and the Appellant was ordered to provide an accounting of monies received and to return all assets to the trustee. The Appellant appealed to the British Columbia Court of Appeal but in the interim a settlement was reached between the Appellant and the Trustee, in which the Appellant agreed to pay $35,000.00 to the Trustee. The Appellant testified that he believed these funds were used to pay trustee and legal fees.
[21] By notice dated February 28, 1996, the Minister reassessed Eco with respect to its unremitted GST. The amount of this assessment was added to other unpaid taxes assessed against Eco. At the completion of the Bankruptcy proceedings, the Trustee advised the Minister that there were no available funds to cover amounts claimed to be owing by Eco.
[22] The Appellant claimed in his notice of appeal and at the hearing that the Minister's assessment of Eco's unremitted GST was incorrect. He claimed that input tax credits were underestimated and also that the auditor did not take into account the full extent of Eco's export sales, which were GST exempt. Further, GST returns from three reporting periods that were filed in September 1995, but unremitted, mistakenly excluded export sales and were filed after his resignation.
[23] At the hearing, Ms. Jaswal, the auditor, testified that all of her audit figures were extracted from Eco's books and records. She stated that she allowed ITCs for Eco's operating expenses for the period that GST returns were not filed based on the actual invoices provided to her and then averaged the ITCs over the period covered by the audit. She stated that she allowed only ITCs based on actual documentation as required under the Act. She also testified that the assessment was based on the actual GST that Eco showed it collected in its sales summaries, which were verified with the actual sales invoices. To verify export sales, she reviewed customs documentation and bills of lading to determine the destination of Eco's shipments. She stated that the documentation which formed the basis of the audit were those remaining on the former business premises of Eco. After the audit, these documents were apparently turned over to the Trustee in Bankruptcy. The Appellant unsuccessfully attempted to obtain this documentation from both the Trustee in Bankruptcy and Eco's former accountant, Dan Huber.
Appellant's Submissions:
[24] The Appellant submitted that the auditor incorrectly estimated the ITCs and suggested that the auditor should have used some alternate method to calculate ITCs. The Appellant presented three possible alternate methods, which he felt, would have resulted in ITCs of up to three times those allowed by the auditor. The first method was to use comparable sales periods where Eco reported ITCs. The second method was to use the two periods immediately following the audited period, being those ITCs reported by Envi Technologies Ltd. ("Envi"), the new corporation commenced by the Appellant and his brother after Eco's bankruptcy. The third suggestion was to use the three periods reported by his brother, Thane J. Cochran, immediately preceding the audit.
[25] The Appellant submitted that the auditor underestimated export sales and that both his witnesses, Thane J. Cochran and Gordon Smith, testified that export sales constituted 65% to 70% of Eco's total sales over the relevant period. The Appellant himself had testified that Eco had one major customer, Aluma Systems. Although its head office was in Ontario, the Appellant stated that most of Aluma's operations were in the United States. Eco was invoiced through the Ontario office of Aluma but most of Eco's product for Aluma was shipped directly to Aluma's U.S. subsidiaries. This would be an export product and GST exempt although ordered by Aluma through its Ontario office. The Appellant pointed to the testimony of the auditor in which she stated that she would have considered an invoice showing an Ontario address as a domestic sale and treated it accordingly. The Appellant submitted that the returns, signed by Thane J. Cochran and filed in September 1995, were inaccurate as they made no allowance for these export sales. This fact coupled with the tremendous amount of money being spent by Eco on repair and maintenance of machinery would substantially alter the entire picture of available ITCs and GST owing.
[26] The second issue addressed by the Appellant in his submissions was the due diligence factor. The Appellant submitted that the Minister applied a test that was excessive. The Appellant directed the Court to the Federal Court of Appeal decision in Smith v. Canada 2001 DTC 5231, where another director of Eco was found to have met the due diligence defence and was not liable for Eco's unremitted GST. The Appellant contended that there was no substantive difference between himself and the Appellant in the Smith case in terms of background, despite the fact that the Appellant in Smith was a retired schoolteacher and the Appellant here is a lawyer. The Appellant submitted that being a lawyer did not necessarily grant him wisdom in financial matters. The Appellant also argued that his actions in continuing to infuse money into a company that was in serious financial difficulties, was not in keeping with the actions of an experienced businessperson. The Appellant also submitted that he had very little to do with the day-to-day operations of Eco, which were left to his brother. He stated that his main focus was operating his law practice so that money would be available for the necessary infusions of cash.
[27] He further submitted that all GST filings, while he was a director, led to refunds. As a result he had no reason to believe that there was any GST liability. He stated that he continually funded Eco's operations, as income fell below expenses, including the payment of source deductions. After resigning as director he injected a further cash advance of $14,000.00. After his resignation as director and his seizure of Eco's assets, his new company, Envi, continued to pay salaries, receiver general payments, rent owing to the landlord and source deduction arrears.
[28] The Appellant submitted that Gordon Smith was dealing with the potential GST problem on behalf of all directors. He argued that if Mr. Smith satisfied the due diligence then the other directors also met the test. The Appellant pointed to the fact that Mr. Smith was told by SRED officials that a "lock" had been placed on the SRED funds to satisfy Eco's tax liabilities. The Appellant stated that he co-operated with Mr. Smith's attempts to have the SRED credit applied to this tax liability.
[29] The Appellant stated in his evidence that he had only the audit document to review but could not obtain source documents or invoices from the company accountant or the Trustee in Bankruptcy. Without getting into a lengthy discourse on this, both the Appellant and Gordon Smith testified as to the deterioration of the relationship between the directors of Eco and the Trustee in Bankruptcy. Because of his lack of documentation, he stated that he was unable to point out exactly where the ITCs were wrong.
[30] The Appellant stated that his decision to discontinue further advances to the company was more a result of the Bank's decision than his own. He had utilized his equity in his home, his credit cards and lines of credit and the Bank had stopped advancing him money.
Respondent's Submissions:
[31] With respect to the accuracy of the GST audit the Respondent counsel on behalf of the Minister submitted that the report of the auditor was accurate because:
(a) Ms. Jaswal extracted the figures for the ITCs from actual invoices over the audit period, in keeping with the requirement under section 169 of the Act (that ITCs are only available if based on actual documentation).
(b) The amount of GST assessed must be based on actual sales, actual GST charged and the actual ITCs supported by evidence. It was therefore not appropriate to base Eco's GST assessment on earlier or subsequent periods as argued by the Appellant.
(c) Ms. Jaswal's evidence at the hearing indicated that she reviewed bills of lading and Customs declarations to verify Eco's export sales.
(d) Ms. Jaswal calculated GST based on amounts of GST shown as charged by Eco on its invoices and sales summaries.
[32] With respect to the issue of quantum, the Respondent submitted that the Appellant is jointly and severally liable for all amounts that became due prior to April 30, 1995 except for the period which Respondent counsel conceded at the hearing was statute barred and less the amount of the GST credits claimed by the Trustee subsequent to Eco's bankruptcy.
[33] The Respondent submitted that the following facts established that the Appellant was an inside director:
(a) The Appellant was Vice-President of Eco, Chairman of the Board and a director of Eco's parent company.
(b) The Appellant was involved in Eco's fundraising activities.
(c) The Appellant dealt with the British Columbia government on behalf of Eco in respect to an appeal for the assessment of provincial sales tax.
(d) The Appellant negotiated with most of Eco's creditors in respect to the 1992 bankruptcy proposal.
(e) The Appellant communicated with the shareholders of Eco's parent company on behalf of Eco's board.
(f) The Appellant admitted that he was in a position of influence over Eco's business operations.
(g) The Appellant, with his brother, held one-third of the issued shares of Eco's parent company.
[34] The Respondent submits that the Appellant was deeply involved in the management of Eco and that this is supported by the evidence. It was also contended that the present case was analogous to the case of Stein v. The Queen [1999] GSTC 64 where the Tax Court of Canada found a director to be an inside director despite not being involved in the day to day management of the company because of the director's influence over the conduct of the company's business affairs. It was submitted that such an influence was evidenced by the Appellant's guarantee of the company's line of credit and his signing authority at the bank.
[35] Whether the Appellant is characterized as an inside or outside director, the Respondent submits that he would be liable because he had knowledge that GST was not being remitted and was not entitled to rely on others to ensure that GST was remitted when due. The Respondent pointed to the Appellant's funding of Eco's deficit position as evidence of his knowledge.
[36] The Respondent referred this Court to the case of Worral v. The Queen, 2000 DTC 6593 where it was stated that you must take into account the characteristics of the directors whose conduct is in question including their level of skill, experience and knowledge. In the present case the Respondent stressed the fact that the Appellant was a lawyer who was familiar with a director's responsibilities. The Respondent argued that the Appellant would be familiar with the requirement to remit GST as he handled such remittances in his law practice. The Respondent also referred to the cases of Ewackniuk v. The Queen, [1997] GSTC 29 and Gregory v. M.N.R, (28 December 1990), Tax Court File No. 89-2521(IT) where the Tax Court found an Appellant's skill and knowledge as a lawyer placed a heavier burden on him as a director.
[37] The Respondent submits that the Appellant cannot rely on the due diligence of Gordon Smith as Smith's actions occurred primarily after June 1995 and therefore after the period for which the Appellant was assessed.
[38] The Respondent suggested that the case of Smith could be distinguished from the present case. It was submitted that Smith was a schoolteacher with no business training or experience and was a minority shareholder who acted as an outside director until June 1995. The Appellant, it was argued, was a lawyer familiar with GST returns, an inside director, a major shareholder in Eco's parent company and a substantial investor in Eco.
[39] The Minister criticized the Appellant's assertions that his injections of capital to Eco serve as a due diligence defence because they were used for paying the Receiver General and other creditors. The Respondent states that the Appellant was compensated by receiving shares in Eco's parent company and that in any event the evidence did not suggest that the Appellant directed his funds advanced to pay GST.
[40] The Respondent submits that although the Appellant was aware of the steadily increasing deficit of Eco, he made no inquiry as to GST remittances and therefore according to the decision in Soper v. The Queen, 97 DTC 5407, even an outside director has a duty to inquire whether GST remittances are being made.
[41] Finally the Respondent contends that GST returns were not filed for the period from November 1993 through July 1994 until September 1995 and that no returns were ever filed for the period from August 1994 through October 1995. The Respondent states that the Appellant was aware that Eco was charging GST on taxable supplies throughout this period, but did nothing to ensure that the returns were being filed.
Issues:
[42] The appeal raises two issues:
(a) Was there an error in the assessment of GST payable by Eco?
(b) Did the Appellant as a director of Eco exercise the degree of care, diligence and skill that a reasonably prudent person in similar circumstances would have exercised to prevent Eco's failure to remit GST?
Conclusion:
Issue # 1 Was there an error in the assessment of GST payable by Eco?
[43] At the hearing, there was considerable time devoted to argument over actual quantum of the assessment. It is therefore imperative that I address this as an issue.
[44] The onus is upon the Appellant in proceedings such as these to demonstrate to the Court that the assessment is in error.
[45] Where there is a dispute regarding the calculation of tax or credits, the Appellant is required to produce documentation to support his calculation if it differs from that of the Minister.
[46] Pursuant to paragraph 169(4)(a) of the Act, the Appellant could not claim ITCs unless he produced documentary evidence to support his claim. The information required under paragraph 169(4)(a) of the Act is further outlined in SOR/91-45 Input Tax Credit Information Regulations. In order for the Appellant to claim ITCs he would have to produce invoices that included the "prescribed" information.
[47] In Spectra Development Corp. v. The Queen, 98 GTC 2146, Bowman, T.C.J. (as he then was) considered an appeal from an assessment under the Excise Tax Act where the Minister disallowed a claim for ITCs. The Appellant claimed it was entitled to recover GST it had paid on the supply of goods and services. The appeal was dismissed as the evidence did not establish a prima facie case that there was any right to the ITCs as the Appellant had not shown that GST was ever paid, on its behalf, or that it ever fell heir to any ITCs. Bowman, T.C.J. stated at paragraphs 3 and 4 of his judgment:
[3] Section 169 of the Excise Tax Act permits a registrant to recover GST that it has paid in respect of a supply of goods or services. Essentially the process of payment, collection and recovery of GST occurs at each stage as goods or services move down the line to the ultimate consumer where, in effect, the buck stops.
[4] Among the conditions that must be met before a registrant is entitled to claim an ITC is that the registrant has received a supply of goods and services and that it has paid GST in respect thereof. Subsection 169(4) imposes strict requirements on a claimant to provide information and documentation relating to a claim for an ITC, and the Input Tax Credit Information Regulations go even further.
[48] In the present appeal the Appellant is contending that the GST assessment underestimated the ITCs. However at the hearing, the auditor stated that she used the actual books and records of the company to calculate the ITCs allowed. This approach is in compliance with legislation and case law. The Appellant did not produce any documentation that would be sufficient to support his claim for additional ITCs. He stated that such documentation was not available to him and he could therefore not produce them to support his allegation that ITCs were incorrectly calculated. That however is simply not sufficient to discharge the onus which is upon him.
[49] The Appellant contends that the GST assessment was too high as it included export sales that should be GST exempt. However the evidence was that Ms. Jaswal reviewed the sales summaries of Eco in calculating GST liability and that these summaries were verified with actual sales invoices. Her evidence was that these summaries and invoices showed the GST that Eco collected from its customers. She stated these were the figures she used to calculate GST owed by Eco. Ms Jaswal in cross examination, however, did acknowledge that she would have considered an invoice showing an Ontario address as in the case of Aluma Systems as a domestic sale, not an export sale.
[50] Two factors reduce the Minister's initial assessment. The first is the statute barred period and the second is the credits allowed during the period the Trustee operated Eco. These credits were applied to reduce the GST for the period November 1, 1993 through January 31, 1994.
[51] The Minister's assessment, less adjustments for the statute barred period and the credit claimed by the Trustee, shall stand. Therefore the correct quantum of the assessment is $16,530.55, comprised of:
(a) $1,958.40: November 1, 1993 to January 31, 1994.
($3,196.04 for the period from November1, 1993 to January 31, 1994 reported by Eco as owing on September 13, 1995 but unremitted, plus interest ($323.44) and penalties ($321.92), less $1,237.64 for the credits allowed for the periods from November 1, 1995 to January 31, 1996 ($981.03) and from February1, 1996 to April 30, 1996 (256.61) claimed by Eco's Trustee);
(b) $6,073.76: February 1, 1994 to April 30, 1994.
($4,971.43 reported by Eco as owing on September 13, 1995, but unremitted, plus interest ($564.80) and penalties ($537.53);
(c) $898.37: May 1, 1994 to July 31, 1994.
($756.35 reported by Eco as owing on September 13, 1995, but unremitted, plus interest ($73.78) and penalties ($68.24));
(d) $1,497.80: August 1, 1994 to October 31, 1994
(Ms. Jaswal's assessment based on her audit of $1,298.70, plus interest ($104.28) and penalties ($94.82));
(e) $2,767.44: November 1, 1994 to January 31, 1995
(Ms. Jaswal's assessment based on her audit of $2,466.99, plus interest ($161.25) and penalties ($139.20)); and
(f) $3,334.78: February 1, 1995 to April 30, 1995
(Ms. Jaswal's assessment based on her audit of $3,067.30, plus interest ($43.72) and penalties ($39.62));
Issue # 2: Did the Appellant as a director of Eco exercise the degree of care, diligence and skill that a reasonably prudent person in similar circumstances would have exercised to prevent Eco's failure to remit GST?
[52] It is section 323 of the Act which imposes liability on directors of a corporation where the corporation fails to make GST remittances. Subsection 323(3) provides relief however to a director from such liability where a director has exercised the degree of care, diligence and skill that a reasonable person would have exercised in similar circumstances to prevent the failure by a corporation to remit GST.
[53] The leading case on the issue of director's liability is Soper, in which Robertson, J.A. concluded that the standard of care required of a director to meet the due diligence defence is a flexible one, with both subjective and objective components. Robertson also discussed the distinction between inside and outside directors in assessing whether a due diligence defence has been successfully met. He went on to state that it is primarily a question of fact whether a given director would have known that a company was in such serious financial difficulty that it could be assumed that tax remittances were not being made. At page 5419 he states:
...In each case 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.
[54] The Federal Court of Appeal re-examined this standard in the case of Smith where Sharlow, J.A. stated that the standard is one of reasonableness and not perfection.
[55] The Appellant argued that if the Appellant in the Smith case, being a fellow director of Eco, was in charge of the company's tax problems, and yet met the required standard of care, then all other directors of Eco must accordingly be exonerated from liability. However, I must reject the Appellant's assertion that he may rely on Mr. Smith's due diligence. The liability of each director must be determined on the facts of each individual case with a view to the relative experience and knowledge of the individual director.
[56] It is clear that the Appellant here can be categorized as an inside director. His degree of involvement with Eco cannot be described a superficial. He was involved in fundraising for the company, dealt with an appeal of an assessment of provincial sales tax on Eco's behalf and negotiated with creditors in respect to Eco's 1992 proposal in bankruptcy. He was in a position to exert control as Eco relied on his constant infusions of cash to sustain its operations. However the Appellant stressed that his time was monopolized in running a busy law practice and that he relied at all times on his brother, the President of the company, to manage its day-to-day operations. Although the facts support my finding that the Appellant was an inside director, he did not argue the contrary during the hearing. In fact the Appellant stated in giving his evidence that:
...I will make clear that I'm not going to argue that I was an outside director. While the reality is I had very little to do with the day-to-day operation of the company, I'm not advancing the position that I wasn't, as a director, in a position to exert some control.
[57] As an inside director with the skill and knowledge a lawyer should possess, the Appellant has a more onerous task in meeting the due diligence test in subsection 323(3). Although it is more onerous it is not impossible.
[58] The Appellant's knowledge of the company operations and financial difficulties, coupled with his legal expertise, dictated that he would understand the consequences of not making the proper remittances. His evidence indicated that he fully appreciated the workings of remittances and ITCs. But as he pointed out he clearly took steps to monitor the financial statements to ensure proper remittances were completed. Financial statements of MPI were introduced to support the reasonableness of his belief that the company owed no GST. The consolidated financial statement of MPI dated December 31, 1993 contained a balance sheet, showing an asset of $23,382.00 described as a GST recoverable. The unaudited financial statement dated August 31, 1994 contained a consolidated balance sheet, showing an asset of $19,251.00 described as GST recoverable. On April 6, 1993, the Appellant supported a motion by Gordon Smith that priority be given to Revenue Canada accounts to ensure proper GST payments were being made.
[59] Although the Appellant's brother dealt with the day-to-day corporate operations, the Appellant's legal background gave him an understanding of how income tax credits worked in a business. He knew that a very large portion of the company's sales were export sales and therefore not subject to GST. He also had knowledge of the problems the company was encountering with its equipment and that large amounts were being expended on maintenance. The Appellant had every reason to believe these conditions would result in a GST credit position for Eco.
[60] I accept as a fact that the Appellant's time was not spent in the day-to-day, hands-on operation of the company. He left that to his brother. I also accept that his main preoccupation was in running his law practice so that sufficient funds would be generated to keep Eco operating. Equipped with his knowledge of the general workings of GST and ITCs and the overview he had of Eco's operations and problems, coupled with the percentage of export sales and the equipment maintenance problems, it was reasonable for the Appellant to conclude that the company would be in a GST credit position at all times. When he looked at the history of GST reporting, there was always credit for those periods reported while he was a director. The three reporting periods submitted in error by the Appellant's brother in September 1995 were subsequent to the Appellant's resignation. These reports were not part of the equation in respect to the Appellant's history with GST reporting. I conclude that it was reasonable in the Appellant's mind in those set of circumstances to assume no money was owing in this respect.
[61] Until June 1995, when the company was alerted that there could be potential GST remittance problems, it had always been in a GST credit position. Although the letter was dated in November 1994, and addressed to the company accountant, it was clear from the evidence that the existing acrimony between the directors and their accountant led to a breakdown in communications and that it was June 1995 or thereabout when such communication reached the Appellant. At this time the Board requested Gordon Smith to assume responsibility for resolving the problem. The Appellant also knew that the company was eligible for a SRED grant and that Gordon Smith on behalf of the Board of Directors was actively pursuing this money and had specifically requested the GST department to withhold any funds that were owed to them. These funds were to be paid in December 1995. After the Appellant effected seizure of the assets in October 1995, he did not walk away. He paid some $14,000.00 to cover source deductions and rent. Given the history of the company, he reasonably concluded that no GST was owing but that if it were, the scientific research credit would sufficiently cover any liability. He had knowledge that the GST department had been alerted to the company's entitlement to these funds and had requested them to deduct any amount owing before issuing the funds. It is simply unreasonable to conclude that the Appellant would have continued to see that source deductions, payments to a landlord and other expenses were covered, after his seizure of assets, to the exclusion of any amounts that might be owing for GST. Given the steps that were taken in pursuing the grant and informing GST officials of this source of funds, it was reasonable for the Appellant to conclude that he had taken all reasonable steps to ensure any GST liability was covered. Prior to June 1995, the Appellant's cash advances over time continued to keep the company afloat. When his brother called and requested money to cover source deductions, rent and so forth the Appellant made the funds available until the bank simply shut down his avenues of credit. During this period it was reasonable for him to believe no GST would be owing and if it had been, it would have been paid from one of his many advances.
[62] Has the Appellant taken the steps that a reasonably prudent person ought to have taken or could have taken at the time in comparable circumstances? I conclude he did. Were there other steps that he could have taken or should have taken but did not? I think not and in answering this question I am vigilant of the fact that hindsight is a wonderful beast. Until June 1995, the evidence establishes that the Appellant had no reason to suspect that there was GST liability. Thereafter, he knew the SRED credit would be available to remedy any potential default. If the Appellant had known that the scientific credit would not be utilitized for potential GST liability, his actions may have followed an entirely different path, knowing as a lawyer the potential for his own liability. This type of logic is not relevant here.
[63] Directors are required to act reasonably. They are not required to obtain perfection or to accomplish the impossible. In the case of Cloutier et al v. M.N.R., 93 DTC 544 at page 546, Judge Bowman, now Associate Chief Judge summarized this standard of care as follows:
...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 the 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.
[64] This approach is also consistent with a number of cases decided in the Federal Court of Appeal. Holding the Appellant to the standard of care dictated by the statute and the jurisprudence, I find that he took reasonable care to prevent the failure by the company to remit GST. The Appellant has complied with his legal obligation as he acted reasonably and took positive steps to ensure funds were available when it became apparent there could be problems. His actions complied with the standard of care.
[65] The appeal is allowed with costs and the assessment made under section 323 of the Excise Tax Act is vacated.
Signed at Ottawa, Canada, this 14th day of December 2001.
"Diane Campbell"
J.T.C.C.
COURT FILE NO.: 1999-730 (GST)G
STYLE OF CAUSE: Douglas Scott Cochran
and Her Majesty the Queen
PLACE OF HEARING: Vancouver, British Columbia
DATES OF HEARING: May 8 and 11, 2001
REASONS FOR JUDGMENT BY: the Honourable Judge Diane Campbell
DATE OF JUDGMENT: December 14, 2001
APPEARANCES:
For the Appellant: The Appellant himself
Counsel for the Respondent: Lisa Macdonell
COUNSEL OF RECORD:
Counsel for the Appellant:
Name:
Firm:
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
1999-730(GST)G
BETWEEN:
DOUGLAS SCOTT COCHRAN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on May 8 and 11, 2001, at Vancouver, British Columbia, by
the Honourable Judge Diane Campbell
Appearances
For the Appellant: The Appellant himself
Counsel for the Respondent: Lisa Macdonell
JUDGMENT
The appeal from the assessment made under the Excise Tax Act,notice of which is dated October 15, 1998 and bears number 20970, is allowed, with costs, and the assessment made under section 323 is vacated in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 14th day of December 2001.
|
"Diane Campbell" |
J.T.C.C.