Tax Court of Canada Judgments

Docket: 2001-453(IT)G

BETWEEN:

STEVEN L. CLEMENTS,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

____________________________________________________________________

Appeals heard on March 6, 2003 at Toronto, Ontario

Before: The Honourable Judge Michael J. Bonner
Appearances:
Counsel for the Appellant:	David A.S. Mills
Counsel for the Respondent:	Donna Dorosh

____________________________________________________________________

JUDGMENT

          The appeals from assessments imposing liability under s. 227.1 of the Income Tax Act, s. 21.1 of the Canada Pension Plan and s. 83 of the Employment Insurance Act are allowed, without costs, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the Reasons for Judgment.

Signed at Vancouver, British Columbia, this 17th day of June 2003.

"Michael J. Bonner"

T.C.J.

Citation: 2003TCC289

Date: 20030617

Docket: 2001-453(IT)G

BETWEEN:

STEVEN L. CLEMENTS,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

REASONS FOR JUDGMENT

Bonner, T.C.J.

[1]      The Appellant appeals from assessments imposing liability under s. 227.1 of the Income Tax Act (the "Act"), s. 21.1 of the Canada Pension Plan (CPP) and s. 83 of the Employment Insurance Act (EI). The assessments are based on a finding that SLC Cartage Inc. (SLC) fail to remit to the Receiver General amounts deducted or withheld from its employees' salary or wages for the months of January, February, March and April 1998.

[2]      The statutory provisions giving rise to the obligation of SLC to deduct or withhold and to remit are s. 153(1) of the Act, s. 21(1) of the CPP and s. 82(1) of the EI. Where there has been a failure by a corporate employer to comply with its obligations under those provisions "... the persons who were the directors of the corporation at the time when the failure occurred..." are made jointly and severally liable with the corporation to pay to Her Majesty the amount which the employer should have paid.[1]

[3]      There are two issues in this case:

a)        Did SLC fail to remit to the extent found by the Minister on assessment?

b)       Did the Appellant exercise the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances? If and to the extent that he did, he is relieved of liability by s. 227.1(3) of the Act.

[4]      In Smith v. R., [2001] 2 C.T.C. 192, the Federal Court of Appeal discussed the legislative purpose underlying the directors' liability provisions of the Income Tax Act and Excise Tax Act. At paragraphs 6 and 7, the following is said:

"[6]       The directors' liability provisions were enacted to strengthen the Crown's ability to enforce the statutory obligation imposed on certain taxpayers to remit taxes payable by other parties, such as tax withheld at source from wages paid to employees, and net GST collected from customers. Normally, the Crown's remedies against a corporation that fails to remit these third party taxes would be limited to the corporation's assets.    That is a necessary incident of separate corporate personality.    However, it was perceived that a corporation, particularly a corporation in financial difficulty, might prefer to default on its obligation to remit taxes, in order to satisfy creditors whose claims were more immediately pressing.    It was apparently thought necessary to enact legislation that would deter corporations from making such a choice.

[7]         Consequently, subsection 227.1(1) of the Income Tax Act and subsection 323(1) of the Excise Tax Act were enacted to impose liability, subject to certain conditions, on the directors of a corporation that had failed to remit tax collected from others: Soper v. R., (1997), [1998] 1 F.C. 124, 215 N.R. 372, 149 D.L.R. (4th) 297, [1997] 3 C.T.C. 242, 97 D.T.C. 5407 (Fed. C.A.).    This is based on the presumption that a decision by a corporation to default on its remittance obligations would originate with the directors: Kalef v. R. (1996), 194 N.R. 39, 39 C.B.R. (3d) 1, [1996] 2 C.T.C. 1, 96 D.T.C. 6132 (Fed. C.A.)."

What is said there applies with equal force to the analogous provisions found in the EI and CPP.

[5]      In Smith, the Federal Court of Appeal provided in paragraphs 9 to 14 of its reasons a useful outline of the main elements of the due diligence defence:

"[9]       The Soper decision, supra, established that the standard of care described in the statutory due diligence defence is substantially the same as the common law standard of care in City Equitable Fire Insurance Co., Re (1924), [1925] 1 Ch. 407 (Eng. C.A.).    It follows that what may reasonably be expected of a director for the purposes of subsection 227.1(1) of the Income Tax Act and subsection 323(1) of the Excise Tax Act depends upon the facts of the case, and has both an objective and a subjective aspect.

[10]       The subjective aspect of the standard of care applicable to a particular director will depend on the director's personal attributes, including knowledge and experience.    Generally, 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 acumen or experience whose presence on the board of directors reflects nothing more, for example, than a family connection.    However, the due diligence defence probably will not assist a director who is oblivious to the statutory obligations of directors, or who ignores a problem that was apparent to the director or should have been apparent to a reasonably prudent person in comparable circumstances (Hanson v. R. (2000), 261 N.R. 79, [2000] 4 C.T.C. 215, 2000 D.T.C. 6564 (Fed. C.A.)).

[11]       In assessing the objective reasonableness of the conduct of a director, the factors to be taken into account may include the size, nature and complexity of the business carried on by the corporation, and its customs and practices. The larger and more complex the business, the more reasonable it may be for directors to allocate responsibilities among themselves, or to leave certain matters to corporate staff and outside advisers, and to rely on them.

[12]       The inherent flexibility of the due diligence defence may result in a situation where a higher standard of care is imposed on some directors of a corporation than on others.    For example, it may be appropriate to impose a higher standard on an "inside director" (for example, a director with a practice of hands-on management) than an "outside director" (such as a director who has only superficial knowledge of and involvement in the affairs of the corporation).

[13]       That is particularly so if it is established that the outside director reasonably relied on assurances from the inside directors that the corporation's tax remittance obligations were being met. See, for example, Cadrin c. R. (1998), 240 N.R. 354, [1999] 3 C.T.C. 366, 99 D.T.C. 5079 (Fed. C.A.).

[14]       In certain circumstances, the fact that a corporation is in financial difficulty, and thus may be subject to a greater risk of default in tax remittances than other corporations, may be a factor that raises the standard of care.    For example, a director who is aware of the corporation's financial difficulty and who deliberately decides to finance the corporation's operations with unremitted source deductions may be unable to rely on the due diligence defence (Ruffo c. R., 2000 D.T.C. 6317 (Fr.) (Fed. C.A.)).    In every case, however, it is important to bear in mind that the standard is reasonableness, not perfection."

[6]      At the hearing of the appeal evidence was given by the Appellant and by his sister Joan Michelle Clements, who was responsible for the accounting, payroll and government remittance functions of SLC at the relevant time.

[7]      SLC was incorporated in April of 1990. At all material time, the Appellant was its sole shareholder and director. It carried on a trucking business. Its work consisted almost exclusively of delivering goods for Sears Canada (Sears). It had about 38 employees in early 1998.

[8]      The Appellant has a high school education followed by a two-year diploma course which qualified him as a lab technician. He has driven trucks since 1983. During the period 1986 to 1988, the Appellant worked as an employee of a company called Canada Cartage. It was engaged in the delivery of goods for Sears. In 1988 there was a falling out between Canada Cartage and Sears and the Appellant became involved in freelance delivery for Sears. Subsequently SLC was incorporated and it commenced to work for Sears. The relationship between SLC and Sears was terminated in 1995. In June of 1997 a new delivery contract was formed between SLC and Sears. This contract appears to have been the source of almost all of SLC's business during the relevant period.

[9]      The financial position in June 1997 of the Appellant and SLC appears to have been precarious. The Appellant testified that his credit at the time was nil. Prompt payment of money earned under the Sears' contract appears to have been essential to the financial well-being of SLC. The contract called for Sears to pay SLC on the day following presentation of an invoice.

[10]     It was the Appellant's evidence that SLC's failure to remit source deductions was caused by financial difficulties resulting from a departure from or change in the time of payment provisions of the delivery contract. According to the Appellant, Sears warned in February of 1998 that it intended to commence making payments 30 days following receipt of SLC's invoice.

[11]     Sears paid SLC's invoice rendered March 4, 1998 but made no further payment until April 20. According to the Appellant, the March 15, 1998 remittance to the Receiver General in respect of February 1998 source deductions could not be made because SLC had no money. He testified that he told Sears that SLC would file for bankruptcy if Sears did not pay and that Sears "started taking over our people".

[12]     It may be noted here that while the change in the timing of payments by Sears to SLC may have made it difficult for SLC to remit in March 1998 the February source deductions, that change cannot account for SLC's failure to remit in February 1998 the source deductions which had been made in January.

[13]     Evidence given by Joan Clements made it clear that SLC was in a continuous state of financial crisis from June of 1997 until May of 1998 when the company became bankrupt. She said that "we were always scrounging" and that Sears had failed to advance to SLC the start-up funds which it had promised. She described SLC as a small company which was "starving to start with".

[14]     Both the Appellant and Ms. Clements agreed that the February 1998 cheque to the Receiver General to remit January source deductions was not signed because there were not sufficient funds to cover it. The Appellant claimed that he had been told that the payment was made but he was unable to identify the person who told him. Two persons had authority to sign SLC's cheques, the Appellant and his sister Debby Best. Ms. Best was not called as a witness. In my opinion it is most unlikely that the Appellant believed that SLC, a company which for some time had been in perilous financial condition, made the February 15 payment. I am not convinced that the Appellant was misled or in any way prevented from discovering the truth. I reject the suggestion that the Appellant was not aware of any problem in January and February and that he did not learn of a source deduction shortfall until March.

[15]     There is evidence that in February payments were made by SLC to creditors other than Her Majesty. SLC did pay its landlord. It also paid members of the Appellant's family to whom SLC was indebted.

[16]     The Appellant did acknowledge that he realized, just before the middle of March 1998, when the source deductions for February were to be remitted, that there would be a shortfall. He stated that at that time he knew that the company would be "folded". There is no evidence to support a conclusion that the Appellant made any effort to gather funds to make the March 15 remittance to the Receiver General. The Appellant said that he thought it best to let the trustee in bankruptcy handle the remittance of source deductions and that SLC's receivables at the time were sufficient to permit the trustee to pay the company's debts. He expressed the view that the shortfall in payment by the trustee to the Receiver General was attributable to fees charged by the trustee in bankruptcy.

[17]     In his submissions with respect to the due diligence defence which arises under s. 227.1(3) of the Act, counsel for the Appellant referred to the objective and subjective elements discussed by the Federal Court of Appeal in Neil Soper v. the Queen, 97 DTC 5407. Counsel submitted that the Appellant had no formal business or accounting training, little formal education and little business experience. He argued that, given those subjective limitations, the Appellant met the statutory standard by retaining his sister Joan as bookkeeper or accountant and by holding weekly meetings in order to discuss problems with the business. His submission was that the failure flowed from matters beyond the Appellant's control.

[18]     It is difficult to find support in the evidence for counsel's submissions. I formed the opinion that the Appellant was entirely capable of managing and controlling the business of SLC. The company was of modest size and the task was not formidable. The Appellant possessed post-secondary education. His experience in the trucking business was considerable. The Appellant had the able assistance of his sister Joan who operated a computerized accounting system capable of furnishing the Appellant with up-to-date information on financial matters including the state of the payroll.

[19]     I cannot accept the suggestion that the failures to remit were caused by circumstances beyond the Appellant's control. He was in charge of a business that was in evident financial difficulty. The risk of default in remitting source deductions was obviously great. The Appellant's access to the facts was unimpaired. As sole director and shareholder he had the power to take effective steps to prevent failures to remit. I have no doubt that he had the knowledge and skill required to appreciate the gravity of the situation and to take effective measures to remit as required. In the circumstances the Appellant was under an obligation to take positive steps to prevent failure. There is simply no credible evidence that the Appellant addressed the problem until mid-March 1998 when he decided to allow SLC to go bankrupt and to leave the payment of source deductions to a trustee in bankruptcy. That decision can hardly be characterized as an effort to prevent failure. It does not even qualify as a practical plan for rectifying prior failures for there is simply no evidence to support the Appellant's assumption that the trustee would be provided with assets adequate to pay the arrears.

[20]     In Soper v. the Queen (supra), Marceau, J.A. delivered brief reasons concurring in the result. At page 5420 he spoke of the duty imposed upon directors by s. 227.1. He said:

"I simply cannot imagine that such a duty may ever be seen as having been fulfilled by a director who, as here, has never put his or her mind to the requirement and has remained completely uninterested and passive with respect to it."

In my opinion the Appellant was "completely uninterested and passive" with respect to the duty to act reasonably to prevent the failures in this case.

[21]     The assessments result from the failure of SLC to remit source deductions for the period from January 1998 to the end of April. The evidence of both the Appellant and of Joan Clements establishes that SLC did not have the funds required to pay salary or wages for April of 1998. The evidence suggests that Sears "took over" SLC's employees early in April in order to prevent an interruption in service to its clients. SLC was under no obligation to withhold or remit in respect of the salary or wages which it did not pay. In consequence, the Appellant cannot be vicariously liable with respect to failures to remit for the month of April.

[22]     Some evidence was adduced regarding the amount of April wages. Counsel for the Appellant produced a calculation, Exhibit A-6, purporting to list $42,901.36 in unpaid wages for the period March 29 to April 30, 1998. That calculation was not shown to be reliable. The author was not called to testify. Exhibit A-7, containing a calculation made by the Ontario Department of Labour showed unpaid wages for April to be $20,334.80 and counsel for the Respondent conceded that SLC was not liable to pay source deductions on this amount. As I see it, both calculations are beside the point. What is relevant is the fact that SLC did not have the funds to pay and did not pay any wages during April. The Minister of National Revenue is, I assume, capable of recalculating the assessments to eliminate any amount included in respect of the wages which SLC did not pay in April.

[23]     Judgment will therefore issue allowing the appeals and referring the assessments back to the Minister of National Revenue for reassessment to delete liability in respect of wages erroneously found to have been paid to SLC's employees for the month of April 1998. Success was divided. There will be no order as to costs.

Signed at Vancouver, British Columbia, this 17th day of June 2003.

"Michael J. Bonner"

T.C.J.

CITATION:

2003TCC289

COURT FILE NO.:

2001-453(IT)G

STYLE OF CAUSE:

Steven L. Clements and H.M.Q.

PLACE OF HEARING:

Toronto, Ontario

DATE OF HEARING:

March 6, 2003

REASONS FOR JUDGMENT BY:

The Honourable Judge Michael J. Bonner

DATE OF JUDGMENT:

June 17, 2003

APPEARANCES:

Counsel for the Appellant:

David A.S. Mills

Counsel for the Respondent:

Donna Dorosh

COUNSEL OF RECORD:

For the Appellant:

Name:

David A.S. Mills

Firm:

Mills & Mills LLP Toronto, Ontario

For the Respondent:

Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada

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