Crossley v. MNR, 91 DTC 827, [1991] 2 CTC 2082 (TCC)

Bonner, T.CJ.:—This is an appeal from an assessment of the appellant's liability under section 227.1 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). The assessment was made in respect of the failure of Smallwood Lumber Ltd. ("Smallwood") to remit income tax deducted at source from salary or wages of the employees of the company. The appellant was one of five directors of Smallwood.

Section 227.1 provides in part:

227.1 (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.”

(2) 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 of Canada under subsection 223(2) and execution for such 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 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.

(3) A director is not liable for a failure under subsection (1) where he exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.

(4) 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 he last ceased to he a director of that corporation.

Two of the failures to remit which gave rise to the assessment under appeal relate to income tax deductions at source from wages paid during the months of October, November and December of 1985. There were two other failures to remit which, according to the reply to the notice of appeal, form part of the assessment under appeal. One was a failure to remit $6,007.54 in income tax for an unnamed 1986 period and the other was a failure to remit $331.28 for an unnamed 1985 period.

While on the subject of failures I will observe that a failure by the respondent to disclose the precise timing of each of the failures in respect of which he seeks to impose vicarious liability can seriously affect the fairness of the appeal process in cases arising under section 227.1 in which an appellant seeks to rely on subsection 227.1(3). Obviously the exercise by a director of care, diligence and skill to prevent a failure must occur before the failure has taken place. A director must be able to identify the period of time during which due diligence will entitle him to relief under subsection (3). Accordingly it is appropriate to remind the respondent that it his duty to fully disclose ”. . . to the taxpayer the precise findings of fact and rulings of law which have given rise to the contro- versy". (Per Rand, J. in Johnston v. M.N.R., [1948] C.T.C. 195; 3 D.T.C. 1182 (S.C.C.) at 203 (D.T.C. 1183).)

In this case the notice of assessment does not supply the missing particulars. Subsection 170(2) of the Act requires the respondent after receiving notice of an appeal to ”. . forward to the Tax Court of Canada copies of all returns, notices of assessment, notices of objection and notification, if any, that are relevant to the appeal”. The respondent forwarded to the Court a copy of a notice of assessment mailed to the appellant on July 13, 1988. It mentions a balance of $97,445.42 and states that it is a notice of assessment in respect of:

The liability under Subsection 227.1(1) of the Income Tax Act, Section 40.1 of the British Columbia Income Tax Act, Section 22.1 of the Canada Pension Plan and Section 68.1 of the Unemployment Insurance Act, 1971 in the amount of $97,445.42 being the amount of the unpaid deductions, interest and penalties payable by Smallwood Lumber Ltd. in respect of Notices of Assessment dated December 16, 1985, January 16, 1986, May 8, 1986, August 19, 1986 and August 20, 1986.

The notices of assessment to which reference was made were assessments made against Smallwood, not against the appellant. I assume that copies of the notices of assessment against Smallwood were not sent to the appellant. Certainly they were not transmitted to this Court under subsection 170(2). Where, as here, a notice of assessment incorporates by reference another document which is essential to complete notice, a copy of that document should be attached to the notice of assessment. I might add too that it is the duty of the respondent to include in the material transmitted to this Court copies of any document so incorporated.

Smallwood was incorporated in June of 1984. The company was intended to hold and exploit a timber licence for which the appellant had made application. The plan was that the company would, upon issuance of the licence, build a sawmill and cut timber from the licence for conversion to lumber. The appellant was the president and general manager of the company. He was one of five shareholders, all of whom were directors. The shareholders raised a total of $700,000 as an equity investment in the company. Smallwood sought and secured a loan from the Bank of British Columbia of >1,300,000. The major shareholder of Smallwood was one Alan Hern. He held the office of vice- president and owned about 75 per cent of the equity. The appellant owned about ten per cent of the shares. The bank loan was secured by a debenture which created a floating charge on the book debts, receivables and inventory of the company as well as a charge on its fixed assets. Personal guarantees of the five shareholders were also given to the bank.

Construction of the sawmill started early in 1985. By the fall of 1985, the company was experiencing some financial distress. Although the sawmill had been built and, commencing in October 1985, was producing lumber, no roof had been completed and no planer mill had been installed. The lack of a planer adversely affected the marketability of the lumber produced and the price received for it. The capital allocated to complete the mill had been spent. An application was made by the appellant at that time to the British Columbia Development Corporation for financing to permit the acquisition of a planer.

The appellant testified that in the October-November 1985 period the mill was attaining projected levels of production but the company was having difficulties with the timing of receivables and payables. On November 15 the company failed to remit the cheque due to the respondent in respect of October source deductions. By December 15, according to the appellant, “all kinds of payables were backed up”. The appellant stated ”. . . that payable to Revenue Canada, I think, at that time was like all of the other trade payables we had. I don’t think I gave it a special status in my mind.” The appellant further stated that on November 15 and December 15 cheques were not issued to Revenue Canada because ”. . . we didn't want to write cheques that would put the loan past its limiting position . . .”.

I might interject that I did not understand the appellant to suggest that there were insufficient funds to cover a chequefor source deductions. Rather I understood him to mean that there were insufficient funds to pay all creditors falling into the class in which he had placed Revenue Canada. The testimony of the appellant on this subject was general in nature and based on a recollection unsupported by any precise records. It is difficult to see how in the circumstances the appellant exercised due diligence to prevent the failures but it is not necessary to reach a conclusion on the subsection 227.1(3) defence.

In December of 1985 Smallwood's production operations were shut down. After that time some lumber may have been shipped but, the appellant said, from that point onward there was no payroll and only those with an interest in the business continued to attend and work without pay.

On January 27, 1986 the appellant met with Mr. Hern, the Chairman of Smallwood's Board. At that time the appellant was experiencing personal financial problems due to the failure of the company to pay his salary. The meeting with Mr. Hern took place at the mill site. It was also the location of the registered office of the company. The appellant explained to Mr. Hern that there was nothing more he could do for the company, that he had to get a job and that ”. . . my involvement with the situation there was ending." He delivered a letter addressed to Mr. Hern as Chairman reading ”... please accept my resignation as President and Manager of Smallwood Lumber Ltd.” The appellant turned over to Mr. Hern the keys for his office at the company premises. The appellant testified that ”. . . the technicality of whether I was resigning as a director really wasn't on my mind at all”. There was no evidence as to the contents (if any) of the articles of association relevant to the process for the resignation of directors of the company.

The principal submission made by counsel for the appellant was that the appellant ceased to be a director of Smallwood on January 27, 1986, a date more than two years prior to the day on which a notice of assessment was sent to the appellant. That assessment was, it was submitted, an “action or proceeding" commenced on July 13, 1988 with the consequence that it was, by virtue of subsection 227.1(4), invalid. Section 154 of the Company Act, R.S.B.C. 1979, c. 59 provided:

154. (1) A director ceases to hold office when his term expires in accordance with the articles or when he

(a) dies or resigns;

(b) is removed in accordance with subsection (3);

(c) is not qualified under section 138; or

(d) is removed in accordance with the provisions of the memorandum or articles.

(2) Every resignation of a director becomes effective at the time a written resignation is delivered to the registered office of the company or at the time specified in the resignation, whichever is later.

(3) A company may, notwithstanding any provision in the memorandum or articles, remove a director before the expiration of his term of office by special resolution, and may, by ordinary resolution, appoint another person in his stead.

It cannot in my view be said that the letter handed to Mr. Hern on January 27, 1986 was a written resignation from the office of director. Nothing was transmitted in writing expressing a desire to resign as director. Equally, the appellant did not orally express an intention or desire to resign as director. Indeed, as he admitted, he was not then conscious of the fact that he was a director. I cannot construe anything that happened at the meeting with Mr. Hern as an accidental or unintentional resignation from the office of director. The fact of resignation cannot be inferred just because it may be assumed that the appellant would have expressed a desire to resign if he had remembered that he was a director when he met with Mr. Hern. Furthermore, it cannot be found that the appellant ceased to be a director on January 27 simply because after that date he did not exercise the powers of a director or direct his mind to the fact that he possessed such powers. A director does not cease to hold office upon forgetting that he holds it.

The foregoing does not conclude the question whether the assessment was made beyond the period laid down by subsection 227.1(4). The debenture issued by Smallwood in favour of the Bank of British Columbia charged all of Smallwood's property, assets and undertaking. On March 21, 1986 the bank appointed Ernst & Whinney Inc., a licenced trustee in bankruptcy, as receiver and manager of the undertaking, property and assets charged by the debenture. On April 30, 1986, the Bank of British Columbia secured an order of the Supreme Court of British Columbia appointing Ernst & Whinney Inc.:

. . . Receiver-Manager of all of the undertaking of the Defendant, Smallwood Lumber Ltd. ("Smallwood") including the goodwill of the business and all property and assets whatsoever and wheresoever, present and future, including the uncalled capital of the Defendant, Smallwood, with power to manage, to lease or sell the business and undertaking of the Defendant, Smallwood, and to collect the rents and revenues of the Defendant and with power to act at once, and until the trial of this action or until further Order, with full authority to the said Receiver- Manager to enter into possession of the lands of the Defendant.

The initial appointment of Ernst & Whinney Inc. under the debenture ceased upon its appointment by the Court as receiver-manager by virtue of section 112 of the Company Act which reads:

112. (1) Every receiver or a receiver manager appointed under an instrument is an officer of the corporation and not an agent of the persons by, or on whose behalf, he is appointed, and he shall act in accordance with the instrument under which he is appointed and any directions of the court made under section 115.

(2) The appointment of a person as a receiver manager under an instrument ceases on his appointment as receiver manager by the court.

On February 11, 1991 the Supreme Court of British Columbia ordered that Ernst & Whinney Inc. be discharged as receiver-manager. It is not clear whether the discharge order was necessary because Smallwood had previously been dissolved on November 18, 1988 under section 281 of the Company Act, R.S.B.C. 1979, c. 59. Thus it is clear that Ernst & Whinney Inc. was receiver-manager initially under the debenture and subsequently under court order during the period from March 21, 1986 until the dissolution of Smallwood in November of 1988.

Sections 109 and 110 of the Company Act provide:

109. Subject to section 122, a person who is licenced as a trustee under the Bankruptcy Act (Canada) may be appointed under an instrument, or any person may be appointed by the court, as a receiver-manager of all or any part of the undertaking of a corporation, and, in either case, on being so appointed he may carry on any business of the corporation and have access to its records concerning that part of the undertaking for which he is appointed.

110. Where a receiver manager is appointed, the powers of the directors and officers of the corporation cease with respect to that part of the undertaking for which he is appointed until he is discharged.

Counsel for the appellant relied on the decision of this Court in Perri v. M.N.R., [1990] 1 C.T.C. 2071; 89 D.T.C. 723. The receivership commenced more than two years prior to July 13, 1988, the date of the assessment now in issue and it continued in effect at least until November of 1988 when Smallwood was dissolved. Throughout that period the directors of Smallwood were for all practical purposes stripped of their powers to manage or supervise the management of the affairs and business of Smallwood. The receivership deprived the appellant as director of Smallwood of any power to cause the company to rectify the failure to remit. An assessment of liability under subsection 227.1(1) is an "action or proceeding" within the meaning of subsection 227.1(4). The decision in Perri gives effect to a clear legislative intention to limit the period within which subsection 227.1(1) liability may be enforced. Counsel referred to the decision of this Court in Merlyn L. Irvine v. M.N.R., [1990] 2 C.T.C. 2560; 91 D.T.C. 91 and pointed out that the remarks made therein on the subject of the consequences of the appointment of a receiver-manager are obiter.

Counsel for the respondent took the position that the question whether a person is a director of a company is one to be decided by reference only to the relevant Company Act. In this case, so the argument went, the appellant had not ceased to hold office as a consequence of any of the events enumerated in subsection 154(1) of the Company Act. Counsel submitted that Perri was wrongly decided. He said that even after the appointment of a receivermanager, the directors of a company retain substantial powers. He pointed to the following passage from F. Bennett, Receiverships (Toronto: Carswell Company Ltd., 1985) page 426:

The Company Act has codified and varied a number of common law principles applicable to receiverships. For example, once a receiver and manager is appointed, the powers of the directors and officers of the corporation cease with respect to that part of the undertaking for which the receiver is appointed until he is discharged. However, this provision should not prohibit the directors and officers from defending an action brought by the security holder.

In addition counsel referred to the following passage from Kerr on Receivers, 15th ed. (1978), pages 315-16 quoted in the reasons for judgment of McKenzie, J. in Henfrey Samson Belair Ltd. v. A.-G. British Columbia (1984), 55 B.C.L.R. 241 (B.C.) at 246.

Relationship with board of directors. Although as regards the outside world the receiver is the sole person in charge of the company's operations, nevertheless the corporate structure of the company still subsists. The directors are not thereby relieved of their normal statutory duties, although the discharge of those duties may well be rendered extremely difficult or even impossible without the cooperation of the receiver, which they are in no position to require. Moreover, the directors are entitled to use the name of the company for the purposes of litigating the validity of the security under which the appointment has taken place, and presumably also for bringing the kind of actions for damages for gross negligence which, in an ordinary mortgage situation could be brought by the mortgagor against a receiver.

In my view the question whether a person is a director for purposes of section 227.1 of the Act is not to be decided solely on the basis of status under the relevant Company Act. In Perri, supra, this Court decided:

. . . it is the intention or subject of subsection 227.1(4) to fix a limitation period that runs from a time when an individual ceases to be in a position in law and in fact to exercise the powers of a director to rectify the failure of the corporation to deduct or remit or both. I regard that as being the correct meaning of the phrase "ceased to be a director" in subsection 227.1(4).

In McConnachie v. M.N.R., [1991] 2 C.T.C. 2072 I expressed the view that the decision of this Court in Perri ought to be followed and I added:

In Perri the Court construed the meaning of the word "director" as used in subsection 227.1(4) so as to exclude persons who are directors in a technical sense only and who, by reason of receivership or bankruptcy of the company, are stripped of powers of the sort which led to the enactment of section 227.1 in the first place. That section was enacted because it is the directors of a corporation who, in normal circumstances, exercise the powers of the corporation and direct the management of its business and affairs and who are therefore in a position to ensure that the corporation discharges its duty to withhold and remit tax as required by section 153 of the Act. Directors of a corporation which has lost the Capacity to dispose of or deal with corporate property are not the sort of persons who are the target of section 227.1. In my view, Perri follows the "modern rule” of statutory construction approved by the Supreme Court of Canada in Stubart Investments Ltd. v. The Queen, [1984] C.T.C. 294; 84 D.T.C. 6305, which rule is:

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

The purpose of subsection 227.1(4) is to protect directors from indefinite exposure to collection proceedings in respect of liability under subsection 227.1(1). That protection would, as a practical matter, be diminished greatly if directors of a bankrupt corporation are by reason of vestigial powers which they hold after a bankruptcy to be treated as continuing in office until either they resign or the corporation is struck from the register. Few people in such circumstances would ever think of resigning and few bankrupt corporations ever pay their debts in full and are discharged. As a consequence in most cases the two-year period would not start to run until the time when the corporation is struck from the register for failure to file returns.

For the foregoing reasons the appeal will be allowed, with costs, and the assessment will be vacated.

Appeal allowed.