REASONS
FOR JUDGMENT
D'Arcy J.
[1]
The issue in the four appeals before me is whether
the Appellant is liable as a director, under section 227.1 of the Income Tax
Act and section 323 of Part IX of the Excise Tax Act (the “GST Act”), for source deductions and GST that TRAK
Energy Engineering Inc. (“TRAK Engineering”) and
6607306 Canada Inc. (“TRAK Mechanical”) failed
to remit (collectively referred to as the “Remittances”).
The Remittances relate primarily to 2007.
[2]
The four appeals were heard together on common
evidence.
Summary of Facts
[3]
The Appellant, a professional engineer, established
a company in the 1990’s to perform energy audits in buildings. Sometime after
2000, he moved the company to British Columbia.
[4]
During the relevant period, the Appellant
carried on his business through the following three companies (jointly referred
to as the “Three Companies”):
-
TRAK Energy Corporation (TEC), which served as
the general contractor for various projects and entered into the head contracts
with clients.
-
TRAK Engineering, which performed the
engineering work required under the various head contracts.
-
TRAK Mechanical, which served as the payroll
company. During the relevant period it had approximately 40 employees in two
divisions: the plumbing division and the heating and ventilation division.
[5]
The Appellant was the controlling mind and sole
director of each of the Three Companies.
[6]
Sometime in August 2005, TEC entered into a
contract with an entity called Happy Valley Resort to design and build
mechanical systems for a condominium project in Kelowna, British Columbia (the “Happy Valley Contract”). This was a very difficult
project for the Three Companies for the simple reason that the developer of the
project (the “Developer”) refused to pay its
bills on a timely basis.
[7]
By July 2006, the Developer owed over $700,000
under the contract with TEC. This forced the Three Companies to take collection
actions, including sending a notice of payment default and breach of contract.
These actions were somewhat successful, as the receivables fell to $200,000.
[8]
Unfortunately, the Developer continued to defer
payments under the Happy Valley Contract, resulting in an increase in the Three
Companies’ receivables to $670,000 by late 2006. The receivables then dropped
to $400,000 after additional collection actions by the Three Companies, but
then rose once again to $600,000 by early 2007. In June 2007, the Three
Companies stopped working on the Happy Valley Resort project. They filed a
default notice under the Happy Valley Contract and executed a lien on the
project. Notwithstanding these actions, the Three Companies have not been able
to collect the amounts owed to them by the Developer.
The Law
[9]
Subsection 227.1(1) of the Income Tax Act
provides, in part, that the directors of a corporation are jointly and
severally liable for a corporation’s unpaid source deductions, including any
interest on, or penalties relating to, the unpaid source deductions.
[10]
Section 227.1 places certain limitations on the
director’s liability. Two of these limitations are relevant for the purposes of
these appeals. Paragraph 227.1(2)(a) provides that a director is
not liable under subsection 227.1(1) unless “a certificate for the amount
of the corporation’s liability referred to in that subsection [227.1(1)] has
been registered in the Federal Court under section 223 and execution for that
amount has been returned unsatisfied in whole or in part”.
[11]
The second relevant limitation is contained in
subsection 227.1(3), which provides that a director is not 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”.
[12]
Subsection 323(1) of the GST Act imposes
a similar director’s liability in respect of unremitted GST/HST. Subsection
323(1) of the GST Act provides that the directors of a corporation are
jointly and severally liable to pay any amount of net tax that the corporation
fails to remit. A director’s liability under subsection 323(1) includes any
interest on, or penalties relating to, the net tax that is not remitted.
[13]
The GST Act contains the same limitations
as those found in the Income Tax Act. Paragraph 323(2)(a) of the GST
Act provides that a director is not liable under subsection 323(1) unless “a certificate for the amount of the corporation’s liability
referred to in that subsection [323(1)] has been registered in the Federal
Court under section 316 and execution for that amount has been returned
unsatisfied in whole or in part”.
[14]
A due diligence defence is contained in
subsection 323(3) of the GST Act, which provides that a director is not
liable under subsection 323(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.”
[15]
The Federal Court of Appeal noted in Buckingham that subsection 323(3) of the GST
Act and subsection 227.1(3) of the Income Tax Act should be applied
in a similar fashion.
First Issue Before the Court
[16]
The first issue the Court must address is whether
the amounts assessed by the Minister exceed the limitation set out in
paragraphs 227.1(2)(a) of the Income Tax Act and 323(2)(a)
of the GST Act.
[17]
On May 6, 2010, the Minister assessed the
Appellant for $452,347.49 under subsection 227.1(1) of the Income Tax Act
in respect of TRAK Mechanical’s unremitted source deductions and $86,222.48 under
subsection 323(1) of the GST Act in respect of TRAK Mechanical’s
unremitted net tax.
The Respondent indicates in her relevant Replies that these are the amounts at
issue in the appeals before the Court relating to TRAK Mechanical.
[18]
Paragraph 7 p) of the Reply in 2011-2687(IT)G
states that when determining the Appellant’s liability, as a director of TRAK
Mechanical, for unremitted source deductions, the Minister assumed that “on January 10, 2008, the Minister registered with the
Federal Court of Canada a certificate for [TRAK Mechanical’s] liability for the
Source Deductions, plus penalty and interest, in the amount of $373,673.61.”
The Respondent provided the Court with a copy of the certificate. The certificate is for an
amount that is some $78,674 less than the amount the Minister assessed pursuant
to subsection 227.1(1) of the Income Tax Act.
[19]
A similar discrepancy exists with respect to TRAK
Mechanical’s unremitted net GST. The Appellant was assessed for $86,222.48.
However, the Federal Court certificate is only for $74,326.29. The amount assessed exceeds
the certificate amount by $11,896.19.
[20]
Paragraphs 227.1(2)(a) of the Income
Tax Act and 323(2)(a) of the GST Act clearly provide that the
Minister may not assess an amount in excess of the amount of the Federal Court
certificate. As a result, the Court will direct the Minister to reduce the
assessments to the amount of the relevant Federal Court certificate.
[21]
The Minister made a similar error when assessing
the Appellant in respect of the unremitted source deductions of TRAK
Engineering. The Minister assessed the Appellant $97,517.46 in respect of TRAK
Engineering’s unremitted source deductions.
However, the certificate registered by the Minister with the Federal Court was
only for $86,372.61.
The assessment will be reduced to the amount of the certificate: $86,372.61.
Second Issue Before the Court
[22]
The second issue before the Court is whether the
Appellant has satisfied the conditions for the due diligence defence contained
in subsection 227.1(3) of the Income Tax Act and subsection 323(3) of
the GST Act.
[23]
It is a question of fact whether the Appellant,
in his role as director of TRAK Engineering and TRAK Mechanical, 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, skill and diligence required under subsection 227.1(3) of the Income
Tax Act and subsection 323(3) of the GST Act is an objective
standard.
The burden is on the Appellant to show that he has satisfied the conditions of
the two subsections.
[24]
The Appellant knew by January 2007 that the
Three Companies were facing significant cash flow issues due to the failure of
the Developer to pay the amounts owing under the Happy Valley Contract. However,
the Appellant decided that the Three Companies should continue their work under
the contract.
[25]
In early 2007, the Appellant took certain steps
to deal with the Three Companies’ cash flow issues. This included prioritizing
some creditors over others. While he continued to pay the net wages to the
employees, he only paid certain suppliers and stopped making the Remittances.
[26]
The Appellant testified that he firmly believed
that the Developer would pay the amounts owed to the Three Companies. He relied
on the fact that the Developer required an engineer’s certificate before the
building could be occupied and on the Three Companies’ ability to place a lien
on the Happy Valley property, which would have the effect of stopping
construction.
As a result, the Appellant believed the Three Companies would have the funds to
pay the suppliers and make the Remittances by the end of the first quarter of
2007.
[27]
The Appellant also relied on the fact that the
Three Companies carried on a substantial business, which generated revenue of
approximately $10 million per year.
[28]
Unfortunately for the Appellant, the Developer
never paid the amounts owing under the Happy Valley Contract. Instead, it
retained a second engineering firm to issue the required occupancy report. The
Appellant described what happened as follows:
. . . So finally,
we file a lien in the claim. The -- the lien amount was $876,000 at the time.
The -- at the time there were terms put forward that if they had made the
payment we would continue on with the work and we would have been able to pay
down these debts. They did not make that payment. The developer had decided to
do a workaround where he brought in another engineering firm. And it was really
beyond my expectation that he would find an engineering firm that would lie on
the amount of the progress. And that has since been proven and subsequently
that same engineering firm later lied on the state of completion so as a letter
of credit could be released for the developer. . . .
[29]
The Appellant referred to these events as
extraordinary circumstances that he “could not possibly
be prepared for or have the capacity to deal with . . .” Once it became clear that the
Developer would not be paying the outstanding amounts, he stopped working on
the project and began the process of winding down the Three Companies’ business,
a business that the Appellant had carried on successfully for 16 years.
[30]
As the Federal Court of Appeal noted in Buckingham,
the duty of care under subsection 323(1) of the GST Act is intended to prevent
the failure by a corporation to remit net tax. The Federal Court of
Appeal stated that, in order to rely on the subsection 323(3) defence, “. . . a director must . . . establish that he turned his
attention to the required remittances and that he exercised his duty of care,
diligence and skill with a view to preventing a failure by the corporation to
remit the concerned amounts.”
[31]
In the current appeals, the Appellant took no
steps to prevent the failure by the Three Companies to make the Remittances. In
fact, the Appellant made the decision not to make the Remittances.
[32]
I accept that the Appellant believed at the time
the Three Companies failed to make the Remittances that the companies would
collect from the Developer the monies required to make the Remittances.
However, the failure to make the Remittances in the belief that this failure
could be corrected in the future does not constitute a defence under either
subsection 227.1(3) of the Income Tax Act or subsection 323(3) of the GST
Act. As the Federal Court of Appeal stated in Buckingham:
. . . In
circumstances where a corporation is facing financial difficulties, it may be
tempting to divert these Crown remittances in order to pay other creditors and
thus ensure the continuation of the operations of the corporation. It is
precisely such a situation which both section 227.1 of the Income Tax Act
and section 323 of the Excise Tax Act seek to avoid. The defence under
subsection 227.1(3) of the Income Tax Act and under subsection 323(3) of
the Excise Tax Act should not be used to encourage such failures by
allowing a due diligence defence for directors who finance the activities of
their corporation with Crown monies on the expectation that the failures to
remit could eventually be cured.
[33]
While the Appellant may not have been able to
foresee the events that occurred with respect to the Happy Valley Contract, he
was the person who made the decision not to pay certain of the Three Companies’
accounts payable, including the Remittances. In such a situation, he is not
entitled to rely upon the due diligence defence contained in subsection
227.1(3) of the Income Tax Act and subsection 323(3) of the GST Act.
[34]
For the foregoing reasons the appeals are
allowed, in part, to reduce the amount of the assessments to the amounts shown
on the certificates registered in the Federal Court. There will be no order
with respect to costs.
Signed at Ottawa,
Canada, this 25th day of March 2015.
“S. D’Arcy”
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