Van Leenen v. MNR, 91 DTC 1265, [1991] 2 CTC 2442 (TCC)

Mogan. T.C.J.:—The issue in this appeal is whether the appellant, as director of a corporation, is personally liable under subsection 227.1(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the “Act’’) to pay an amount which the corporation deducted from the salary and wages of its employees but failed to remit to the Receiver General of Canada. At all relevant times, the appellant was the president, majority shareholder and a director of Madison Development Corporation Ltd. ("Madison"), a corporation described in evidence as a mid-sized Edmonton real estate developer engaged in the acquisition, construction and either sale or holding of rental properties.

In 1962, the appellant started the business which was later taken over by Madison, constructing small apartment buildings of six suites. Later, he constructed bigger buildings with more suites and, in the early years, all those buildings were sold upon completion. Around 1970, he retained a firm of chartered accountants to help with his bookkeeping and financial statements. As the business grew, his accountants recommended that Madison retain some buildings for depreciation purposes and to provide a more even cash flow that would not be dependent upon sales. As a general pattern, Madison would purchase some land; act as its own general contractor in the construction of residential or commercial buildings; and then sell or retain the buildings upon completion. The construction of the buildings was financed with mortgage funds at 75 per cent of proven value. Because Madison owned the land and acted as its own general contractor, the value of the completed project was such that 75 per cent of that value was usually sufficient to pay all construction costs.

In 1981, Madison had a payroll of 30 to 35 employees including secretaries, accounting staff, maintenance personnel and a property manager. Madison's gross rental revenue was approximately $8,000,000 in 1981; it owned land and buildings valued at $92,000,000; and it had a $3,000,000 line of credit at the Royal Bank secured by a debenture and assignment of receivables. By most commercial standards, Madison was a real success story in 1981. What followed was a financial disaster.

Most of Madison's rental properties were in the Edmonton area. In the latter part of 1981, interest rates in Canada on borrowed money soared to the range of 18 per cent to 21 per cent. There was a drop in the price of oil which reduced employment in Alberta. Some of Madison's tenants (residential and commercial) moved away leaving vacancies which could not be filled. The increase in vacancies decreased the flow of rental revenue. Higher interest rates increased Madison's cost of borrowed money. In a short space of time, Madison was in a cash bind with declining revenue and higher expenses. Madison attempted to sell some of its rental buildings in order to raise cash but the high interest rates made it difficult to sell any properties. According to the appellant's testimony, land values fell by as much as 60 per cent and, in a number of situations, the mortgages and other charges against a particular property would exceed its market value.

In January 1982, Madison hired lan Dark as vice-president and right-hand man to the appellant. Mr. Dark's responsibilities included negotiating with creditors, realtors and municipalities and the management of Madison's 1,300 rental apartments and 3,000 square feet of retail space. He had no equity in Madison and was paid a salary of $45,000 per year which did not change from the time he was hired until he resigned in the spring of 1986. Mr. Dark testified in this appeal and described himself as the "firefighter" in the company. One of his principal duties was fending off creditors. He had to persuade the power company not to turn off the power; and the same applied to other utilities like gas and telephone. Madison reached the point where it paid the creditor who shouted the loudest and whose service was most essential to the continued operation of the company. Mr. Dark described this as a day-to-day decision of Madison's management and not a decision of the Company's directors although he had become a director early in 1982.

Mr. Dark was under the impression that Madison's internal accounting department was well managed until one morning in May 1984 when Mr. Thronson (head of the accounting department) told him that there were unpaid remittances to Revenue Canada, Taxation (referred to herein as "Revenue Canada") in the range of $80,000. Mr. Dark recommended to the appellant that the rents from the Federal Government for the 3rd floor of Hillsborough Place be assigned to Revenue Canada to retire the delinquent remittance problem. The appellant agreed and there was entered as Exhibit A-1 a letter of May 18, 1984 from Public Works Canada confirming a set-off of the rents from its leases at Hillsborough Place. It turned out, however,that a receiver had been appointed for Hillsborough Place and the receiver objected to the diversion of rents from Public Works Canada to Revenue Canada. The set-off arrangement between Madison and Public Works and Revenue Canada was therefore cancelled by Public Works and the receiver for Hillsborough Place before the obligation of Madison to Revenue Canada was discharged. Mr. Dark resigned as a director of Madison in May 1984 and stated that he had no understanding of how the remittances were paid to Revenue Canada prior to the time he first learned of the default in that month.

Madison had a series of internal accountants who had been in charge of the accounting department. Mr. Stasniuk left in 1981 and was followed successively by Messrs. Bortellussi, Paynton and Thronson. Although Mr. Dark did not hire them, it was his impression that each one had some form of professional accountant's certificate. The appellant never calculated any payroll deductions himself and he had no knowledge of reporting requirements to Revenue Canada except that he knew that year-end summaries had to be filed. In the period 1982-84, most of the appellant's time was spent with Madison's lenders as they pressed for repayment of loans. By the late summer of 1984, Madison was down to four employees including the appellant. The appellant stated that he did not know about the possible liability of directors for unpaid source deductions until Mr. Dark told him about it in May 1984.

Revenue Canada issued notices of assessment to Madison dated January 4, May 9 and August 14, 1984 and July 19, 1985 with respect to source deductions which Madison had failed to remit. The aggregate amount assessed for federal tax, interest and penalty was $63,478.31. There was apparently some amount collected from Public Works arising out of the assignment of its rents for Hillsborough Place before the assignment was cancelled by Public Works and the receiver for Hillsborough Place. In any event, on May 20, 1986, a notice of assessment was issued to the appellant under subsection 227.1(1) of the Income Tax Act in the amount of $63,623.50 for federal tax, interest and penalty. That assessment is the subject of this appeal and there is no dispute concerning the computation of the amounts. Also, the respondent proved that he had satisfied the condition in paragraph 227.1(2)(a) of tne Act.

The appellant attacks the assessment in a number of ways which I will list because they must be considered separately. The appellant makes the following claims:

1. He exercised the degree of care, diligence and skill required of him by subsection 227.1(3)

2. The Respondent is estopped from denying that the Appellant exercised the required degree of care, diligence and skill by virtue of certain representations in a letter dated August 31, 1987.

3. The Respondent was dilatory and neglectful when he delayed in taking certain steps which might have collected a portion of the amounts owing by Madison.

4. The Respondent had a common law duty to the Appellant to take reasonable and prudent steps to collect from every reasonable corporate (Madison) source.

5. The Respondent has been contributorily negligent in his own loss.

6. The Respondent has failed reasonably to mitigate the loss of remittances having regard to the degree of co-operation and assistance demonstrated by the Appellant.

In this appeal, the appropriate amount of tax was withheld from the salaries and wages of Madison's employees but that amount was not remitted to the Receiver General in accordance with subsection 153(1) of the Act. Therefore, Madison became liable for that amount under subsection 227(9.4) of the Act. It was Madison's failure to remit that amount which triggered the assessment under subsection 227.1(1) the relevant parts of which state:

227.1(1) Where a Corporation . . . has failed to remit. . . an amount . . ., the directors of the corporation at the time the corporation was required to . . . 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.

In order to avoid the director's vicarious liability under subsection 227.1(1), the appellant relies on subsection 227.1(3) which provides:

227.1(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.

The words in subsection 227.1(3) are important because they indicate the time when a director must exercise a certain degree of care, diligence and skill if he is to obtain the protection offered by that subsection. The director is "not liable for a failure under subsection (1)" where he has exercised the required degree of care, diligence and skill "to prevent the failure". If the failure under subsection (1) was a failure to remit before a prescribed date, the director must show that he exercised the required degree of care, diligence and skill before that date if his care, diligence and skill could possibly "prevent the failure". In White v. M.N.R., [1990] 2 C.T.C. 2566; 91 D.T.C. 54, Taylor, J. referred to subsection 227.1(3) and stated at page 2574 (D.T.C. 59): “As I read that subsection, it would seem to me that the direct responsibility of a director—any director—is to prevent the failure (to deduct or remit), not to attempt to rectify or remedy the failure at a point in time subsequent to the failure itself.”

In this case, the failure to remit occurred in the late months of 1983 and the early months of 1984. The appellant as president and dominant shareholder of Madison permitted the established administrative procedures to continue even though he knew that the corporation was in desperate financial circumstances and he was spending most of his time holding secured creditors at bay while Mr. Dark played a firefighter's role attempting to appease unsecured creditors like the utilities (power, water, gas and telephone) so that vital services would not be cut off. In these circumstances, the appellant thought he could rely on the established administrative procedures which had served Madison well for 20 years (i.e., timely withholding and remitting of tax) even though he knew that there was a tremendous shortage of cash and the corporation could pay only those creditors who shouted the loudest and whose service was most important for the continued operation of the business.

Considering Madison's financial situation in the winter of 1983-84, it is not surprising that certain source deductions were not remitted on time or at any time because the Receiver General was not shouting for payment; he was not delivering a service like power or water which was essential for day-to-day survival; and the unremitted source deductions could provide cash to pay a more immediate threatening creditor. Under subsection 227(4), amounts deducted for income tax are deemed to be held in trust. It is to protect those trust funds and to ensure that they are remitted to the beneficiary of the trust (the federal Crown in the person of the Receiver General) before a prescribed date that a personal liability is imposed on the directors of a corporation under subsection 227.1(1). When a previously healthy corporation comes into financial troubles as Madison did in 1983-84, the reasonably prudent director must exercise some care and diligence to ensure that any amounts withheld from salaries and wages as income taxes and held in trust for the Receiver General do not become part of the working capital of the corporation.

Some individual must have intervened in Madison's administrative procedures for remitting source deductions either by failing to send one or more cheques to the Receiver General within the prescribed time or by failing to take remedial action if certain cheques were in fact sent but later rejected (NSF) by Madison's bank. The individual who so intervened was not identified in evidence but the appellant, as a director of Madison with full knowledge of the corporation's desperate financial circumstances, could not simply rely on past administrative procedures when he knew that only the most threatening creditors were being paid and there was a very real risk that they would be paid at least in part with unremitted source deductions (i.e., funds held in trust). In my opinion, the appellant did not exercise any degree of care, diligence or skill to prevent Madison's failure to remit source deductions within the prescribed time. Indeed, the appellant permitted the old administrative procedures to continue when it should have been apparent to him that Madison was on the road to insolvency. When Madison ceased operations in the latter part of 1984, its liabilities to secured creditors exceeded its assets by $20,000,000. The appellant cannot succeed in his first claim because he did not exercise the degree of care, diligence and skill required to prevent Madison's failure to remit the source deductions.

I will now consider the appellant's claims 3, 4, 5 and 6. After May 1984 when the appellant knew of Madison's liability for unremitted source deductions and his own personal risk as a director of Madison, the appellant worked diligently attempting to obtain some funds for Revenue Canada from the disposition of Madison's remaining properties and from the assignment of certain rents. I have already referred to the Public Works leases at Hillsborough Place (a Madison building) under which Madison apparently assigned the rents to Revenue Canada to set-off its liability for source deductions. A letter from Public Works dated May 18, 1984 confirmed the set-off but it was terminated soon after when the person appointed as receiver of Hillsborough Place objected. Without seeing the correspondence among the parties, I cannot determine the relative merits at law of the receiver's claim to recover all rents at Hillsborough Place and the Crown's claim to a set-off but I am left with the impression that the Crown turned tail and fled at the first rumble of objection from the receiver.

The appellant claims to have tried in other ways to assist Revenue Canada in the collection of the amounts owing and (as a basis for his claims 3, 4, 5, and 6 set out above) he made the following allegations in his notice of appeal:

10. By early 1986, virtually all Properties owned by Madison on which third parties held security had been transferred to those third parties in satisfaction of Madison's debt. There remained some assets which were not so encumbered, but none of Madison's creditors (including the Respondent) were prepared to appoint a Receiver to oversee an orderly liquidation of remaining assets for the benefit of creditors.

11. In early 1986, the Respondent advised the Appellant of its intention to proceed with collection against Madison, and its Directors, if necessary. The Appellant promptly solicited from third parties offers to purchase various remaining assets of Madison and assisted the Respondent in identifying those properties and having writs of execution filed on title to those properties. After payout of any prior encumbrances, the Respondent would have had priority to any unsecured creditors and there was at the time sufficient equity to have paid the Respondent's claim in full.

12. The Respondent's officer, William Gilrie, assured the Appellant that "with this type of co-operation, Revenue Canada would not proceed against the Directors personally". As Madison was in no position to obtain the necessary Court Orders to close the sales, the Appellant urged the Respondent to apply to Court for Orders directing the sales of the properties and the distribution of the proceeds, which the Respondent refused and neglected to do. As a result, property values further declined, encumbrances grew with additional interest, and the Appellant and his fellow directors were severely prejudiced by the Respondent's failure to pursue diligently, or at all, the most expedient means of recovery.

These allegations were not admitted by the respondent and the appellant was put "to the strict proof thereof". Also, the respondent argued that these allegations depend upon this Court having jurisdiction to grant relief in the form of negligence (contributory or otherwise), damages and the right to setoff. On this question of jurisdiction, the respondent relied on section 12 of the Tax Court of Canada Act, R.S.C. 1985, c. T-2 and section 17 of the Federal Court Act, R.S.C. 1985, c. F-7:

Tax Court of Canada Act

12. The Court has original jurisdiction to hear and determine appeals to the Court on matters arising under the Income Tax Act, the Canada Pension Plan, the Petroleum and Gas Revenue Tax Act, Part III of the Unemployment Insurance Act and any other Act of Parliament in respect of which an appeal is provided under any such Act to the Court.

Federal Court Act

17.(1) The Trial Division has original jurisdiction in all cases where relief is claimed against the Crown and, except where otherwise provided, the Trial Division has exclusive original jurisdiction in all of those cases.

(4) The Trial Division has exclusive original jurisdiction to hear and determine proceedings to determine disputes where the Crown is or may be under an obligation, in respect of which there are or may be conflicting claims.

(5) The Trial Division has concurrent original jurisdiction

(a) in proceedings of a civil nature in which the Crown or the Attorney General of Canada claims relief; and

(b) in proceedings in which relief is sought against any person for anything done or omitted to be done in the performance of his duties as an officer or servant of the Crown.

In my view, the above statutory provisions support the respondent on this question of jurisdiction. The Trial Division of the Federal Court of Canada has exclusive original jurisdiction where relief is claimed against the Crown whereas this Court has original jurisdiction to hear and determine only appeals on matters arising under the Income Tax Act and certain other revenuecollecting statutes. When an appeal is instituted under section 169 of the Income Tax Act, the subject of the appeal is an assessment issued by the respondent under that Act and, unless the appeal is dismissed (and the assessment sustained), the only relief which a taxpayer can achieve under section 171 is to have the assessment vacated, varied or referred back to the respondent for reassessment in a defined manner. There is no jurisdiction granted to this Court to hear an issue of negligence and determine the amount of damages when relief is sought against an individual for what he has clone or failed to do as a servant of the federal Crown. On the contrary, that kind of jurisdiction is granted exclusively to the Federal Court-Trial Division under section 17 of the Federal Court Act.

On this question of jurisdiction and the possibility that the Department of National Revenue might have collected certain amounts from the forced sale of Madison properties or the set-off of certain rents owing to Madison by the Department of Public Works, there was no evidence that any particular amount would have been collected from a specific source but for the tardy or negligent conduct of employees of the Department of National Revenue. I infer from the evidence that all of Madison's properties were encumbered with mortgages, liens and other claims of secured and unsecured creditors. In those circumstances, the onus was on the appellant to prove that Revenue Canada could have forced the sale of a specific property at a specific time and that, upon such sale, a particular amount would have been recovered by Revenue Canada. There was a significant deficiency of evidence to discharge such an onus and it was not established as a matter of law that Revenue Canada owed a duty to the appellant to attempt to force a sale of any Madison property. With respect to the set-off of rents at Hillsborough Place, I was left to conclude that Revenue Canada and the Department of Public Works were intimidated by the first objection from the receiver but, here again, there was a dearth of evidence concerning the receiver. Who was he? In what circumstances did he become a receiver for Hillsborough Place? What creditor or creditors did he represent? On what legal basis dia he object to the diversion of rents from Public Works to Revenue Canada? What was the strength at law of Revenue Canada’s claim to the rents? Why should Revenue Canada start litigation with the receiver of Hillsborough Place to save the directors of Madison from personal liability for Madison's tax obligations?

The substance of the appellant's claims 3, 4, 5 and 6 is negligence on the part of one or more individuals employed by Revenue Canada. As such, I do not have jurisdiction to hear those claims. But even if I had such jurisdiction, I was not persuaded that the Department of National Revenue had a duty to the appellant to achieve some standard of persistence or diligence when attempting to collect Madison's unpaid taxes from third parties. And if I were to assume that such a duty did exist, I was not persuaded that any employee of Revenue Canada was negligent in the performance of such assumed duty.

And lastly, I refer to the appellant's claim 2 which is one of estoppel. Because estoppel is part of the law of evidence, there is no issue here of jurisdiction. The appellant's claim is stated in his notice of appeal as follows:

A. 12 The respondent's officer, William Gilrie, assured the appellant that "with this type of co-operation, Revenue Canada would not proceed against the Directors personally" . . .

B. 5 Further, or in the alternative, the respondent is estopped from denying that the appellant exercised the care and diligence required under section 227.1(3) by virtue of its representations of August 13, 1987.

The representations referred to in error as of August 13,1987 were statements made in a letter (Exhibit A-11) dated August 25, 1987 from Revenue Canada to the appellant which commenced as follows:

Dear Mr. Van Leenen:

Re: Notice of Objection—Section 227.1

Mr. lan Dark

Thank you for your letter of August 13, 1987 concerning the above Notice of Objection.

I assume the letter from myself to which you refer is dated July 14, 1987. In that letter, I stated the file had been referred to our Head Office, and it was their legal opinion that the assessment should be upheld. When I I referred the file to them, I outlined everything Mr. Dark had done to ensure payment and indicated such action was sufficient to meet the degree of care and diligence required to avoid liability under this section.

There is no doubt that the author (F.C. Rayner) of that letter thought that Mr. Dark had done what was necessary to avoid personal liability. The appellant claims that he did more than Mr. Dark to assist Revenue Canada in collecting the unremitted amounts from the assets of Madison; and Exhibit A-11 was entered to show that, if one official of Revenue Canada could make that kind of favourable statement about Mr. Dark, it is likely that another official like Mr. Gilrie would have made a more compromising statement to the appellant. Although William Gilrie was not called as a witness, I infer from other evidence that he encouraged the appellant to think that he (the appellant) would not be assessed under section 227.1 because of his efforts to assist in the collection of Madison's unremitted amounts.

Even if Mr. Gilrie made encouraging statements to the appellant about not being assessed under section 227.1, I do not see how such statements could assist the appellant. Firstly, the appellant did not rely on and did not act upon any statement by an official of Revenue Canada because he was already doing everything he could to assist those officials to collect as much as possible from the assets of Madison so that his exposure as a director of Madison would be reduced. Secondly, he could not have relied on or acted upon any statements by officials of Revenue Canada when attempting to assist in the collection of unremitted amounts because those statements would not have been made until after he had demonstrated his assistance. Thirdly, such statements do not appear to have been made by any person who, under the Income Tax Regulations, would have had authority to bind the respondent. And lastly, without having heard counsel on the issue, I doubt that any official of Revenue Canada has authority to promise a taxpayer that he will not he assessed under a specific section of the Income Tax Act if, upon a fair review of the facts, that taxpayer appears to be liable under that specific section. When Parliament has imposed an income tax liability upon a taxpayer in prescribed circumstances, the officials of Revenue Canada have a duty to assess the tax if, upon a fair review of the facts, those circumstances appear to exist. The appeal is dismissed.

Appeal dismissed.