MacArthur v. MNR, 91 DTC 957, [1991] 2 CTC 2078 (TCC)

Brulé, T.C.J.: —In November of 1988 the Minister issued a notice of assessment to the appellant informing him that he was being assessed as a director of Sirloin Steakhouse Restaurant Ltd. for federal income taxes, Nova Scotia income taxes, Canada Pension Plan contributions and unemployment insurance premiums, plus applicable interest and penalties that Sirloin Steakhouse Restaurant Ltd. failed to remit in May, June and July of 1986 in the total amount of $5,703.56. This appeal follows a notice of objection by the appellant to the said assessment and a notice of confirmation by the Minister.

Facts

The parties to this appeal filed an agreed statement of facts, the essence of which is as follows:

1. Sirloin Steakhouse Restaurant Ltd. (hereinafter “the Company") was a body corporate incorporated under the laws of the Province of Ontario on July 10, 1972.

2. Immediately prior to closing on July 10, 1985, the appellant owned all of the outstanding shares of the Company and he was a director thereof.

3. At all relevant times the Company owned and operated a Restaurant in Halifax Nova Scotia that was licensed by the Nova Scotia Liquor License Board to sell alcoholic beverages.

4. On or about June 7, 1985 the appellant signed an agreement to sell his shares in the Company to Peter Christakos, which agreement was originally scheduled to close on July 2, but eventually closed on July 10, 1985.

5. The Nova Scotia Liquor License Board required the appellant, who was also a licensee under the Liquor License Regulations, to obtain permission of the Liquor License Board before transfer of shares of the licensee took place. The appellant remained on as a director until the new owner received approval for the transfer of shares (the license) pursuant to Regulation 10(2) of the Liquor License Board Regulations.

6. On July 10, 1985 the appellant delivered a written document whereby he resigned as a director of the Company, which resignation was to take place on an unspecified, later date.

7. The Company ceased operations by November of 1986 and on November 13, 1986 it was assigned into bankruptcy and the firm of Clarkson Gordon was appointed as Trustee.

8. The Company failed to remit amounts deducted from employees' salaries and wages in 1985 and 1986 to the Receiver General as required by the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the 'Act"), and more specifically failed to remit amounts deducted in May, June and July of 1986 and the respondent filed a proof of claim with the Trustee dated December 9, 1986 which included a claim for these amounts.

Appellant's Position

Counsel for the appellant presented both a factual and legal argument to the Court indicating why his client's appeal should be allowed. He said in written argument:

It is clear that the Appellant resigned as a Director of the Company on or about July 10, 1985 by virtue of his written resignation. The fact that his resignation was not to be registered until a short time following the closing, in accordance with the applicable corporate statute, it is submitted, should not significantly detract from Mr. MacArthur's intention to resign. One must ask, if Mr. MacArthur had no intention to resign;

(a) Why would the agreement of purchase and sale have required his resignation?

(b) Why would he have signed a resignation on July 10, 1985?

(c) Why did he not participate in any Directors meetings? and

(d) Why did he not participate in any management decisions following the closing?

The Appellant was no longer an active Director of the Company when the default occurred; he had no de facto control or freedom of choice with respect to the Company's failure to remit withholdings thereby rendering subsection 227.1(1) inapplicable. In addition, the Appellant honestly and reasonably believed that he had ceased to be an active Director of the Company and therefore exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.

Reference will be made below to certain portions of the appellant's legal argument.

Respondent's Position

Counsel took the position that there is no evidence that the appellant ceased to be a director of the Company prior to May of 1986. Section 121 of the

Ontario Business Corporations Act, S.O. 1982, c. 4 states in part:

(2) A resignation of a director becomes effective at the time a written resignation is received by the corporation or at the time specified in the resignation, whichever is later.

It was pointed out to the Court that in the present case the appellant, on July 10, 1985, issued a resignation as a director to the Company which was obviously not intended to take place immediately, but rather, at an unspecified future time. In addition, on that date he participated in a shareholders' meeting at which he was elected a director of the Company. Counsel submitted that on July 10, 1985 the appellant must have known that he had not resigned as a director of the Company and that some future event must take place before his resignation would take effect. The future event indicated in the resignation was acceptance of the resignation by the Board of Directors. The appellant knew the Board of Directors consisted of himself and one other person (the purchaser of the business). Under these circumstances it is difficult to believe that the appellant could reasonably have believed that his resignation had become effective. As 50 per cent of the Board of Directors, he clearly would have had to participate in the acceptance of the resignation. There is no evidence of this participation.

As a result it was said that there were no reasonable grounds on which the appellant could have based a belief that he had effectively resigned as a director of the company. Therefore the appellant fails to meet the standard provided by subsection 227.1(3) of the Income Tax Act.

Analysis

It is quite clear from the agreed statement of facts that there is no dispute in this area but the difference lies in the interpretation to be placed on the agreed facts and their application in law.

The issue of whether the appellant reasonably believed that he had resigned as a director of the Company is founded in the due diligence defence provided by subsection 227.1(3) of the Income Tax Act. It reads:

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

As was stated by Judge Christie in the case of Cybulski v. M.N.R., [1988] 2 C.T.C. 2180; 88 D.T.C. 1531, at page 2185 (D.T.C. 1535):

While at first blush subsection 227.1(3) suggests a requirement for positive assertion on the part of a taxpayer in order to bring himself within its ambit, this is not necessarily so in all situations. It may well be that a taxpayer would not take positive steps in some circumstances and still be correctly regarded as having "exercised" that degree of care, diligence and skill expected of a reasonably prudent person that creates the protection from liability afforded by the subsection.

In the Cybulski case, supra, Christie, A.C.J.T.C. discussed the due diligence defence provided for in section 227.1(3) at page 2184 (D.T.C. 1534) and in so doing referred to the following passage from Canadian Business Corporations, by lacobucci, Pilkington and Pricnard. This passage discusses the nature of the common law duty imposed on directors, at page 287:

The common law standard of care and skill which a director must meet is generally expressed as an objective standard: he must exercise the reasonable care and skill which an ordinary person might be expected to exercise in the circumstances on his own behalf. However as Mr. Justice Romer indicated, in the leading case of Re City Equitable Fire Insurance Company [1925] Ch. 407 at p. 428, aff'd [1925] Ch. 500 (C.A.), the common law standard is also partly subjective: a director need not exhibit a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. At common law the degree of care and skill demanded of a director varies with the type and size of the company he serves.

Counsel for the appellant referred further to the Cybulski case by quoting another passage from the Court decision to be found at page 2184 (D.T.C. 1535) as follows:

In enacting subsection 227.1(3) Parliament established an exonerating standard of conduct the presence of which is to be determined in particular cases by the actual relevant facts and not by fixing to a taxpayer knowledge of a somewhat esoteric point of corporation law that in reality is probably not within the actual knowledge of a good number of legal practitioners. While at first blush subsection 227.1(3) suggests a requirement for positive assertion on the part of a taxpayer in order to bring himself within its ambit, this is not necessarily so in all situations. It may well be that a taxpayer would not take positive steps in some circumstances and still be correctly regarded as having "exercised" that degree of care, diligence and skill expected of a reasonably prudent person that creates the protection from liability afforded by the subsection. That obtains in respect of this appeal. I am satisfied that reasonable grounds existed for the appellant's belief that he had severed his connection with the Company as director and secretary-treasurer and concomitantly his responsibility for it when he placed his resignation in the hands of the Company's president and it was accepted by him. This relieves him of vicarious liability for the Company's default in remitting the deductions at source and this is so a fortiori where, as here, the appellant was effectively barred from exercising influence over the management of the company by the person in de facto control of its affairs after the resignation was submitted.

In her article "Director's Liability under Income Tax Legislation and Other Related Statutes” 1990 38 Can. Tax J. 537, Evelyn P. Moskowitz says at page 559:

The decision of the court in Cybulski marked a turning point in the jurisprudence regarding Subsection 227.1(1): It was the first case in which a director was successful in establishing a due diligence defence. Mr. Cybulski honestly believed that he had ceased to be a director of the company and that he was no longer required to attend to the company’s tax obligations. As well, the other director of the company also believed that Mr. Cybulski had ceased to be a director, and he therefore would not provide Mr. Cybulski with any information regarding the company. The Cy- bulski case is important, not only because it was the first time that a director was able to prove due diligence with respect to a Section 227.1 assessment, but also because it established that the determination of due diligence was based, at least in part, on subjective criteria.

The reasoning adopted in the Cybulski case has been favourably referred to in subsequent cases dealing with subsection 227.1(3). Edmondson v. M.N.R., [1988] 2 C.T.C. 2185; 88 D.T.C. 1542 (T.C.C.); Fancy v. M.N.R., [1988] 2 C.T.C. 2256; 88 D.T.C. 1641 (T.C.C.); Merson v. M.N.R., [1989] 1 C.T.C. 2074; 89 D.T.C. 22 (T.C.C.); Laxton v. M.N.R., [1989] 2 C.T.C. 85; 89 D.T.C. 5327 (T.C.C.); Perri v. M.N.R., [1990] 1 C.T.C. 2071; 89 D.T.C. 723 (T.C.C.); Swertz v. M.N.R., [1990] 1 C.T.C. 2160; 90 D.T.C. 1056 (T.C.C.); Robitaille v. Canada, [1990] 1 C.T.C. 121; 90 D.T.C. 6059 (F.C.T.D.).

In Fancy, supra, Couture, C.J.T.C., stated at page 2261 (D.T.C. 1644):

The personal liability of directors created by Subsection 227.1(1) is not an absolute liability. It is conditional upon their personal conduct in respect of the circumstances linked to the omission by their company to remit the deductions from its employees' salary. The exercise of care, diligence and skill referred to in Subsection 227.1(3) exempts them from that personal liability.

In Robitaille, supra, Addy, J. stated at page 125 (D.T.C. 6062):

Although that burden would, in the vast majority of cases, fall upon any director seeking to escape liability under section 227.1(1) by qualifying as an exemption under 227.1(3), I cannot accept that it is an inflexible rule of universal application regardless of the facts of any case. There exists, as was decided by Chief Judge Couture, of the Tax Court of Canada in the reported case of Fancy and Fancy v. M.N.R., supra, certain exceptional situations where a distinction can and should be made. Be that as it may, the “circumstances” referred to in subsection (3) must be those which, either directly or indirectly, would have an effect on the actions or on the inaction of the person sought to be held liable under subsection (1).

At page 126 (D.T.C. 6063) Addy, J. goes on to say: “The exercise of freedom of choice on the part of the director is essential in order to establish personal liability.”

The absence of this freedom of choice renders the charging provisions of subsection 227.1(1) inapplicable.

In the present case it is clear that the appellant, de facto, intended to, and did abdicate all power and control over operations, as evidenced by the signed resignation even though it was not effective on July 10, 1985. While the appellant remained as nominal director, this was due to the failure of the Company to formally effect his resignation at a later date. The appellant ceased to be a de facto director of the Company and thereafter was not even in a position to exercise due care, diligence and skill in dealing with payroll deductions.

The result is that the appeal is allowed with costs and the matter is returned back to the Minister for reconsideration and reassessment.

Appeal allowed.