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Citation: 2003TCC884
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Date: 20031203
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Docket: 2001-2757(IT)G
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BETWEEN:
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GORDON MURRAY McKINNON,
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Appellant,
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And
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Bowman, A.C.J.
[1] This is an appeal from an
assessment made under section 227.1 of the Income Tax
Act based on a failure by the appellant's company to remit
payroll deductions in respect of its employees. The total amount
assessed is $25,465.02 consisting of $11,755.47 for federal tax,
and the rest is for Canada Pension Plan, employment insurance
amounts not remitted and penalties and interest. The penalties
and interest amount to more than the amounts that the Crown
alleges ought to have been remitted by the company.
[2] The appellant is the president,
sole shareholder and sole director of Fast Track Glass and
Aluminium Limited, (the "company" or "Fast Track") a company
incorporated by him in 1993, after another company by which he
had been employed ceased operations. His purpose was to start a
small business which was intended to engage in the business of
fabricating and installing glass doors and windows.
[3] He had considerable experience in
this field. In preparation for the business venture he attended a
course about operating a small business at St. Mary's
University in Halifax. He also approached a number of banks and
other financial institutions to obtain a line of credit but was
not successful. He endeavoured to interest other investors
including the Annour Group Limited and the St. Mary's
University Micro Enterprise Equity Fund but was unsuccessful.
[4] He submitted business plans to
proposed lenders and investors and although the business plans
were reasonable and conservative and were regarded by at least
one proposed investor as excellent, he was unsuccessful in
attracting capital either by way of loan or equity except for a
line of credit of $4,000 from Credit Union Atlantic. Nonetheless,
the company started business and the results by the end of 1996
seem to have justified his initial optimism and initiative. On
April 29, 1996, Mr. McKinnon wrote to Peat Marwick
Thorne and stated that the company had contracts for $125,000 and
by the following month, $230,000. According to the company's
income statement for December 1, 1995 to
November 30, 1996, the company's total revenues were over
$486,000.
[5] There was one problem in 1996, but
it was not insuperable. The progress billings and payment of the
progress billings were later than the need to pay workers who
were paid either every week or every two weeks. Accordingly, the
payments to the Receiver General for Canada of payroll deductions
were often late, but they did get paid. If the only problem were
late payment of payroll deductions this case would not have
arisen. The problem is non-payment of two amounts on
March 12, 1997 of $5,403.82 for 1996 and $6,351.65 on May 6,
1997 for 1997. There was simply no money available to make these
payments. The last payment was made by the company on April 29,
1997, in the amount of $5,000.
[6] The cash flow shortfall that made
it impossible for the payments to be made to the Receiver General
for Canada was attributable to two events, neither of which could
have been foreseen by Mr. McKinnon. The first was the loss
of a greeting card distribution business carried on by him
through the company. This source of revenue made up a sufficient
portion of the company's revenues to enable its obligations to be
met, including its obligation to pay the payroll deductions to
the government. In March of 1996 the greeting card company
terminated its business relationship with the appellant and
accordingly this source of cash flow came to an end.
[7] The second and far more serious
development occurred in the company's relationship with a
contractor Rideau Construction Incorporated ("Rideau"). Fast
Track was engaged as subcontractor to install the glass at the
Halifax Air Traffic Control Tower and the Antigonish Court House.
Rideau was the general contractor on these two projects. The
price on the Halifax project was $105,500 and $47,000 for the
Antigonish project. Mr. McKinnon had dealt with Rideau
before and had not had problems being paid. His taking these
contracts was consistent with his conservative practice of
choosing only low risk projects involving municipalities or other
governments.
[8] Rideau in 1997 arbitrarily and
improperly refused to pay the full amount of the contract price
and in the result improperly withheld a total of $58,000 from the
amount owing to Fast Track based on spurious deficiencies which
it concocted. Legal actions were taken by Fast Track on the
instructions of Mr. McKinnon but they had to be dropped in
the year 2000 due to lack of funds. Mr. McKinnon testified
that when he received the assessment he could not fight both the
government and Rideau. This is of course not germane to the
decision here but it does demonstrate the degree of frustration
and indeed despair felt by the appellant. He lost everything he
owned, including his house, and moved to British Columbia
were he works as a senior estimator.
[9] I was impressed with the appellant
and with his demeanour in the witness stand. I found him honest
and straightforward. He worked with his wife to make the Fast
Track business a success but it failed through circumstances
beyond his control.
[10] Counsel for the respondent, in her
usual fair and thorough way, stated that the appellant's lack of
due diligence[1]
manifested itself at two points in time:
(a)
when he started the business without ensuring that sufficient
capitalization was in place by means of larger lines of
credit;
(b)
when he failed to terminate the business once he started to have
cash flow problems when the greeting card company withdrew
its business from the appellant.
[11] Counsel referred me to a number of
decisions where the facts bear a certain resemblance to the facts
here. Short v. R., [1999] 3 C.T.C. 435 involved, as here,
a construction company in a Maritime province. Both the Tax Court
and the Trial Division of the Federal Court found on the facts
that Mr. Short did not display the degree of care, diligence
and skill required to bring himself within the provisions of
subsection 227.1(3) of the Act. The same conclusion
was reached by Margeson J. in Blanchard v. R., [2000]
4 C.T.C. 2131, by Lamarre Proulx J. in Ruffo v.
R., [1998] 2 C.T.C. 2203, by Mogan J. in
W.F. Zwierschke v. M.N.R., [1991] 2 C.T.C. 2783 and
by Archambault J. in Fauteux v. R., [1997] 3 C.T.C.
2277.
[12] Each of these cases depended on its own
facts and is based in some measure upon the trial judge's
assessment of the director's credibility, character and general
demeanour in the witness stand. As Rothstein J.A. said in a
concurring judgment in Worrell v. R., [2000]
G.S.T.C. 91-1 at 91-24, "whether the due diligence
defence will be successful is fact-driven in each case;
i.e. always comparing what the directors did to prevent the
failure with what a reasonably prudent person would have done in
comparable circumstances". I think it is fair to say that prior
to a number of Federal Court of Appeal decisions to which I shall
refer presently, some of the judges of the Tax Court of Canada
were placing the barrier unrealistically high. This approach has
been mitigated substantially by the Federal Court of Appeal. The
first of these cases is Soper v. R., [1997]
3 C.T.C. 242, in which Robertson J.A. enunciated a
number of principles relating to the standard of care.
[13] The next case is the decision of the
Federal Court of Appeal in The Queen v. Corsano et al., 99
DTC 5658, where Noël J.A. agreed with the analysis of the
standard of care in subsection 227.1(3) stated by
Létourneau J.A.
[14] A passage which I find particularly
helpful is that found in Smith v. The Queen, 2001 DTC
5226 at p. 5231, paragraphs [31] and [32], where
Sharlow J.A. said:
[31] The Tax Court Judge appears to have recognized the
efforts made by Mr. Smith in an after June of 1995, but he noted,
at paragraph 138:
The actions that he took did
not have the effect of ensuring that Revenue Canada received any
of the monies here.
And, at paragraph 142:
The Court is satisfied that the actions taken by the Appellant
did nothing to prevent the failure.
[32] It appears to me that these comments reveal another
error in the Tax Court Judge's application of the due diligence
defence. A director is required only to act reasonably in the
circumstances. The fact that his efforts are unsuccessful does
not establish that he has failed to act reasonably.
This comment was followed by Linden J.A. in Cameron v. The
Queen, [2001] DTC 5405.
[15] The guidance which the Federal Court of
Appeal has given us in these cases is helpful in deciding this
case. In Fremlin v. R., 2002 G.S.T.C. 65 at 65-8 to
65-9, I referred to these cases and outlined the approach
which I followed and which I believe was consistent with the
Federal Court of Appeal decisions.
30 I turn then to a consideration of whether
the appellants have
exercised the degree of care, diligence and skill that a
reasonably prudent person would have exercised in
comparable circumstances.
31 There have been numerous cases involving
directors' liability
under
section 323 of the Excise Tax Act and section 227.1 of
the
Income Tax Act. Two recent cases in this court reviewed
the decisions of the Federal
Court of Appeal and noted the
less stringent test
enunciated in that court.
32 In Mosier v. R., [2001] T.C.J. No.
692 (T.C.C. [General
Procedure]), I dealt with a director of a company whose
finances were completely controlled by
the bank. At paragraphs 33-35 the
following appears
[33] One has to ask: what could he have done that he did not
do? The answer is absolutely nothing. The case is in some ways
reminiscent of Holmes v. R., [2000] 3 C.T.C. 2235, where the
directors were unable to ensure that the CCRA be paid because the
company's finances were completely controlled by their
supplier. At pages 2241-2242 I referred to an earlier decision as
follows.
I set out in Cloutier v. Minister of National Revenue (1993),
93 D.T.C. 544 (T.C.C.) at pp. 545-6, my approach in these
cases.
The question therefore becomes one of fact and the court must
to the extent possible attempt to determine what a reasonably
prudent person ought to have done and could have done at the time
in comparable circumstances. Attempts by courts to conjure up the
hypothetical reasonable person have not always been an
unqualified success. Tests have been developed, refined and
repeated in order to give the process the appearance of
rationality and objectivity but ultimately the judge deciding the
matter must apply his own concepts of common sense and fairness.
It is easy to be wise in retrospect and the court must endeavour
to avoid asking the question "What would I have done, knowing
what I know now?" It is not that sort of ex post facto judgement
that is required here. Many judgement calls that turn out in
retrospect to have been wrong would not have been made if the
person making them had the benefit of hindsight at the time.
Section 227.1 is an example. That section imposes a
standard of care on directors that requires reasonable prudence
and skill in ensuring that the money raised through the SRTC
program be in fact used for scientific research or else that the
Part VIII tax be paid either out of the money so raised or
otherwise. In determining whether that standard has been met one
must ask whether, in light of the facts that existed at the time
that were known or ought to have been known by the director, and
in light of the alternatives that were open to that director, did
he or she choose an alternative that a reasonably prudent person
would, in the circumstances, have chosen and which it was
reasonable to expect would have resulted in the satisfaction of
the tax liability. That the alternative chosen was the wrong one
is not determinative. In cases of this sort of failure to satisfy
the Part VIII liability usually results either from the making of
a wrong choice in good faith, or from deliberate default or
wilful blindness on the part of the director.
I find as a fact that there is nothing that Mr. and
Mrs. Holmes could reasonably have done to prevent the
failure. They struck me as decent, honourable people who did all
they could to ensure that the corporate obligations were
fulfilled, but the economic circumstances rendered that
impossible.
[34] This approach is one that I have followed in other cases
and one that is, I believe, consistent with the series of cases
in the Federal Court of Appeal which have invariably modified the
more stringent standards applied in this court. The cases in the
Federal Court of Appeal to which I am referring are The Queen v.
Corsano et al. (supra), Worrell v. R., [2000] G.S.T.C. 91, Smith
v. The Queen, 2001 D.T.C. 5226, Cameron v. The Queen, 2001 D.T.C.
5405, and Soper v. The Queen, 97 D.T.C. 5407.
[35] I need not quote from them. They stand for the
proposition that section 227.1 of the Income Tax Act and
subsection 323(3) of the Excise Tax Act require only that
directors act reasonably. They do not demand the impossible. I
have no hesitation in following that approach.
[16] I revert then to the question "what
could Mr. McKinnon reasonably have done to prevent the
failure?" The single most significant contributing factor was the
wholly unexpected refusal of Rideau to pay the agreed amount.
Mr. McKinnon instructed his lawyer to proceed with legal
actions but this is time consuming and expensive and was met with
stonewalling, prevarication and arrogance by Rideau and its
lawyers. Mr. McKinnon did all he could to keep the company
afloat and ensure that its obligations were met. I regard the
Canada Customs and Revenue Agency's stock response of "You should
have pulled the plug and let the whole business go down the
drain" as neither commercially realistic nor morally defensible.
It implies that a person, such as Mr. McKinnon, who has put
all he owns and all his time into the creation of a business can
simply walk away from it and abandon all he has built up and
leave his employees and their families in the lurch. If everyone
did this it would mean that many more businesses that manage to
survive would simply fold as soon as the going gets rough.
[17] These cases are usually difficult. We
start from the irrefutable fact that the payroll deductions or
goods and services tax were in fact not remitted and so the CCRA
looks to the directors. If one is so minded it is as a rule
easier to dismiss an appeal by a director than to allow it.
Frequently the director who is assessed is in difficult financial
straits, cannot afford a lawyer and attempts to represent himself
or herself. It is easy for the CCRA or the judge, with the
benefit of hindsight, to tell the director all of the things he
should have done. Here the CCRA is telling Mr. McKinnon "you
should not have gotten into the business in the first place and
once in it you should have gotten out sooner" I dare say that
might have prevented the failure but everyone, including the
government would have lost. That course of action would have been
unreasonable.
[18] Another argument that is frequently
made in these cases and which I regard as fallacious runs
somewhat as follows: "You were stealing from money held in trust
for the Crown to run your business and pay your employees". This
is, I think, an inaccurate and unfair characterization. It
implies that there is a separate account (or cookie jar if you
will) into which the payroll deductions are put and then
withdrawn to pay the company's expenses. The fact is there is no
cookie jar, real or notional, and no money to put into it even if
there were. The net amount paid to the employees is all there is
to go around. The employees, suppliers and other creditors are
paid because if they are not the business will be closed down.
Where, as here, unforeseen supervening events make it impossible
for the payroll deductions to be paid to the government, I do not
think there is anything the appellant could reasonably have done
to ensure the payment.
[19] The appeal is allowed and the
assessment is vacated.
[20] The appellant is entitled to his costs,
if any.
Signed at Montréal, Quebec, this 3rd day of
December, 2003.
A.C.J.
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