Fraser v. MNR, 87 DTC 250, [1987] 1 CTC 2311 (TCC)

Bonner, T.C.J.:—This is an appeal by the Trustee in Bankruptcy of the Estate of Harold Fraser from an assessment under subsection 227.1(1) of the Income Tax Act of Mr. Fraser's liability as director of Kemac Inc. (hereinafter “Kemac”). Subsection 227.1(1) reads:

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.

The appellant relied primarily on the defence provided by subsection 227.1(3) which reads:

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 respondent based his assessment on findings of fact which included the following:

(a) at all material times, the Appellant (Mr. Fraser) was a shareholder, director, and vice-president of Kemac Inc., which corporation formerly was 461263 Ontario Limited;

(b) Kemac Inc. was, at all material times, liable to pay to the Receiver General of Canada the sum of $16,659.95 of federal income tax withheld from payments of wages and salaries to its employees for the months of December, 1981 through May 1982, inclusive, and not remitted as and when required under the Income Tax Act, plus related penalty and interest thereon;

(f) at no time did Kemac Inc. keep tax withheld from payments of salary and wages separate and apart from its own monies;

(g) the Appellant was a person who was a Director of Kemac Inc. at the times when it was required to remit employee source deduction of tax as required by the Income Tax Act, which that corporation has failed to remit and which, at 18 April, 1984, being the date the Appellant was assessed, totalled at least $25,334.11.

Kemac was incorporated in November of 1980 under the laws of Ontario. Shortly after the incorporation Mr. Fraser became a director of the company and was appointed vice-president of manufacturing operations. He held 15 of the 100 issued shares of the capital of the company. He was responsible for securing the raw material required for the company's manufacturing operations and for the production and shipping of its products. Mr. Fraser had signing authority with respect to Kemac's bank account, but he exercised it only once.

There were two other directors of the company, a Mr. Foster and a Mr. Bolton. The former was president of the company and held 48 per cent of the issued share capital. The latter was treasurer of the company and held 37 per cent of the issued share capital. Mr. Bolton was a chartered accountant who worked on a full-time basis with an accounting firm and came into Kemac’s plant twice a month to sign documents and cheques. He and Mr. Foster were the persons primarialy responsible for the issuance of cheques.

Late in 1981 Kemac entered into a contract with the Post Office for the manufacture of certain goods. Mr. Fraser stated that the Post Office took months to pay its bills and that as a result the Company ran into a cash-flow problem and began to experience difficulties in securing raw materials and meeting its payroll. It was in March of 1982 that Mr. Fraser first became aware of those financial difficulties. At that time he also discovered that there were income tax problems. Mr. Fraser stated that he happened to be in the office when a National Revenue official came in and “. . . raised quite a ruckus and was threatening to close the gates of the plant unless he got paid”. Mr. Fraser made enquiries of Messrs. Foster and Bolton as to the nature of the problem. He was informed that there were arrears with Revenue Canada and was told not to worry because they were looking after the financial side of the company and would look after the problem. Mr. Bolton told Mr. Fraser that a $30,000 payment for a job completed the previous month would be used. Mr. Fraser did not raise the matter again until sometime in May of 1982 at the time when the business was closing. He was assured for a second time that the receivable would be used to pay the taxes. At no time did Mr. Fraser attempt to learn the exact nature of the indebtedness. All he knew was that . . some taxes (were) owing to the government".

Mr. Fraser was asked what steps he took to ensure that all proper payments were made to the government. His response was that there were no steps which he could take on his own, that he asked Messrs. Foster and Bolton,

. . . what the situation was and was it being looked after, and I was assured by both of them and Mr. Bolton, our financial man, that the job I had completed for Halolight, which was valued at $30,000.00, that this $30,000.00 was going to be paid to the federal people to look after this tax problem and not to worry. That’s the way I left it.

Mr. Youngman submitted that a director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge or experience. In this regard he referred to Re City Equitable Fire Insurance Company, [1925] Ch. 407. He pointed out that Mr. Fraser's expertise was in manufacturing and not in accounting or finance. He submitted that by making enquiries of the president and of the treasurer, a chartered accountant, Mr. Fraser had done all that was necessary to fulfill his obligations as a director. He argued that Mr. Fraser was entitled to rely on statements made by the other two directors, that he had no reason not to trust them and that he was not in a position, because of his lack of knowledge, to examine the books of the company in order to determine whether he was being told the truth. Finally, he argued that because Mr. Fraser had no knowledge of the financial affairs of Kemac he was not in a position to give any instructions regarding the payment of creditors. He was in a position only to make enquiries, he had done just that and, in doing so, had fulfilled his duties as director and brought himself within the ambit of subsection 227.1(3).

Section 227.1 effectively imposes a duty on directors to ensure that the corporation performs the obligations listed in subsection (1). It does so by making them vicariously liable for any failure of the corporation to perform and by creating a defence for those who exercise the requisitie degree of care, diligence and skill to prevent the failure. It is not necessary to a decision in this appeal to attempt to set down in a general way what must be done to meet the standard of care required by subsection (3). The central fact in this case is that Mr. Fraser did absolutely nothing to prevent a failure. The directors of Kemac who, under subsection 130(1) of the Business Corporations Act, R.S.O. 1980, c. 54, were under a duty to “.. . manage or supervise the management of the affairs and business of the corporation . . .” did not pass any resolution or exercise any power vested in them as directors with a view to ensuring compliance with the requirements of the Income Tax Act relating to source deductions. Mr. Fraser did not at any time urge them to take any such action. Even after the March 1982 "ruckus", when the existence of a problem came to his attention, he made no attempt to prevent further defaults. He complacently accepted an assurance that the prior default would be rectified and did nothing further. It was not suggested that he was assured that no future default would be permitted.

Subsection 227(5) of the Income Tax Act requires that:

227(5) All amounts deducted or withheld by a person under this Act shall be kept separate and apart from his own moneys and in the event of any liquidation, assignment or bankruptcy the said amounts shall remain apart and form no part of the estate in liquidation, assignment or bankruptcy.

The company did not keep source deductions separate from its own funds. It seems unlikely that a failure to remit would have occurred if subsection 227(5) had been complied with. Mr. Fraser impressed me as an intelligent man. Although his expertise lay in the field of manufacturing operations I cannot believe that he did not possess the skill and ability necessary to formulate policies required to ensure that Kemac was at least discharging its obligations under subsection 227(5). This is not a case in which a director is forced to rely on other directors or officers or subordinate employees because those others possess skills which he does not. Mr. Fraser did not make an unsuccessful attempt to prevent default. He simply did not try.

Mr. Fraser was unaware of the requirements of sections 153 and 227 of the Income Tax Act and that is why he did nothing. However, subsection 227.1(1) of the Act imposes liability on ".. . the directors of the corporation . . . and not just on those directors of the corporation who are aware of the requirements of the Act.

The presence on the Board and in the office of treasurer of a person capable, if so inclined, of preventing default is not, standing alone, sufficient to afford the appellant subsection (3) protection. Mr. Bolton was not given any special responsibility for or direction to comply with the source deduction requirements of the Income Tax Act. Internal arrangements are a circumstance to be taken into consideration in an appropriate case. Subsection (3), however, does not assist those whose only excuse is that others had a better opportunity to prevent failure than they did.

Mr. Youngman advanced what he called a secondary argument. He submitted that a taxpayer “. . . is entitled to a certain amount of accuracy on the part of Revenue Canada . . .” and pointed to the fact that the June 1982 assessment against Kemac and a November 1983 demand letter written by Revenue to the appellant referred to amounts of tax owing by Kemac which were different from each other and greater than the amount finally assessed against Mr. Fraser. Mr. Youngman suggested that the assessment ought to be vacated on the grounds of inaccuracy and uncertainty in the amount of the assessment. He did not suggest that the figure assessed against Mr. Fraser was incorrect nor that the conditions precedent laid down by subsection 227.1(2) had not been met. He cited no authority in support of his argument. The basic issue in an appeal from an income tax assessment is whether the tax assessed is too high. Mere confusion among Revenue officials is no ground for tampering with the assessment. There is no evidence that the assessment now in question is too high and there is therefore no basis for disturbing it.

For the foregoing reasons the appeal will be dismissed.

Appeal dismissed.