Edmondson v. MNR, 88 DTC 1542, [1988] 2 CTC 2185 (TCC)

Brule, T.C.J.: —By notice dated September 3, 1986 the Minister assessed the appellant under subsection 227.1(1) of the Income Tax Act ("Act") for tax and penalty, and interest thereon in the amount of $24,772.02 in respect of the failure by Ultra Collision Repairs (1983) Ltd. to remit deductions of income tax withheld from employees' wages under section 153 of the Act.

Facts

The appellant, who had no previous business experience, invested the sum of $30,000 in Ultra Collision Repairs (1983) Ltd. (the "Company") on the advice of his son-in-law who was the Company auditor. These funds were borrowed and were needed before the bank would refinance the operation. The appellant became a director but had no idea of any duties or obligations attaching to such an office. He was not signing officer, never went to the Company offices nor attended any directors' meetings, if in fact any were held.

During the early months of 1984 the auditor, Mr. Rothwell, believed everything was in order including payments to Revenue Canada. In May or June of that year Mr. Rothwell was asked to examine the Company books and realized there were problems. He discussed the matter with his father- in-law, the appellant, sometime in the summer of 1984. It was learned that Revenue Canada made a demand for arrears in remittances. At no time did the son-in-law discuss with the appellant his potential personal liability as a director under subsection 227.1(1) of the Act.

The Company, including the payment of accounts, had been under the supervision of a Kim Jennings, one of the principals involved. The management of the company had been entrusted to him.

In September 1984 the appellant was made aware that there existed serious difficulties and that Revenue Canada had to be paid. He proceeded to raise funds by mortgaging his home for $70,000, paying off the original $30,000 loan and injecting another $40,000 into the Company. Revenue was paid. As a consideration for doing this the appellant insisted on co-signing all cheques and having his daughter, an experienced bookkeeper, work for the Company.

In February 1985 the daughter advised her father that Revenue Canada was looking at the Company books. In March 1985 it was learned that certain cheques made out to Revenue Canada by the appellant's daughter and cosigned by him were found in jenning's desk, not having been remitted to Revenue Canada.

Subsequent to this the Company filed a proposal to its creditors pursuant to the Bankruptcy Act but the proposal was rejected and a bankruptcy ensued. The appellant was then assessed giving rise to this appeal.

Analysis

The appellant's counsel pleaded the provisions of subsection 227.1(3) of the Act. He also brought forward to the Court the possibility of relying on the interpretation of paragraph 227.1(2)(c), a Charter of Rights argument and an error made by the Minister in his notice of confirmation.

The Minister's counsel argued that the appellant had not exercised the degree of care, diligence and skill required by a director as expressed in subsection 227.1(3) to avoid liability. He also stressed the absence of a special trust account or the money being held in trust as required by the Act.

I do not think it is necessary to deal with any other provision than the exempting subsection of 227.1(3) which reads as follows:

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.

A brief summary of how this subsection became a part of income tax legislation can be found in the case of Denis John Cybulski v. M.N.R., [1988] 2 C.T.C. 2180 wherein Christie, A.C.J. of the Tax Court of Canada refers to the position at common law of a director regarding the basic requirements of care and skill imposed on a director.

He quotes from Canadian Business Corporations by lacobucci, Pilkington and Prichard 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, affd [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.

Recently there have been several cases dealing with this particular subsection 227.1(3). They are:

Barnett v. M.N.R., [1988] 2 C.T.C. 2336; 85 D.T.C. 619

Walters v. M.N.R., [1986] 2 C.T.C. 2327; 86 D.T.C. 1740

Fraser v. M.N.R., [1987] 1 C.T.C. 2311; 87 D.T.C. 250

Quantz v. M.N.R., [1988] 1 C.T.C. 2276; 88 D.T.C. 1201

Beutler v. M.N.R., [1988] 1 C.T.C. 2414; 88 D.T.C. 1286

Wilson v. M.N.R., (March 7, 1988) (not yet published)

Cybulskiv. M.N.R., [1988] 2 C.T.C. 2180

Moore v. M.N.R., [1988] 2 C.T.C. 2191

In the Wilson case, supra, Kempo, J. said, "the appellant's purported answer to any liability in this matter rests on an almost exclusively subjective approach to subsection 227.1(3) exculpation".

Revenue Canada, Taxation in its directive of October 6, 1987, suggests that directors must take positive action to prevent the failure of the corporation to deduct, withhold and remit if they wish to rely on the defence provided in subsection 227.1(3).

The directive goes on to say that a high degree of vigilance is required before directors can rely on the "due diligence” defence.

In the present case the appellant who was completely unsophisticated in corporate management had the good sense, after Revenue Canada had been paid arrears and before putting additional funds into the Company, to insist on being a co-signer on all cheques and in having his daughter placed in the position of bookkeeper.

One would believe that these safeguards, both positive steps, would be sufficient to insure that moneys required to be withheld would be paid to Revenue Canada. The deceit of Jennings in not mailing the cheques frustrated the steps taken by the appellant.

In the 23rd edition of Palmer's Company Law there is set out at page 888:

A director is not to be held responsible for the fraud of his co-directors, unless he has expressly or impliedly authorised it.

As authority for this statement there is offered the case of Cargill v. Bower (1878), 10 Ch.D. 502.

As to Jenning’s act of not forwarding the cheques to Revenue Canada being "fraud", such was intended to deceive, and in the Oxford English Dictionary fraud is defined to include “to cheat or deceive” and "to withhold (something) fraudulently".

On the basis of the evidence it can be concluded that Jennings acted fraudulently in relation to the actions of the appellant.

The Minister’s counsel set out that because the appellant was not familiar with a director's duties and potential personal liability this was no excuse.

In the Cybulski case, supra, Christie A.C.J. said:

In my opinion the principle that ignorance of the law is no excuse [1] can have no application here. 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 the 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.”

There was no dispute in this case that the appellant was completely unaware of a director's duties. He considered himself only an investor and only took protective action when almost forced to do so.

Based on all the facts I believe that the appellant can bring himself within the exempting provisions of a director's liability as set out in subsection 227.1(3) and accordingly this appeal is allowed and the matter referred back to the Minister of National Revenue for reconsideration and reassessment.

The appellant is entitled to his costs on a party-and-party basis.

Appeal allowed.