Swertz v. MNR, 90 DTC 1056, [1990] 1 CTC 2160 (TCC)

Goetz, T.C.J.:— This appeal relates to a notice of assessment dated September 13, 1984 for the appellant's 1982 taxation year in respect of the appellant's alleged liability under subsection 227.1(1) of the Income Tax Act claiming the sum of $61,578.63 with respect to federal tax, penalties and interest. The notice of assessment stated that it is in respect of:

Liability under subsection 227.1(1) of the Income Tax Act for $83,854.53 being the amount of unpaid deductions, interest and penalties payable by Swertz Bros. Construction Ltd. in respect of a Notice of Assessment dated November 30, 1982.

On November 30, 1982, a notice of assessment was issued against the company (which was then in receivership) in the amount of $83,854.33 including interest and penalties, for failure to remit employee source deductions. On March 1, 1984 a Certificate, No. ITA 895-84, for unpaid taxes, interest and penalties of $72,465.21 was filed with the Federal Court of Canada and an undated writ of fieri facias was registered and filed with the Weyburn Sheriff's Office in respect of the March 1, 1984 Certificate for $72,465.21.

The issue to be determined is whether the appellant as a director of Swertz Bros. Construction Ltd. is liable for taxes, penalty and interest under subsection 227.1(1) of the Act. Maurice Swertz was the president and sole shareholder of Swertz Bros. Construction Ltd., a construction firm that had expanded through western Canada. The company had obtained a line of credit by way of a demand debenture in the amount of $2,000,000 on May 16, 1975. This was a floating charge with personal guarantees. Associated companies as well were hypothecated to the Canadian Imperial Bank of Commerce. The business was subject to fluctuations in the market and especially in the spring of 1982 no houses were being built or sold due to high interest rates.

In May and June 1982, accounts receivables amounted to $450,000 and $590,000 respectively. In June, the receivables were less than the payables and Mr. Swertz borrowed $25,000 personally from the Royal Bank and deposited it to the company account on June 30, 1982. The bank had always stood behind the company when there were “slumps in the market". The bank manager kept in constant touch with the appellant and stated that interest payments would be deferred until April 1,1983 at which time the bank would reconsider its position. Mr. Swertz said: "I took them for their word".

From May 1982, the local bank manager came to the company office every day and would inquire and was appraised of what cheques were required to pay accounts and how much was receivable. At no time during this period did the bank manager intimate to the appellant that the company was in trouble as far as the bank was concerned.

The appellant’s wife, Colly Swertz, was the office manager who was in charge of the accounting department and she made the cheques that would be signed at the end of the day after ascertaining that there were sufficient funds to do so. With every payroll cheque there would be a deduction recorded on the books of the company and the company was in the habit of paying to Revenue Canada the payroll deductions by the fifteenth of the following month and if the fifteenth fell on a holiday or a Sunday, the deductions would be made and paid the previous business day. Mrs. Swertz says that when money was tight "we were in the habit of having the payroll of Revenue Canada cheques certified", which she did personally.

On Friday, the thirteenth of August 1982, the bank manager contacted the appellant advising that a receiver would be in the office at one o'clock. At exactly 1:00 p.m. the receiver and the bank manager attended the office asking whether the appellant company could pay the amount owing on its line of credit which at this point in time amounted to $3,000,000 covering all the subsidiary companies. The bank manager on being advised that the company could not pay off its indebtedness, took the appellant's keys and asked him to leave and stated that he and the receiver were in charge of the company. The appellant cleaned out his desk and left.

Payroll deductions were not placed in a separate account from the company's general account and although Revenue Canada had made several audits on the company, at no time did the auditor advise that a separate account for payroll deductions should be maintained. Evidence showed that $74,000 had been deposited in the bank on August 12, 1982 and that there were sufficient funds at that point in time to have the payroll deduction cheque payable to Revenue Canada certified. The intervention of the bank and the receiver, he says, precluded this as he was stripped of all authority.

Findings:

The respondent seeks to establish liability on the appellant to pay penalties and interest and payment personally of unremitted payroll deductions pursuant to the provisions of subsections 227.1(1) and (2) which provide that:

(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.

(2) A director is not liable under subsection (1), unless

(a) a certificate for the amount of the corporation's liability referred to in that subsection has been registered in the Federal Court of Canada under subsection 223(2) and execution for such amount has been returned unsatisfied in whole or in part;

(b) the corporation has commenced liquidation or dissolution proceedings or has been dissolved and a claim for the amount of the corporation's liability referred to in that subsection has been proved within six months after the earlier of the date of commencement of the proceedings and the date of dissolution; or

(c) the corporation has made an assignment or a receiving order has been made against it under the Bankruptcy Act and a claim for the amount of the corporation's liability referred to in that subsection has been proved within six months after the date of the assignment or receiving order.

Counsel for the respondent further contended that the appellant was liable by virtue of the provisions of subsection 227(5) which reads:

(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.

He virtually rested his position on subsection 227(5).

The appellant, on the other hand, argues that subsection 227.1(3) relieved the appellant from the vicarious liability imposed by subsection 227.1(1). Subsection 227.1(3) reads as follows:

Sec.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 appellant operated on an extended line of credit with the Imperial Bank of Commerce since 1975 and although its business was cyclical, the bank exerted no pressure on the company when the ratio between the receivables and payables was very tight. This was the business climate under which the appellant operated until August 13, 1982.

On that date sole and effective control passed to the receiver and the appellant was excluded from any direction or control of the company operations. There was no formal resignation and the Minister relies on the provisions of section 103 of the Business Corporations Act which requires a written resignation be sent to the corporation on the resignation of a director. On the other hand, section 91 of the Business Corporations Act reads as follows:

91. If a receiver-manager is appointed by the Court or under an instrument, the powers of the directors of the corporation that the receiver-manager is authorized to exercise may not be exercised by the directors until the receiver-manager is discharged.

The appellant being the shareholder and director of the company can be forgiven for being unaware of the intricacies and niceties of the Business Corporations Act in not writing his company (himself) a letter of resignation.

To all intent and purposes, once the receiver stepped in on August 13, 1989, he had no further opportunity to oversee the operation of the company. In the recent decision of Denis John Cybulskiv. M.N.R., [1988] 2 C.T.C. 2180; 88 D.T.C. 1531, at page 2185 (D.T.C. 1535) said:

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 and, in particular, it is not a requirement in the circumstances of this appeal.

The degree of care, diligence and skill to be exercised by a director under subsections 227(1) and (3) is that of a reasonably prudent person having due regard to all the circumstances in the conduct of the affairs of The Company v. The Appellant. The company had carried on the construction business since 1957 and had never in all that time failed to remit payroll deductions to the Minister on or before the fifteenth day of the month immediately allowing the month for which the deductions were made in accordance with requirements of subsection 227(9).

Subsection 227(9) provides that remittances shall be made on the fifteenth day following the month in which the source deductions relate. The testimony indicates that August 15, 1982 fell on a Sunday and that in such a case, remittances would be normally made in the afternoon of the preceding Friday. The appellant was ousted Friday morning by the receiver and was powerless to do anything further by virtue of the receivership documents and section 91 of the Business Corporations Act.

The decision not to pay Revenue Canada Taxation was the decision of the receiver and the Canadian Imperial Bank of Commerce. When the appellant learned of the failure to make Revenue Canada remittances he was not in a position to affect matters.

It is no coincidence that the bank manager of Canadian Imperial Bank of Commerce brought in the receiver at 1:00 p.m., August 12, 1982 knowing that the appellant was about to certify the cheques covering the payroll deductions (as he had done the previous month).

There were sufficient funds in the bank at this crucial time to remit the payroll deductions cheque.

Counsel for the Minister relied heavily on the provisions of subsection[s] 227(4) and (5) but did not plead these subsections or the fact that the appellant failed to keep payroll deductions in a separate trust account. Further the assessment only alludes to subsection 227.1(1) which only refers to the liability of a director for failure to deduct and remit as required by section 153.

As Rand, J. stated in Johnston v. M.N.R., [1948] S.C.R. 486; [1948] C.T.C. 195; 3 D.T.C. 1182, at page 203 (D.T.C. 491):

It must, of course, be assumed that the Crown, as is its duty, has fully disclosed to the taxpayer the precise findings of fact and rulings of law which have given rise to the controversy.

In an “Overview of Income Tax Litigation” by Hugh F. Gibson, Q.C. 83 C.R. 967 at 971 the author states that:

In sum, therefore, the assumptions of fact which the Minister, the Crown, may assume in pleadings and in respect of which the taxpayer has the onus to demolish, that is, one or all of them, may be found in the following documents, and are set out in them and are part of the record for the Court to consider: (1) the notice of assessment and the T7W accompanying the assessment; (2) the notice of objection; and (3) the notice of confirmation. Any other facts assumed by the Minister, the Crown, that are not found in those documents and therefore are not part of the record at trial, must be pleaded and proved by the Minister, the Crown.

[Emphasis added.]

The obligation to keep funds separate and apart are not referred to in subsection 227.1(1) in any event. The respondent has failed to discharge the onus of establishing that the appellant failed to keep source deductions separate and apart in a trust account and cannot incorporate subsection 227(5) with subsection 153(1).

I have carefully considered the decisions in Fancy v. M.N.R., [1988] 2 C.T.C. 2256; 88 D.T.C. 1641, and Merson v. M.N.R., [1989] 1 C.T.C. 2074; 89 D.T.C. 22 which have been of weighty relevance in reaching my conclusion that from the facts of the case at bar that the appellant exercised due care, diligence and skill in dealing with payroll deductions as a reasonably prudent person.

The appeal is allowed, and the matter referred back to the respondent for reconsideration and reassessment. The appellant is awarded party-and-party costs.

Appeal allowed.