Citation: 2006TCC480
Date: 20060911
Docket: 2002-281(IT)G
BETWEEN:
BRUNO HARTRELL,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Paris, J.
[1] This is an appeal from an assessment made under section 227.1 of the Income Tax Act[1], (the "Act"). The Appellant was assessed on the basis that he was a director of the Toronto Lynx Soccer Club Inc. (the "Lynx") at the time the Lynx failed to remit source deductions of income tax totaling $88,022.51 to the Receiver General in 1998 and 1999.
[2] The Appellant takes the position that he was never a director of the Lynx and therefore is not liable for the unremitted source deductions. In the alternative, the Appellant argues that if, at any point, he did become a director of the Lynx, he exercised due diligence to prevent the failures to remit that occurred. He also submitted that the amount of the assessment should be reduced to take into account certain GST refunds owing to the Lynx in respect of periods prior to 2000.
[3] The Respondent admits that the Appellant never formally became a director of the Lynx, but says that at all times the Appellant was a de facto director. The Respondent also takes the position that the Appellant failed to exercise due diligence to prevent the failure to remit. Finally, the Respondent says that the amounts assessed are correct, and that there are no outstanding GST refunds available to the Lynx that could offset any of the income tax remittances that are owed.
[4] For the reasons that follow, I conclude that:
1) the Appellant was a de facto director of the Lynx throughout 1998 and 1999;
2) the Appellant has failed to show that he exercised due diligence to prevent the failures to remit that occurred in 1998;
3) the Appellant did exercise due diligence with respect to the failures to remit that occurred in 1999; and
4) the Appellant has failed to show that the amount of the Lynx's liability for unremitted source deductions was less than the amounts for which he was assessed.
Facts
[5] The Appellant is a chartered accountant who has practiced in the Toronto area since 1976. He became involved in the Lynx through one of his clients, Fiorenzo Iantorno. Mr. Iantorno and his spouse owned a company who had been a client of the Appellant since approximately 1990.
[6] In the early 1990's Mr. Iantorno became interested in acquiring and operating a professional soccer franchise for Toronto. In 1996 he approached the Appellant and another business acquaintance, Bruno Tasan, to invest in an A League franchise that had become available from the American Professional Soccer League.
[7] It is unclear from the evidence what form of participation in the franchise Mr. Iantorno proposed to the Appellant and Mr. Tasan. No written agreement was drafted. The intended arrangement was referred to in subsequent documents variously as a joint venture or limited partnership. On a number of occasions the Appellant and Mr. Iantorno referred to themselves as partners in the business or owners of the Lynx[2].
[8] In September 1996, the Appellant, Mr. Iantorno and Mr. Tasan each contributed $32,500 to a company set up by Mr. Iantorno called "Hit Pro Soccer Inc." The "Hit" of Hit Pro was taken from the first letter of the last names of the Appellant (Hartrell) Iantorno and Tasan. Hit Pro used the money to acquire the franchise and to fund the initial set up of the team.
[9] In April 1997, the Lynx was incorporated by a lawyer, Jack Rosati, who was a neighbour and friend of Mr. Iantorno. According to Mr. Rosati, he received the instructions to set up the Lynx from both Mr. Iantorno and the Appellant. Mr. Iantorno said that the decision to incorporate the Lynx would have been made by all three of the "partners" (i.e. the Appellant, himself and Mr. Tasan) and that he would not have made the decision on his own. The Appellant, on the other hand, testified that he was not advised of the incorporation of the Lynx and that he did not give any instructions to Mr. Rosati regarding the incorporation.
[10] I accept Mr. Rosati's evidence that the Appellant took part in the discussions which preceded the incorporation of the Lynx. I find it difficult to accept that the Appellant was not aware of the incorporation, especially given that he became a signing officer on the Lynx's bank account within weeks of the Lynx being set up, and given the degree of his involvement in the organization and operation of the Lynx.
[11] Mr. Rosati listed himself as the first director and incorporator of the Lynx and in May 1997 sent a letter to the Lynx's office, to the attention of Mr. Iantorno, seeking instructions to complete the organization of the company and to prepare the "limited partnership agreement". No instructions were provided to Mr. Rosati and therefore no shares were ever issued and no directors were appointed to replace him.
[12] Mr. Rosati testified that he was not aware that the company began operating and said that if he had known he would have insisted on being replaced as a director.
[13] Mr. Iantorno opened the Lynx bank account on April 1, 1997 and represented himself, the Appellant and Mr. Tasan as directors and as the president, treasurer and secretary, respectively, of the company. Each of the three was a signatory to the account, but it appears that the signature card for the account was signed by them on April 18, 1997. There was no evidence that the Appellant ever saw the forms filled out by Mr. Iantorno listing him as a director, and no evidence that the Appellant ever represented himself to the bank as a director. From April 1997 on, advances made by the parties to fund the team were made to this account.
[14] The Lynx played their first season in 1997, but did very poorly financially. By the end of 1997, the Appellant and Mr. Iantorno had each advanced over $300,000 and Mr. Tasan approximately $170,000 to fund the team. At this point Mr. Tasan advised Mr. Iantorno and the Appellant that he could not provide any further funding.
[15] Despite the Lynx's dismal financial performance, the Appellant testified that he felt the team's finances could be turned around. He, along with Mr. Iantorno, therefore agreed to continue to fund the team.
[16] The Lynx's 1998 season proved equally unsuccessful and the Appellant and Mr. Iantorno, each lost another $230,000.
[17] During 1998, the Lynx failed to remit income tax of $47,434.36 withheld from wages paid to its employees. The Appellant testified that an error in the Lynx's bookkeeping system led to the failure. He said that the accounting software used by the bookkeeper, Gus Koudounis, tracked payroll deductions on a monthly basis rather than a bi-weekly basis, and since the Lynx paid its employees bi-weekly, the system only recorded one-half of the payroll remittances that were in fact due. The Appellant said that the problem only came to his attention at the end of the year when the T-4 slips were being prepared. The bookkeeping procedures were then corrected and the subsequent remittances made on a timely basis but it appears that nothing was done to pay the shortfall that had already accumulated. The Appellant testified that he prepared 10 post-dated monthly cheques to pay the arrears, the first of which was dated July 1999. According to the cheque numbers, these cheques would apparently have been sent to Canada Revenue Agency in May or June 1999.
[18] In August or September 1998, Nicole Hartrell, the Appellant's spouse, took over as the office manager for the Lynx. The previous manager had become ill and quit while Mr. Iantorno and Mr. Tasan were out of town. Ms. Hartrell agreed to fill in until a replacement could be found. However, she remained in that position until the end of the 1999 season and even decided that she should be given the position of Chief Operating Officer of the company.
[19] Both the Appellant and Mr. Iantorno testified that the working relationship between Mr. Iantorno and Ms. Hartrell became very strained in the early months of 1999. This, in turn, led to a deterioration in the working relationship between the Appellant and Mr. Iantorno. Much of their communication during this time appears to have been done in writing and a series of letters and notes between the Appellant and Iantorno were produced at the hearing. I will refer in more detail to the correspondence later in these reasons.
[20] According to the Appellant, Mr. Iantorno's dissatisfaction over Ms. Hartrell's role in the company led Mr. Iantorno to begin withholding the contributions he had agreed to make to fund the Lynx. Mr. Iantorno testified that he made the contributions to which he had agreed at the beginning of 1999, but that the Appellant asked for additional amounts beginning in May 1999 without giving him sufficient financial information to enable him to determine why they were required.
[21] According to the Appellant, by May 1999 it was clear that the Lynx were over budget, that its line of credit had been used up, and that additional capital was required from both himself and Mr. Iantorno. He said that they both agreed at that point that another $150,000 would be required to complete the season and that each would pay his share. The evidence shows that Mr. Iantorno was reluctant to make the payments and that, starting in mid-July, Mr. Iantorno was late in paying. Then, in mid-August, Mr. Iantorno decided he would not fund the team any longer. The Appellant was given no notice of Mr. Iantorno's decision and only became aware of it when salary cheques to the Lynx's employees began bouncing. The bank, which had up to this point allowed the Lynx's account to operate in overdraft, refused to honour any more cheques, including ones to the Receiver General for source deductions.
[22] In late August 1999, Mr. Iantorno instructed the bank to cash pay cheques for the Lynx's players (but not for Lynx's office staff) by pledging to cover the amount of the cheques personally. The Appellant tried to keep operations afloat by injecting more of his own money in order to pay employees' wages, stadium rent and supplier invoices, but said he did not have enough funds to cover the remittances that were due. He made several attempts to get Mr. Iantorno to contribute but Mr. Iantorno refused. According to the Appellant's calculations, by the end of the 1999 season (the Lynx's final game was in early September); he had paid in $240,000 more than Mr. Iantorno.
[23] In the hopes of salvaging something from the Lynx, the Appellant took over the franchise personally and operated it as a proprietorship in 2000. No details of the Lynx financial performance after 1999 were provided.
Analysis
[24] It is clear from the jurisprudence that de facto directors as well as de jure directors may be liable under section 227.1 of the Act for unremitted source deductions of income tax: see Wheeliker v. Canada[3] and McDougall v. Canada[4].
[25] In this case one of the assumptions relied upon by the Minister of National Revenue (the "Minister") in assessing the Appellant as a de factor director was that he "represented himself to be a director of the corporation". The Appellant denies ever having done so.
[26] The only evidence produced by the Respondent to counter this assertion was the banking document signed by Mr. Iantorno listing the Appellant as a Lynx's director. However, as I stated previously in these reasons, it was not shown that the Appellant was present when the form was signed or that he had knowledge of the representation that he was a director.
[27] However, in circumstances such as those in this case, where a corporation operates without having been properly organized and the only director of record plays no part in running the corporation, those persons who take it upon themselves to direct the affairs of the company may be held to be de facto directors, whether or not they have explicitly represented themselves as directors to any third party. The essential question is whether those individuals have, in fact, taken on the role of director of the corporation.[5]
[28] Therefore, the absence of any representation by the Appellant to a third party that he was a Lynx director is not conclusive of whether he was a de facto director. In my view the role played by the Appellant in the affairs of the corporation and the degree of responsibility he assumed in its direction and management are consistent with a finding that he was acting as a director of the corporation throughout the period in issue. I do not accept his evidence that he took no active part in the management and direction of the company prior to August 1999, and that he only did so at that point to fill the vacuum left by Mr. Iantorno's withdrawal. I am satisfied that the Appellant played a key role in the administration of the Lynx and that he, along with Mr. Iantorno, had ultimate decision making authority for the company from the date of its incorporation through to the end of 1999. It is apparent that the Appellant and Mr. Iantorno each intended to have an equal say in how the company was run and that the Appellant handled most of the company's financial matters and shared the oversight of the office administration with Mr. Iantorno. In short, I find that the Appellant was a directing mind of the company at all material times.
[29] There is ample evidence, in the form of letters and notes exchanged between the Appellant and Mr. Iantorno starting in December 1998, that the Appellant was very involved with the management and administration of the Lynx. This evidence runs directly contrary to the Appellant's assertions that he left these matters in the hands of Mr. Iantorno and the employees of the company (including his spouse).
[30] In that correspondence, the Appellant and Mr. Iantorno discussed in detail many of the day-to-day management issues facing the Lynx and shared ideas on how to improve the company's performance. The Appellant and Mr. Iantorno also criticized one another's actions and argued over the role played by the Appellant's spouse in the company.
[31] In a letter to the Appellant dated December 23, 1998, Mr. Iantorno wrote to the Appellant setting out concerns relating to the operation of the Lynx, including sales and marketing, financial record-keeping, liability for provincial sales tax and personnel matters. The Appellant responded on the same day, dealing with each of the ten points raised by Mr. Iantorno. Further discussion of the company's business appears in subsequent correspondence from which I have taken the following excerpts:
On January 21, 1999, the Appellant wrote to Mr. Iantorno:
You do have an equal say and we meet every Tuesday (this week was one of the few exceptions). Its [sic] easy to be negative. You should come to the meeting with positive ideas and strategies so that we can share them and implement them if they are practical. I think the important thing is not to get involved in every detail but rather deal with the broader more important issues and set the direction for the staff.
Speaking frankly as I have always done, it is my feeling that if we cannot repair the personal relationships we will have to contend with the breakup of the partnership.
(Exhibit A-1 Tab 20)
On February 13, 1999, the Appellant again wrote to Mr. Iantorno:
I am enclosing a list of the payables and receivables from 1998. In respect to 1999 the only significant outstanding payable which pertains to the 1999 taxation year is the balance of the League dues totaling approximately 16,500. Cdn. which we should pay around the end of February or early March.
In respect to the revenue, as you know there is a binder in the Lynx office where all of the invoices are kept. I will have Mike Hughson provide a cumulative total of ticket sales. We have received around $1,500 to date. The sponsorship and ads are in a binder as well. I will have J.P. prepare a cumulative total. There have been no receipts for sponsorships or ads to date.
(Exhibit A-1 Tab 21)
On April 21, 1999, Mr. Iantorno wrote to the Appellant:
As for my not attending meetings, I do not have the time or the patience to listen only to Nicole. You or Nicole do not take my input at the meetings into consideration. As a majority owner, I demand to have my input into what goes on and I also remind you that at this point, Nicole is an employee hired by yourself without my prior consent.
(Exhibit A-1 Tab 23)
On April 25, 1999, the Appellant wrote to Mr. Iantorno:
[at] our last meeting we agreed that certain objectives would have to be met by the organization as whole for Nicole to remain in her current position.
It is you who have chosen not to attend the weekly meetings so that if you have any questions or solutions, they can be dealt with.
I don't believe that given the current state of affairs that we will be able to settle all of the matters this week. In spite of your new "position" I faxed you on April 20th because we still have to deal with the day-today operations.
(Exhibit A-1 Tab 24)
On May 21, 1999, Mr. Iantorno wrote to the Appellant:
As an equal partner with you, I will not follow directions from Nicole if I feel that her actions will be detrimental to the Lynx. Policies are to be set by the partners and carried out by Nicole.
...
You suggested at a meeting to alternate the presidency. I have no reservation about this but all three partners should vote on it.
But it was you who decided to trade our forwards ... to Montreal during a game in 1998. You did this on your own without first consulting myself and/or the coach.
The same way I take responsibility for my "dismal" performance as president and general manager, you must take responsibility as chief financial officer and secretary/treasurer. As chief financial officer for the first two years you made most if not all of the financial decisions.
There has been irreparable damage caused by our differences in opinion, actions and management styles.
(Exhibit A-1 Tab 31)
On May 25, 1999, the Appellant wrote to Mr. Iantorno:
The owners will, by committee, hire the Chief Operating Officer who will be responsible for all of the areas of the club including the team. They will also hire a general manager with the necessary background and experience to carry out those duties. This position can be combined with the coach's position. Each area of the operations will be assessed and each area will receive the necessary staff in order to accomplish the objectives. The budget including cost and revenue goals will be set at the beginning of each year and the COO will report at least monthly at a committee meeting on the progress.
...
Since we "cleaned house" and established Nicole as the person in charge, only one person has left for personal family reasons.
Based on the prior two years you and I are approximately equal in the amount of ticket revenue generated by our personal contacts. The amount generated by myself and Nicole will double this year, as well as all of the ticket revenue from arms-length sources will double.
Either you or I will execute the contracts and no one else. You can continue to review Peter and Armando's choices for players but both of us must agree on the dollars to pay.
In respect to my role as Chief Financial Officer, I will respond to your vitriol when and if it becomes necessary. I have in practical terms resigned my post as CFO which includes Sec-Treas. We have hired Derek Stevens to take over as our CFO/Comptroller.
(Exhibit A-1 Tab 32)
On July 5, 1999, the Appellant wrote to Mr. Iantorno:
Your claim that you are not receiving any correspondence or messages must be an exaggeration. I am in the office every day and last week there were copies of A-League's memo in your mail box. In respect to your finding the lack of messages unusual, I would state the opposite. The majority of the previous correspondence and messages related to your duties as general manager. You resigned that post on June 1st. I can't think of any area where you have any significant active involvement, so I can't see why you would expect anyone to write or call you.
(Exhibit A-1 Tab 41)
On July 5, 1999, Mr. Iantorno wrote to the Appellant:
YOUR COMMENTS THAT YOU CANT THINK OF ANY AREA WHERE I HAVE ANY SIGNIFICANT ACTIVE INVOLVEMENT, AND WHY I WOULD EXPECT ANYONE TO WRITE AND OR CALL ME SHOWS AGAIN YOUR CHILDISH IMMATURE ACTIONS IN MAKING A BUSINESS PARTNERSHIP SUCCEED. I AGAIN MUST REMIND YOU THAT I AM AN OWNER OF THE TORONTO LYNX AND ALSO THE PRESIDENT. YOU AND THE C.O.O. NICOLE HARTRELL YOUR WIFE SEEM TO FORGET THAT OFTEN.
(Exhibit A-1 Tab 40)
[32] Proof of the Appellant's involvement in the direction and management of the Lynx is also found in a document prepared by Jack Rosati in early June 1999 following a meeting with the Appellant, Mr. Iantorno and Mr. Tasan. The purpose of the meeting was stated to be "to arrive at a general consensus in order to complete the [1999] Toronto Lynx soccer season". At paragraph 3 of his memorandum of the meeting, Mr. Rosati stated that:
Bruno Hartrell provided a general overview of the administration's efforts in the promotion and administration of the TorontoLynx. Although, success could not be guaranteed, Bruno Hartrell believes that a positive effort is being made and the results should improve from prior seasons...
[emphasis added]
(Exhibit A-1, tab 3)
[33] This demonstrates that the Appellant had oversight of the Lynx's administration and confirms the evidence of Mr. Iantorno concerning the Appellant's and Mr. Iantorno's respective roles in the company. I also note that the Appellant signed many of the cheques issued by the Lynx[6], had frequent contacts with the bank regarding the Lynx's account, participated in the preparation of the Lynx's budgets, and (along with Mssrs. Iantorno and Tasan) paid significant amounts of Lynx's operating expenses personally[7]. In addition, Derek Stevens testified that in his role as controller of the Lynx he had more frequent contacts and discussions with the Appellant than Mr. Iantorno.
[34] All of this leads me to conclude that the Appellant's uncorroborated testimony that he was only a passive investor in the Lynx (at least until August 1999) is not credible. I find that the assumptions made by the Minister that at all relevant times the Appellant performed the functions of a director of the Lynx has not been shown to be incorrect, and that the Appellant was a de facto director throughout the periods when the corporation failed to make remittances of income tax withheld from employees' wages.
[35] The Appellant also raised the issue of whether the Minister was required to offset certain refunds of GST to which the corporation was entitled at the time it failed to remit the source deductions. However, the Appellant admitted in cross-examination that the GST refunds in question were received by the corporation in August 2003 and used to pay an outstanding liability for provincial sales tax. There is no basis therefore upon which to conclude that the Minister's calculation of the corporation's liability was incorrect.
[36] The final issue in this appeal is whether the Appellant has made out a defence under subsection 227.1(3) of the Act which provides:
227.1(3) Idem - A director is not liable for a failure under subsection (1) where the director exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.
[37] In Soper v. The Queen[8], the Federal Court of Appeal held:
... The standard of care laid down in subsection 227.1(3) of the Act is inherently flexible. Rather than treating directors as a homogeneous group of professionals whose conduct is governed by a single, unchanging standard, that provision embraces a subjective element which takes into account the personal knowledge and background of the director, as well as his or her corporate circumstances in the form of, inter alia, the company's organization, resources, customs and conduct. Thus, for example, more is expected of individuals with superior qualifications (e.g. experienced business-persons).
The standard of care set out in subsection 227.1(3) of the Act is, therefore, not purely objective. Nor is it purely subjective. It is not enough for a director to say he or she did his or her best, for that is an invocation of the purely subjective standard. Equally clear is that honesty is not enough. However, the standard is not a professional one. Nor is it the negligence law standard that governs these cases. Rather, the Act contains both objective elements-embodied in the reasonable person language-and subjective elements-inherent in individual considerations like "skill" and the idea of "comparable circumstances". Accordingly, the standard can be properly described as "objective subjective".
[38] The Appellant had been a chartered accountant for 30 years at the time he became a director of the Lynx. He also admitted that he had been a director of four or five other corporations. In this case, the Appellant is an experienced business person and was an inside director involved in the day-to-day management of the company.
[39] Against this backdrop it is necessary to consider the circumstances which led to the failures to remit the income tax deductions. It appears that the failures to remit in 1998 were unconnected with the later failures starting in August 1999. I was provided with little information about the 1998 remittances which were not made. The Appellant's explanation that the problem with the remittances arose as a result of a problem with the reporting system used by the company's bookkeeper was not corroborated by any other witness or by anything in the documents that were produced at the hearing. The company's bookkeeper was not called to testify.
[40] I also note that in a letter written to Mr. Iantorno on January 21, 1999 the Appellant commented on the source deductions issue as follows:
In respect to the source deductions I am sure you were aware each month of the growing liability. If you are interested in laying blame then remember that each of us have signing authority and you could have just as easily written the cheque. Please confirm that I can transfer my comptrollership duties to Derek Stevens as discussed.
[41] In my opinion, this indicates that the Appellant was aware at the time the 1998 remittances were due that they were not being made, and that the decision not to make the remittances was a conscious one made at least by the Appellant and more likely by the Appellant and Mr. Iantorno jointly. I reject the Appellant's testimony that he only learned of the remittance problem at the end of the 1998 year and that the failures to remit were outside of his control.
[42] The Appellant argued that I should take into account the efforts he made to rectify the failures to remit by sending in the series of post-dated cheques to the Canada Revenue Agency. Firstly, it is clear from the case law that the director must show that efforts were made to prevent the failure to remit rather than to rectify the situation after the failures had occurred. Furthermore, the steps to make up the missed remittances were not taken by the Appellant until well into 1999 and were taken more in an attempt to forestall collection action by the Agency than out of a genuine desire to pay the remittances. The first interest of the Appellant and Mr. Iantorno was to keep the team operating, and from January to August of 1999 each of them provided over $200,000 of funding. None of that money though was used to pay off the outstanding tax debt.
[43] Therefore, I find that the Appellant has not shown that he exercised the degree of care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances to prevent the 1998 failures to remit which, according to the Reply to the Notice of Appeal, totaled $47,434.46.
[44] The circumstances surrounding those failures to remit which occurred after mid-August 1999 were different than those that occurred in 1998. It should be noted that the Appellant met its obligation to remit the current source deductions between the latter part of 1998 and mid-August 1999, and that the financial difficulties in which the Lynx found themselves in August 1999 were the direct result of Mr. Iantorno refusing to provide any additional capital to the company, despite his apparent commitment in June 1999 to continue funding the team to the end of the season. Mr. Iantorno was unwilling to commit further amounts because he was unhappy with the role played by Ms. Hartrell in the company and felt he was being pushed out. I accept that Mr. Iantorno did not advise the Appellant in advance that he would be withdrawing his support from the company, and that it was unclear for a number of weeks after mid-August whether Mr. Iantorno was going to relent and pay his share of the team's obligations. I also accept that the Appellant could not foresee these events, and that once they had occurred there was little he could do to prevent the company from defaulting on its obligations. Mr. Iantorno's withdrawal of support occurred within weeks of the end of the 1999 playing season, and I believe it was reasonable for the Appellant at that point to expect that Mr. Iantorno would pay up. I also accept that the Appellant tried to convince the company's bank to allow it to continue to operate in overdraft but that the bank refused. These are the actions that could be expected of a reasonably prudent person in comparable circumstances.
[45] Given the precipitous nature of Mr. Iantorno's refusal to contribute any more money to the Lynx and given the point in the playing season at which the crisis occurred, I am of the view that the Appellant was powerless to prevent the failures to remit. This is what distinguishes these failures to remit from those that occurred the previous year.
[46] For these reasons, the appeal is allowed in part with respect to the amounts which the Lynx failed to remit in 1999 which totaled $40,588.05.
[47] Given that the Appellant has been only partially successful in this appeal, each party shall bear its own costs.
Signed at Ottawa, Canada, this 11th day of September, 2006
"B. Paris"
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