Citation: 2012 TCC 239
Date: 20120827
Dockets: 2009-3419(GST)G,
2009-3420(IT)G
BETWEEN:
JAMES K. MARTIN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Angers J.
[1]
These appeals were
heard on common evidence. They both concern assessments issued to the appellant
in his capacity as director of a corporation known as Codiac Boring and
Drilling Ltd. (Codiac). The appellant was assessed amounts under subsection
323(1) of the Excise Tax Act (ETA) with respect to Codiac's
failure to remit net tax and under section 223 of the Income Tax Act (ITA)
with respect to payroll deductions and employer contributions payable by Codiac,
plus interest and penalties. In both appeals, the issue is whether the
appellant exercised the degree of care, diligence and skill to prevent the
failure to remit the net tax and payroll deduction amounts that a reasonably
prudent person would have exercised in comparable circumstances.
[2]
The appellant was at
all relevant times the director and shareholder of Codiac as well as director
and shareholder of more than a dozen other, related corporations, including one
known as Robinson Construction Company Ltd. (Robinson). They were all part of a
group of corporations that were used by Robinson for various reasons in the
performance of various contracts prior to the events leading to this appeal.
The appellant is a licensed electrician who acquired these corporations in the
early 1980's from his father, who in turn had succeeded the appellant’s grandfather.
[3]
At first, Robinson was
an electrical contractor, but it eventually specialized in underground
utilities and expanded to other underground pipes, as it was one of the few companies
in New Brunswick that did directional drilling. Robinson and Codiac ultimately
became water line and sewer line contractors. Robinson had around 30 employees
and Codiac 10.
[4]
In the spring of 2000,
Robinson entered into a contract with MRM Technical Group Inc., known as Exelon,
which was an American corporation that had obtained a contract with Enbridge
Gas New Brunswick Inc. (Enbridge) for the development of a natural gas
distribution system in New Brunswick. Robinson became the main subcontractor
and the other Robinson group corporations became subcontractors for Robinson,
Codiac being the most important of them all because of the directional
drilling.
[5]
Robinson decided to
join with Exelon in early 2000. Exelon placed bids on seven contracts that were
put out to tender by Enbridge and was successful on four of them. These
contracts ranged in value between three and four million dollars each and all
the work was to be performed by Robinson. One of these contracts alone represented
the equivalent of one year of operations for Robinson. It was evident that
Robinson could not finance all four contracts. It therefore had to either
increase its line of credit or find a way to invoice and get paid on a weekly
basis. Exelon agreed to the latter, which assured Robinson of sufficient cash
flow or working capital to finance a project of that size. Codiac had no line
of credit.
[6]
Robinson and Codiac had
to hire three times more employees than they had ever had and grew to a size
three times greater than they had ever been. The weekly payment arrangement was
the only way the Robinson group of companies could work with Exelon in order to
keep the work going.
[7]
The contract was for
the installation of pipes on a paid‑per‑unit basis. The contract
did not provide for any extras unless they were approved and only a holdback of
10% was to be retained by Exelon. The work was to begin in June 2000, and
Robinson and Codiac were ready to proceed. They had hired their workers and
rented the necessary equipment. Enbridge, on the other hand, had not obtained
the necessary permits on time and start-up was delayed until August. The
resulting standby time and the non-payment of extras created an upfront loss of
between $800,000 and $900,000. By July, Robinson's line of credit of $600,000 had
been used up.
[8]
That delay in start-up meant
that much of the work had to be done in the winter months at a higher cost. In
addition to the 10% holdback, an additional 15% was held back, and there were
also extras, all of which contributed to the creation of severe financial
hardship for Robinson and its group of companies. Robinson’s suppliers were
also beginning to suffer financially. After about three months of operations,
one million dollars or about 40% of Robinson’s billings was being held back.
[9]
On December 11, 2000,
the appellant hired one David Ross, a chartered accountant, as chief financial
officer for Robinson and its group of companies. Once he became apprised of the
situation, he immediately called for a meeting with representatives from Exelon
and Enbridge to discuss the mounting costs due to winter drilling, and to
discuss as well the holdbacks, the extras and the costs occasioned by late
start-up. Promises were made but not kept. Robinson was promised $500,000 but
only received $200,000. Other problems surfaced as well. They were asked to dig
the trenches deeper and to use more sand bedding. By mid‑February,
Robinson and its group of companies knew that these projects would not end
well. Up to February 2001, Robinson and Codiac had been able to pay its GST/HST
and payroll taxes owing, but the appellant became seriously concerned with the
situation in that regard.
[10]
In February 2001, Mr.
Ross consulted Kent Robinson, the lawyer for Robinson and its group of
companies, who in turn suggested they retain a bankruptcy expert in the person
of David Stevenson, a chartered accountant. At the time, the appellant was
concerned with the suppliers and the taxes. The following provides the context
in terms of possible arrears in taxes:
A. If we were, it was as it evolved through February. I think
he was there in. . . because of the things that would have been
eminent [sic] was that taxes would be due in a couple of weeks or
something. So that's one of the things he was brought in for, to help us
address or to help us prepare for what, by January or February, we could tell
was going to be a rough deal.
Q. So
you met with Mr. Stevenson and you met with Kent Robinson?
A. Yes.
[11]
The appellant's
understanding of the entire process at the time and even at trial was that the GST/HST
remittances would fall off in that, if you send a bill and you cannot collect on
that bill, there will be no GST/HST. If you do not collect, there is no GST/HST
to remit. As for the deduction amounts to be remitted, he understood that they had
a different priority level and that, in spite of everything, he still had to
pay what he called the payroll taxes.
[12]
Other meetings were
also held in February in order to settle the financial difficulties arising
from the contracts in question. The matter had become even more important at that
time because the bank wanted to reduce Robinson's line of credit from $600,000
to $450,000.
[13]
As of January 31, 2001,
Codiac's shortfall was $249,000. By August 31, it had risen to $833,000. As for
Robinson, as of June 2001, it had $3,750,000 that was receivable from Exelon. Mechanic's
liens were put on the project and David Ross made representations to
senior bureaucrats and senior ministers of the New Brunswick government as
well as to the New Brunswick Public Utilities Board assistance with a view to
obtaining assistance. For David Ross, it was clear by April 15, 2001 that
the die was cast. It was going to be a struggle to collect the receivables.
Exelon was paying the minimum necessary to keep the project going. They paid
Robinson enough to keep the suppliers going and to pay only the out‑of‑pocket
payroll. He corresponded with Exelon’s chief operating officer as early as January
2001, saying they needed more in order to meet their tax obligations and bank obligations
and keep things current in that regard.
[14]
In the second quarter
of 2001, David Ross and others met regularly with representatives of the
Moncton Canada Revenue Agency (CRA) office. They kept the CRA informed of all
the actions they were taking to collect their receivables and they provided the
CRA with monthly reports.
[15]
In the fall of 2001,
Enbridge began to pay Robinson's suppliers directly. Robinson requested of the CRA
that third party demands be issued to Enbridge and Exelon, which was done.
[16]
Robinson eventually
settled its $3,750,000 lawsuit for $545,000 in 2005. The appellant had it in
mind, and instructed his lawyer to make sure, that $200,671 of the settlement
fund would be used to pay Codiac’s payroll deduction amounts and to pay
Robinson’s other liabilities toward the CRA. Again, in his own mind, the
appellant was convinced that Codiac's GST/HST account would disappear because
Codiac could not collect GST/HST from Robinson and that this would result in
what he describes as a wash. He believed that all of Robinson’s and Codiac’s
tax issues would be cleared up, as the entire settlement proceeds went to the CRA.
Notwithstanding the instructions given, the proceeds were all applied to
Robinson's tax liabilities by the CRA.
[17]
Robinson, Codiac and
the other members of the group of companies all operated under a consolidated
treasury, i.e., there were no separate accounts. The payroll was met through a
payroll service company and the books were kept in such way that they knew
which company in the group needed to have its remittances paid. For the
project, Robinson billed Exelon and then the internal accounting allowed each
company to receive the funds required in order to meet its obligations. Codiac
would bill Robinson.
[18]
The details of the
reassessment issued to Codiac with regard to the payroll deductions and
employer contributions, for which the appellant was assessed, are set out in
Schedule A of the Reply to the Notice of Appeal (2009‑3420(IT)G). The
breakdown is as follows:
|
Taxation
Year
|
Federal Taxes
$
|
Provincial Taxes
$
|
CPP
$
|
EI
$
|
Penalties
&
Interest
$
|
Total
$
|
|
2001
|
66,287.95
|
34,255.89
|
26,617.16
|
20,756.90
|
136,679.21
|
284.597.11
|
[19]
The details of the
assessment issued to Codiac with regard to its failure to remit an amount of
net tax, for which the appellant was assessed, is detailed as follows in the
respondent's Reply to the Notice of Appeal (2009‑3419(GST)G):
|
Period End
Date
|
[Unremitted Net]
Tax
|
Interest
|
Penalty
|
Total
|
|
2001-03-31
|
—
|
$ 5,501.75
|
$ 6,784.90
|
$ 12,286.65
|
|
2001-06-30
|
$ 81,940.30
|
$ 42,846.00
|
$36,157.63
|
$160,943.93
|
|
2001-09-30
|
$ 26,173.48
|
$ 11,142.19
|
$ 8,317.95
|
$ 45,633.62
|
|
2001-12-31
|
$105,623.89
|
$ 61,512.06
|
$13,858.90
|
$180,994.85
|
|
TOTAL:
|
$213,737.67
|
$121,002.00
|
$65,119.38
|
$399,859.05
|
[20]
Codiac had been
assessed for GST/HST for the period from January 1, 2001 to December 31, 2003. Following
an appeal before this Court, the assessment was adjusted to reflect the Tax
Court's decision, which resulted in the same adjustment to the appellant's
assessment under subsection 323(1) of the ETA. According to Mr. Ross,
the chief financial officer for Robinson, had Codiac been able to claim a bad
debt credit, the GST/HST payable would have been considerably diminished. They
were unable to claim the bad debt credit as Robinson and Codiac were related
and thus not dealing at arm's length. Subsection 231(1) allows a bad debt
credit only if the parties are dealing at arm's length. Had the companies been
closely related persons as that term is defined for GST purposes and had they made
the election made under section 156 of the ETA to have supplies made
among them treated as having been made for nil consideration, the result would
have been quite different.
[21]
Mr. Ross also testified
that Codiac could, under subsection 232(2) of the ETA, have reduced its
invoiced amounts by the amounts charged but unpaid and thus reduced the GST/HST
owing in accordance with the rules contained in subsection 232(3) of the ETA.
They found out about those provisions too late, however, as they have to be invoked
within four years. Mr. Ross did in fact introduce some calculations he had
made which show a substantial difference in the GST/HST owing (Exhibit A-3), so
much so that Codiac would have had no GST/HST owing. He went on to say that the
effect of allowing these credits would be that the payroll taxes and GST/HST of
both Robinson and Codiac were overpaid by about $160,000.
Relevant sections
[22]
The liability of
directors for failure to remit an amount of net tax under the ETA is set
out in section 323 of the ETA, the relevant subsections of which read as
follows:
323.
(1) Liability of
directors — If a corporation fails to remit an
amount of net tax as required under subsection 228(2) or (2.3) or to pay an
amount as required under section 230.1 that was paid to, or was applied to the
liability of, the corporation as a net tax refund, the directors of the
corporation at the time the corporation was required to remit or pay, as the
case may be, the amount are jointly and severally, or solidarily, liable,
together with the corporation, to pay the amount and any interest on, or
penalties relating to, the amount.
(2) Limitations — A director
of a corporation 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 under section 316 and execution for that 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 subsection (1) 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
bankruptcy order has been made against it under the Bankruptcy and
Insolvency Act and a claim for the amount of the corporation's liability
referred to in subsection (1) has been proved within six months after the date
of the assignment or bankruptcy order.
(3) Diligence [due diligence
defence] — A director of a corporation 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.
[23]
The liability of
directors for failure to remit an amount withheld as required by the Income
Tax Act is set out in section 227.1, the relevant subsections of which read
as follows:
227.1 (1) Liability
of directors for failure to deduct — Where a
corporation has failed to
deduct or withhold an amount as required by subsection 135(3) or 135.1(7) 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, or
solidarily, liable, together with the corporation, to pay that amount and any
interest or penalties relating to it.
(2) Limitations on liability — A director is not
liable under subsection 227.1 (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 under section 223 and execution for that 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
bankruptcy order has been made against it under the Bankruptcy and
Insolvency 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 bankruptcy order.
(3) Idem
[due diligence defence] — A director is not liable for a failure under
subsection 227.1(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.
[24]
The only issue before
the Court is whether the appellant exercised the degree of care, diligence and
skill to prevent the failure to remit that a reasonably prudent person would
have exercised in comparable circumstances. In two recent decisions of the
Federal Court of Appeal (Balthazard v. Canada, 2011 FCA 331, and Canada
v. Buckingham, 2011 FCA 142), Justice Mainville dealth with the legal
framework applicable to the care, diligence and skill defence. In Balthazard,
he summarized that framework as follows, at paragraph 32:
a. The standard
of care, skill and diligence required under subsection 323(3) of the Excise Tax Act is an objective standard as set out by the
Supreme Court of Canada in Peoples Department Stores
Inc.(Trustee of) v. Wise, 2004 SCC 68, [2004] 3 S.C.R. 461. This
objective standard has set aside the common law principle that a director's
management of a corporation is to be judged according to his or her own
personal skills, knowledge, abilities and capacities. However, an objective
standard does not mean that a director's particular circumstances are to be
ignored. These circumstances must be taken into account, but must be considered
against an objective "reasonably prudent person" standard.
b. The assessment of the director's conduct, for the
purposes of this objective standard, begins when it becomes apparent to the
director, acting reasonably and with due care, diligence and skill, that the
corporation is entering a period of financial difficulties.
c. In circumstances where a corporation is facing
financial difficulties, it may be tempting to divert these Crown remittances in
order to pay other creditors and thus ensure the continuity of the operations
of the corporation. That is precisely the situation which section 323 of the Excise Tax Act seeks to avoid. The defence under
subsection 323(3) of the Excise Tax Act must not be
used to encourage such failures by allowing a care, diligence and skill defence
for directors who finance the activities of their corporation with Crown
monies, whether or not they expect to make good on these failures to remit at a
later date.
d. Since the liability of directors in these respects is
not absolute, it is possible for a corporation to fail to make remissions [sic]
to the Crown without the joint and several, or solidary, liability of its
directors being engaged.
e. What is required is that the directors establish that
they were specifically concerned with the tax remittances and that they
exercised their duty of care, diligence and skill with a view to preventing a
failure by the corporation to remit the amounts at issue.
[25]
There is no doubt that
the events that led to Robinson’s and Codiac’s financial difficulties were, to
say the least, somewhat unforeseeable. The appellant saw in this project an
opportunity for his companies to acquire expertise for the future, particularly
in what was to become a new industry for New Brunswick. That project was, however,
an undertaking larger by far — three times larger,
in fact — than any that Robinson and its group had
ever been involved in before. It required a lot of manpower and equipment, and,
most importantly, sufficient cash flow to finance it.
[26]
The appellant is an
electrician by trade, who, over the years, became the shareholder and director
of Robinson and its group. He is very familiar with the construction aspect of
the business and had appropriate staff to manage the administration side of the
business, even with Robinson’s limited line of credit. He knew that the size of
this project would require different conditions in terms of payment and he was
successful in obtaining from Exelon their undertaking to pay Robinson on a
weekly basis. This, apparently, was exceptional in the construction industry
but was an essential element for this project and the relationship between
Exelon and Robinson.
[27]
Despite the delays in
start‑up and the additional related costs created thereby, and
notwithstanding the holdbacks and the extras that did not get approved,
Robinson and particularly Codiac were able to meet their obligations in terms
of the remittance of payroll deductions and also of the GST/HST Codiac
collected on its billings to Robinson. These remittances were kept up to date
until at least the end of February 2001. The appellant knew very early on in
the project, and more particularly in the fall of 2000, that the delays in
obtaining payment on its billings would eventually lead to serious financial
difficulties with the project. The upfront losses and the cost of standby time
were in the $900,000 range. Winter was approaching and by January the holdbacks
alone had reached one million dollars, which represented 40% of Robinson’s
billings.
[28]
In order to address
this particular financial crisis caused by Enbridge’s refusal to pay Exelon and
Exelon’s being unable to resolve the situation, the appellant hired a chief financial
officer on December 11, 2000. Two days later, the chief financial officer met
with the parties involved but he was ultimately only able to get $200,000 of
the $500,000 asked for.
[29]
The appellant also
consulted Robinson’s lawyer and, in February 2001, retained a chartered
accountant as he was afraid Robinson and its group of companies would go
bankrupt. Although Robinson and Codiac were up to date with their remittances
at that time, concern over GST/HST and payroll deduction remittances was being
felt by everyone, including the appellant. The appellant was of the belief that,
with regard to the GST/HST remittances, the end result would eventually be a wash
for the simple reason that you do not remit what you cannot collect. That
belief was also shared by both the chief financial officer and the accountant who
had just been retained. The payroll deductions were a more serious concern and
as early as March 2001 meetings were held with representatives of the CRA to
keep them apprised of the financial difficulties and the efforts that were
being made to collect from Exelon and Enbridge.
[30]
The belief of the
appellant and his two advisors that the situation with regard to the GST/HST would
be a wash was not wrong. What was unknown to everyone was that Robinson’s group
of companies were not a closely related group of companies as defined for GST/HST
purposes and therefore could not benefit from subsection 231(1) of the ETA.
Consequently no bad debt was available to Codiac nor could Codiac benefit from
a reduction with respect to the unpaid invoices under subsection 232(2) of
the ETA and thus reduce by means of credit notes under
subsection 232(3) of the ETA the tax owing. Codiac was therefore
left with no recourse. These events occurred in the spring of 2001, about ten
years after the GST was introduced. Given this short period after its
introduction, it is not surprising that all of the workings of the GST were not
known. What is surprising, given the good rapport Robinson and its group of
companies had with CRA officials, is that information as to the relief
available to Codiac with regard to its GST/HST remittances was not communicated
to the appellant and his advisor, nor were any suggestions made to them in that
regard when they met with the aforementioned CRA representatives to discuss the
problem in the spring of 2001. Although the amount of GST/HST owed by Codiac is
not at issue herein, I have no reason to disbelieve that, as a result of the
appropriate measures not being taken, Codiac’s GST/HST debt has been overpaid
by many thousands of dollars, as suggested by David Ross. But for that
overpayment, there could have been sufficient money left to pay the payroll
deductions.
[31]
The appellant could
easily have walked off the job, but the consequences would have been disastrous
for his group of companies. Exelon was giving Robinson just enough money to
keep him crawling forward, as he said, in the hope that one day he would get
paid. Although his efforts were made on behalf of Robinson, they no doubt included
all companies in the group as all were dependent on Robinson being able to get
paid.
[32]
It became apparent to
the appellant in the fall of 2000 that Robinson and its group of companies were
going to run out of money. Notwithstanding the fact that Codiac remained up to
date in its remittances until the end of February 2001 as regards payroll
deductions and the end of March 2001 as regards GST/HST, the appellant hired a chief
financial officer, a lawyer and a chartered accountant to assist him in resolving
the financial crisis. His concern during the winter months was to pay the taxes
first. He refused to have suppliers get paid directly by Enbridge as he could
use that money to pay the taxes. In addition, had Robinson and its group of
companies been properly advised on the GST issues, there would have been
sufficient money to make the payroll deduction remittances.
[33]
In my opinion, the
appellant did turn his attention to the required remittances and he did, in the
circumstances of this case, exercise the degree of care, diligence and skill
that a reasonably prudent person would have exercised in similar circumstances.
For those reasons, I would vacate the reassessment against the appellant with
respect to the GST/HST owed for the periods ending March 31, June 30
and September 30, 2001 and with respect to the payroll deductions for the
2001 taxation year.
[34]
As for the GST/HST owed
for the period ending December 31, 2002, I find that the appellant’s
effort were no longer directed at that point toward avoidance of failures to
remit.
[35]
The appeals are allowed
in part and the assessments are referred back to the Minister for
reconsideration and reassessment in accordance with these reasons. Each party will bear its
own costs.
Signed at Ottawa, Canada, this 27th day of August
2012.
"François Angers"
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