Ivezic v. MNR, 92 DTC 1066, [1992] 1 CTC 2124 (TCC)

Bonner, T.C.C.J. [Orally]:—This appellant appeals from an assessment issued against him as director of Atlantis Software Corporation Ltd. ("Atlantis") in respect of the failure of Atlantis to pay tax as required under Part VIII of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). Directors are made vicariously liable for the failure of the corporation to pay by virtue of subsection 227.1(1) of the Act. Many of the basic facts underlying this appeal are set forth at paragraphs 1 to 5, 10, 11, and 13 to 15 of the notice of appeal. Those paragraphs were admitted by the respondent and I will not pause to read them now.

The notice of appeal raises three defences to the assessment. One, of course, is the so-called due diligence defence under subsection 227.1(3) of the Act which reads:

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.

I will deal with this defence later in more detail.

The second defence raised by paragraph 1 of Part B of the notice of appeal in essence asserts that the quantum of the Atlantis liability is less than computed by the Minister. The short answer on this issue is that there was a total absence of evidence supporting a conclusion that the Minister erred in calculating the "amount of tax" which Atlantis “ failed to pay" to use the words of subsection 227.1(1).

The third defence raised by paragraph 3 of Part B is in essence that the notice of assessment against the appellant relies on" the one issued against Atlantis and that the latter which is elated Februar 11, 1988, is defective because it was not served on the trustee in bankruptcy of Atlantis. Atlantis had become bankrupt on August 7, 1986. This attack must fail as well. I am not persuaded that the assessment against the appellant in any way" relies" on the assessment against Atlantis as alleged. It is not open to the appellant to challenge the assessment against Atlantis. Only the trustee in bankruptcy can do or could have done that. Furthermore, the liability of the appellant arises, to use the words of subsection 227.1(1):

Where a corporation . . . has failed to pay an amount of tax for a taxation year as required under. . . Part VIII . . .

The language of the statute does not suggest that the liability of the director arises only if a proper assessment has been issued against the corporation in respect of the primary liability of the latter. This attack therefore fails as well.

I turn now to the due diligence matter which was the third and final defence. The basic case advanced by the appellant was that he was duly diligent in following a procedure involving the depositing of the money raised by the quick flips in an escrow account from which the money was released only after securing the necessary accountant's certificate and otherwise following the formalities of the financing scheme. That process, as will be seen, is quite beside the point. The real question is what scheme or plan was put in place for the payment or discharge of the Part VIII tax liability whether sooner, under subsection 195(2) of the Act, or later.

Subsection 195(2) provided that:

Where, in a particular month in a taxation year, a corporation issues a share or debt obligation, or grants a right, in respect of which it designates an amount under section 194, the corporation shall, on or before the last day of the month following the particular month, pay to the Receiver General on account of its tax payable under this Part for the year an amount equal to 50% of the aggregate of all amounts so designated.

It will be noted that the respondent pleaded that the assessment was based on findings or assumptions of fact which included subparagraphs 2(a), (b), (c),

(d) and (h) of the reply to the notice of appeal. Subparagraphs 2(a), (b) and (c) were not challenged. They are as follows:

(a) at all material times, the appellant was the sole director, officer, and shareholder of Atlantis Software Corporation Ltd. (“Atlantis”);

(b) on or about November 13, 1984, Atlantis designated the sum of $3,100,000 under subsection 194(4) of the Act and the further sum of $900,000 on or about November 27, 1984, resulting in total Part VIII tax payable of $2,000,000.

(c) Atlantis did not, at any time, pay its Part VIII liability of $2,000,000.

The assumption pleaded in subparagraph 2(d) of the reply was challenged. Subparagraph 2(d) reads as follows:

(d) Atlantis did not, at any material time, expend any funds on qualifying scientific research and experimental development;

The appellant did not adduce any evidence of the dollar amount spent or the exact nature of the activity on which the money was spent.

Subparagraph 2(h) of the reply is worthy of considerable attention. It should be noted that it is ambiguous with respect to the question of the precise timing of the failure on which the Minister relied in making his assessment against the appellant. Subparagraph 2(h) reads:

The appellant did not, at any time, exercise the degree of care, diligence, and skill that a reasonably prudent person would have exercised in comparable circumstances to prevent the failure of Atlantis to remit the Part VIII tax payable by it for its 1985 taxation year.

I regard this as evasive pleading. When a defence is raised under subsection 227.1(3) it is essential that the timing of the failure relied on by the respondent be identified so that evidence can be directed toward the exercise of "care, diligence and skill to the failure”. Prevention, of course, involves taking action before an event, not after.

With regard to the failure of Atlantis to make the payment due under subsection 195(2) of the Act on or before the last day of December, 1984, the appellant testified that his understanding was that Part VIII tax was payable at or after the company's year end and that if qualifying research was underway when the tax would otherwise have been due under subsection 195(2), the expenditures on such research would ultimately reduce the Part VIII tax liability. Testimony as to an understanding that Revenue Canada had taken the position that it did not intend to enforce a provision of the Income Tax Act seems at first blush highly improbable. If such evidence is unsupported by clear proof such as an authoritative pronouncement by a responsible Revenue Canada official, such testimony might ordinarily be regarded as wishful thinking. However, I accept that the appellant had an honest and well-founded belief that the Part VIII tax did not have to be paid until year end despite the clear language of subsection 195(2). It would seem that Revenue Canada did, amazingly enough, make public statements which could have formed a reasonable basis for the appellant's understanding. In this regard I refer to the "advice to taxpayer" referred to in the decision of the Federal Court of Appeal in Canada v. Optical Recording Inc., [1990] 2 C.T.C. 524, 90 D.T.C. 6647, at 525 (D.T.C. 6649). Though no notice similar to that quoted in the Optical Recording reasons was attached to the copy of the notice of assessment entered as Exhibit A-3, it is not at all improbable that knowledge of the unusual position which apparently had been taken by Revenue Canada came to the appellant by other means.

In my view, no great degree of care, diligence, and skill need be exercised to prevent a failure to pay at the time required under subsection 195(2) in a case such as this when the responsible director of the taxpayer believed on reasonable grounds that the corporation would be given an opportunity to eliminate the Part VIII liability by means of qualifying expenditures before year end. Subsection 227.1(3) refers to comparable circumstances and the public posture of the Minister is a relevant circumstance.

The next question then is whether the appellant exercised the diligence contemplated by subsection 227.1(3) to prevent the failure of Atlantis to extinguish the Part VIII liability by year end. Although I cannot conclude that the appellant did not exercise such diligence, more importantly, I cannot conclude that he did. There are simply too many gaps in the evidence. Following the SRTC flip transactions, Atlantis was in the position that it had to make qualifying expenditures in the amount of $4 million to satisfy the Part VIII liability. The cash on hand from the flips approximately was $1.6 million. No other particulars were supplied as to the financial position of Atlantis or as to its ability to undertake such an ambitious research program. The appellant testified that the required funds were to be obtained by leveraging the cash proceeds of the financing. He spoke in general terms of buying on credit the equipment required for the research and of mortgaging the building being erected to house research activities, but he did not point to any detailed concrete financial plan whereby the objective might have been accomplished. No research budget was produced. No particulars as to timing were given in evidence. It appears that no arrangement was ever completed for a mortgage of the building under construction. The appellant said that a decision was made by a company which supplied programs for resale by Atlantis, thus generating cash flow, to market those programs itself and in consequence Atlantis lost at a critical time a source of cash flow and in the end became insolvent. While I have no doubt that some or all of the events described by the appellant did occur, I cannot find that the ill-defined scheme for financing the $4 million of research with about $1.6 million in cash plus unknown other assets and liabilities was one on which the appellant might reasonably have relied.

I am aware that the appellant testified that the records of Atlantis were destroyed by the trustee in bankruptcy in October of this year. That misfortune may very well have impeded the appellant in putting in his case by depriving him of records which might have served to refresh his mind and otherwise to establish the existence of a viable plan on which he might reasonably have relied for the discharge by Atlantis of its liability. The destruction of the records underlines as nothing else can the regrettable results which can flow from delays in getting cases on for trial. The circumstance is particularly unfortunate in this case because the date for this hearing was fixed many months ago long before the time when the records of Atlantis were said to have been shredded. Be that as it may, the burden was on the appellant to establish the subsection 227.1(3) defence and he has failed to adduce evidence establishing that defence on the balance of probabilities. The appellant's testimony amounts to nothing more than vague generalities which will not suffice.

For the foregoing reasons the appeal will be dismissed.

Appeal dismissed.