Citation: 2012TCC270
Date: 20120726
Dockets: 2008-3636(GST)G
BETWEEN:
TIMOTHY DEAKIN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
DOCKET: 2008-3637(IT)G
AND BETWEEN:
TIMOTHY DEAKIN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
DOCKET: 2008-3639(IT)G
AND BETWEEN:
BRIAN DEAKIN,
and
HER MAJESTY THE QUEEN,
Respondent,
DOCKET: 2008-3640(GST)G
AND BETWEEN:
BRIAN DEAKIN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Boyle J.
[1]
The only issue in these
income tax and goods and services tax (“GST”) appeals is whether the two
appellants are entitled to rely upon the so-called “due diligence” defence to
their potential liability as directors for a corporation’s unremitted employee
withholdings and GST. It is not disputed that they were directors at all
relevant times. Neither the corporation’s liability nor the amounts are in
dispute.
Facts
[2]
The two appellants are
brothers. They were directors of Deatech Systems Inc. (“Deatech”). Deatech was
in the home-security business. It was incorporated in 1998 following their sale
to ADT of Parkwood Security Systems (“Parkwood”).
[3]
Parkwood had originally
been incorporated as Parkwood Home Improvements by Timothy Deakin in 1982,
carrying on a business of building fences and decks for new home owners. In
1984, Parkwood switched to home security systems sales, installation and
monitoring. In 1994, Brian Deakin became a 50% partner in Parkwood.
[4]
The Deakins built
Parkwood into a very successful business. At its peak, Parkwood had more than
20 employees and did 100 to 150 installations per month.
[5]
In 1998, the Deakins
sold the shares of Parkwood to ADT for $1.664 million, reduced by the
amount of internal debt in Parkwood. The debt was $664,000 which left
$1,000,000 payable for the shares to the Deakins. When the sale closed, ADT had
Parkwood pay off its debts, however the $1,000,000 was to be paid after closing
as monitoring accounts transitioned to ADT.
[6]
Shortly after closing,
another monitoring company to which Parkwood had subcontracted its monitoring
services, threatened and then instituted legal action against ADT claiming that
Parkwood had granted it a right of first refusal to purchase its
alarm-monitoring customers. This dragged on for some time. The Deakins were
joined to the action. ADT refused to pay the Deakins the $1,000,000 share
purchase price until the matter was resolved. The matter was settled by ADT for
an unknown amount four years later. Despite their continuing hopes and
expectations, no part of the $1,000,000 has ever been received by the Deakins from
ADT. None of the documents relating to this claim or its settlement were put in
evidence. The Deakins have never sued ADT for the unpaid $1,000,000.
[7]
After selling Parkwood
the Deakins incorporated Deatech to carry on a similar home security business.
The Deakins expected to have $1,000,000 to invest in their new Deatech
business. When that was not forthcoming, Deatech started to encounter financial
difficulties with its cashflow. The Deakins owned, worked at and were directors
of Deatech. Deatech had a bookkeeper on staff and used an outside chartered
accountant. The Deakins were at all times informed of and aware of Deatech’s
financial position, jointly made its long-term and short-term business
decisions, and decided how to deal with the company’s cashflow shortfall
relative to its operating expenses.
[8]
Deatech did not fully
remit employee withholdings or net GST collected to Canada Revenue Agency
(“CRA”). This money was intentionally used instead to pay other Deatech
creditors in order to keep the business afloat. For a long time it was hoped
that this could be corrected and repaid once the $1,000,000 was received from
ADT. There were also attempts to find other investors and obtain greater bank
financing but the financial difficulties persisted and the unremitted taxes
grew as some of these amounts were further diverted to pay suppliers and
employees in order to keep the business going. According to Deatech’s
bookkeeper, its key supplier had it on a “cash only” basis and Deatech therefore
had to use the GST collected and employee withholdings to buy products.
[9]
The Deakins stopped
receiving salary and were successful in lining up a $100,000 investor. One of
them put a second mortgage on his house to make available to Deatech. However,
in the end Deatech made an assignment in bankruptcy in 2005. By then Deatech
had failed to remit more than $200,000 in employee source deductions and more
than $50,000 in GST. The amounts assessed exceed $400,000 once penalties and
interest are accounted for.
[10]
These arrears accrued
by Deatech over a number of years. Deatech and the Deakins were in regular
contact with the CRA to work out repayment plans for the arrears and otherwise
tried to address them. There is no suggestion that the Deakins were not forthright
in their dealings with CRA relating to the arrears. Deatech’s financial
position did not allow it to keep up the agreed repayment plans for the
arrears.
Law
[11]
Subsection 227.1(3) of
the Income Tax Act (“ITA”) provides:
Idem
(3) 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.
[12]
Subsection 323(3) of
the Excise Tax Act (“ETA”) provides:
(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.
Analysis
[13]
An employer is generally
required by law to remit to the CRA the source deductions it has withheld from
its employees’ salaries and wages for income tax, CPP and EI deductions. This obligation
differs from the employer’s liability for its own taxes on its income. These
amounts were withheld from the employees to be remitted to CRA and CRA, and
hence Canadian taxpayers at large, give the employees credit for these amounts
against the employees’ tax liabilities. For this reason, the legislation gives
CRA greater collection powers for such unremitted amounts than for the
employer’s own income taxes.
[14]
Similarly, a business
is generally required to remit the amount of GST it collected from its
customers, net of the GST the business paid on its purchases, supplies and
inputs. The GST was collected by the business from its customers to be remitted
to the CRA to satisfy the customers’ GST liabilities. Again, recognizing this,
the legislation gives CRA greater collection powers for such unremitted GST
amounts.
[15]
Subsection 227.1 of the
ITA and subsection 323 of the ETA provide that the directors of a
corporation will be personally liable for a corporation’s failure to remit
employee withholdings and GST as required by law. Directors are not generally
liable for a corporation’s own income tax. The potential liability of directors
reflects the degree of management and control directors have over a
corporation’s management and its affairs.
[16]
Subsections 227.1(3) of
the ITA and 323(3) of the ETA each provide that a director will
not be liable for the corporation’s failure to remit such amounts as required
by law if the director exercised a degree of care, diligence and skill to prevent
the failure that a reasonably prudent person would have exercised in
comparable circumstances.
[17]
The Federal Court of
Appeal most recently had the occasion to consider the due diligence defence of
directors for unremitted source deductions and GST in Her Majesty the Queen
v. Buckingham, 2011 FCA 142. In that case, the Court wrote:
[33] On the other hand, subsection
227.1(1) of the Income Tax Act and subsection 323(1)
of the Excise Tax Act specifically provide that the
directors "are jointly and severally, or solidarily, liable, together with
the corporation, to pay the amount and any interest or penalties relating
to" the remittances the corporation is required to make. Subsection
227.1(3) of the Income Tax Act and subsection 323(3)
of the Excise Tax Act do not set out a general duty
of care, but rather provide for a defence to the specific liability set out in
subsections 227.1(1) and 323(1) of these respective Acts, and the burden is on
the directors to prove that the conditions required to successfully plead such
a defence have been met. The duty of care in subsection 227.1(3) of the Income Tax Act also specifically targets the prevention of
the failure by the corporation to remit identified tax withholdings, including
notably employee source deductions. Subsection 323(3) of the Excise Tax Act has a similarly focus. The directors must
thus establish that they exercised the degree of care, diligence and skill
required "to prevent the failure". The focus of these provisions is
clearly on the prevention of failures to remit.
[. . .]
[40] The focus of the
inquiry under subsections 227.1(3) of the Income Tax Act and 323(3) of
the Excise Tax Act will however be different than that under 122(1)(b)
of the CBCA, since the former require that the director's duty of care,
diligence and skill be exercised to prevent failures to remit. In order to
rely on these defences, a director must thus establish that he turned his
attention to the required remittances and that he exercised his duty of care,
diligence and skill with a view to preventing a failure by the corporation to
remit the concerned amounts.
[. . .]
[49] The traditional approach has been
that a director's duty is to prevent the failure to remit, not to condone it in
the hope that matters can be rectified subsequently: Canada
v. Corsano, [1999] 3 F.C. 173 (C.A.) at para. 35, Ruffo
v. Canada, 2000 D.T.C. 6317, [2000] 4 C.T.C. 39 (F.C.A.). Contrary to
the suppliers of a corporation who may limit their financial exposure by
requiring cash-in-advance payments, the Crown is an involuntary creditor. The
level of the Crown's exposure to the corporation can thus increase if the
corporation continues its operations by paying the net salaries of the
employees without effecting employee source deductions remittances, or if the
corporation decides to collect GST/HST from customers without reporting and
remitting these amounts in a timely fashion. 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
continuation of the operations of the corporation. It is precisely such a
situation which both section 227.1 of the Income Tax Act
and section 323 of the Excise Tax Act seek to avoid.
The defence under subsection 227.1(3) of the Income Tax Act
and under subsection 323(3) of the Excise Tax Act
should not be used to encourage such failures by allowing a due diligence
defence for directors who finance the activities of their corporation with
Crown monies on the expectation that the failures to remit could eventually be
cured.
[. . .]
[52] Parliament did not require that
directors be subject to an absolute liability for the remittances of their
corporations. Consequently, Parliament has accepted that a corporation may, in
certain circumstances, fail to effect remittances without its directors
incurring liability. 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 concerned amounts.
[. . .]
[56] A director of a corporation cannot
justify a defence under the terms of subsection 227.1(3) of the Income Tax Act where he condones the continued operation
of the corporation by diverting employee source deductions to other purposes.
The entire scheme of section 227.1 of the Income Tax Act,
read as a whole, is precisely designed to avoid such situations. In this case,
though the respondent had a reasonable (but erroneous) expectation that the
sale of the online course development division could result in a large payment
which could be used to satisfy creditors, he consciously transferred part of
the risks associated with this transaction to the Crown by continuing
operations knowing that employee source deductions would not be remitted. This
is precisely the mischief which subsection 227.1 of the Income
Tax Act seeks to avoid.
[. . .]
[57] Once the trial judge found as a
matter of fact that the respondent's efforts after February 2003 were no longer
directed towards the avoidance of failures to remit, no successful defence
under either subsection 227.1(3) of the Income Tax Act
or subsection 323(3) of the Excise Tax Act could be
sustained.
[Emphasis added]
[18]
Similarly, in HMQ v.
McKinnon, [2001] 2 F.C. 203 CA, subnom Worrell v. Canada (“Worrell”)
the Federal Court of Appeal wrote:
69. It will normally not be sufficient for the
directors simply to have carried on the business, knowing that a failure to
remit was likely but hoping that the company’s fortunes would revive with an
upturn in the economy or in their market position. In such circumstances
directors will generally be held to have assumed the risk that the company will
subsequently be able to make its remittances. Taxpayers are not required
involuntarily to underwrite this risk, no matter how reasonable it may have
been from a business perspective for the directors to have continued the
business without doing anything to prevent future failures to remit.
[19]
By their own evidence,
the Deakins were responsible for Deatech’s decision not to fully remit source
deductions and GST to CRA, and to instead ensure that the suppliers and
employees needed to keep the business going were paid. Keeping the company afloat
was their prime motivation. I am unable to conclude that the wording of the
statutory due diligence defence, as interpreted by the Federal Court of Appeal
in Buckingham, permits the Deakins to avail themselves of the due
diligence defence. The many steps they actively took to try to address the
repayment of the arrears simply cannot support a due diligence defence. The
Deakins took a business risk and lost.
[20]
It must be noted that
the Federal Court of Appeal in Buckingham addressed and affirmed that
Court’s earlier decision in Worrell. Specifically in Buckingham
the Court wrote in Worrell:
50 The respondent however relies on Worrell for the proposition that this traditional approach
has been modified. Worrell concerned the application
of the defence of care, diligence and skill in circumstances where the
corporation's ability to make remittance payments was at the discretion of its
bank and where it was reasonable for the directors to believe that, by
continuing the business of the corporation, they could restore its fortunes.
While recognizing that it will normally not be sufficient for directors to
simply carry on a business knowing that a failure to remit was likely but
hoping that the company's future would revive with an upturn in the economy or
in its market position, the Court also recognized in Worrell
that where a reasonable expectation supported this belief in order to avoid
future failures to remit, the defence of due diligence could be established in
certain exceptional circumstances. Worrell must
however be read in light of the particular facts of that case, including
notably "the limitations placed on [the directors] by the bank's de facto control of the company's finances" (Worrell at para. 79), and it should therefore not be
understood as providing for a new approach to the due diligence defence.
51 It is thus important
to note that Worrell did not modify the focus of the defence of care,
diligence and skill, which is to prevent the failure to remit, not to cure
failures to do so. As noted in Worrell at paragraph 34:
·
However, whether the
directors did enough to exempt themselves from liability for the unremitted
source deductions and G.S.T. will depend, in part at least, on the fourth
principle to be found in the case law: the due diligence required of company
directors by subsection 227.1(3) is to prevent the failure to remit. This has
been held to mean that, if directors become liable prima facie for a
company's failure to remit, they normally cannot claim the benefit of
subsection 227.1(3) if their efforts were capable only of enabling them to
remedy defaults after they have occurred. Accordingly, of the measures
taken in an attempt to rescue [their corporation], the most relevant to this
inquiry are limited to the ones that were logically capable of preventing
failures to remit the source deductions and G.S.T. when they became due.
[Emphasis added]
[21]
In these two paragraphs
affirming Worrell, the Federal Court of Appeal appears to be
acknowledging that directors’ efforts to try to restore the corporation’s
fortunes by continuing its business and hopefully allowing it to repay its
accrued arrears can, in certain exceptional circumstances, be a relevant
consideration in a due diligence defence appeal. It is likely that the extent
and scope of this exception and the relevance of such post-default steps will
need to be considered and developed by the courts over time. I am satisfied
that it is not relevant in the Deakins’ case in any event. Firstly, the Deakins’
situation is very like that in Buckingham in which there was also an expected
$1.6 million payment of sales proceeds to alleviate the financial difficulties
and allow the arrears to be repaid. Secondly, unlike in Worrell, neither
the Deakins’ bank nor any other person had or exercised power to appoint a
monitor and to decide which cheques would be honoured based upon the payee. In Worrell,
the bank had and exercised such power and refused to honour the cheques
regularly drawn to CRA in respect of the required remittances. Thirdly, in this
case there was insufficient evidence to allow me to conclude that it was
reasonable at any time to keep the business going with a reasonable expectation
or likelihood that its fortunes would be reversed and the arrears would be
paid. Even had it been reasonable at the outset, there was no evidence to allow
me to conclude that it continued to be reasonable throughout. This is also in
contrast with the facts in Worrell. For example, absent details of the
claim against ADT and its settlement, I am unable to assess whether their
anticipation of $1,000,000 was reasonable and for how long it was reasonable.
[22]
Based upon the facts of
this case, nothing was done to prevent the failures to remit. The Deakins made
informed and considered decisions to use the source deductions and GST in part
to pay its suppliers and employees and only remitted a portion to CRA. The many
earnest efforts of the Deakins to address the arrears cannot help in this case
to establish a due diligence defence. For this reason, the appeals must be
dismissed except to the extent of the concession made by the Crown at trial in
respect of the dividend received from the bankrupt estate of Deatech in the
amount of $23,316.99 which reduced the income tax source deduction arrears.
[23]
Given the specific wording
of the subsections and the Federal Court of Appeal’s comments in Buckingham,
it appears somewhat difficult to imagine circumstances in which an informed and
active owner-manager and director of a corporation will not be liable for
unremitted employee source deductions and unremitted GST amounts. As mentioned
above, the scope of the Worrell exception post-Buckingham remains
to be developed in other cases than the Deakins’.
[24]
Source deductions and
GST remittances are required by law to be made by a business corporation. These
are not the corporation’s own funds. The corporation has collected them from
its employees and customers. Those employees and customers are given credit for
these amounts once withheld and collected, even when not remitted. When owner-managers
and directors decide to use these funds to keep their business afloat and
support their investments, they are making all Canadian taxpayers invest
involuntarily in a business and investment in which they have no upside. In
doing so, shareholders and corporate decision-makers are investing or gambling
with other people’s money. Directors should be aware of that when they cause or
permit this to happen. The directors’ liability provisions of the legislation
should be regarded by business persons as somewhat similar to a form of
personal guarantee by the directors that can expose them to comparable
liability for the amount involved. It is they who are deciding to invest the
funds in their own business, for their own gain, not the government or people
of Canada. They are doing so contrary to clear law and it appears appropriate as
a policy matter that Parliament has legislated clearly that they will generally
be responsible for such decisions and the loss resulting from them. In essence,
if a corporation and its directors choose to unilaterally “borrow” from
Canadian taxpayers and the public purse, Canadians get the benefit of security
akin to personal guarantees of the directors.
[25]
The appeals are
dismissed, with costs, except to the extent of the Crown’s concession referred
to above.
Signed at Ottawa, Canada, this 26th day of July, 2012.
"Patrick Boyle"
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