Citation: 2011 TCC 429
Date: 20111003
Dockets: 2005-766(IT)G
2005-767(GST)I
BETWEEN:
ADAM HEANEY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Dockets: 2005-768(IT)G
2005-769(GST)I
AND BETWEEN:
KEN CHASSE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Dockets: 2005-770(IT)G
2005-771(GST)I
AND BETWEEN:
DAVID GILBERT,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Campbell J.
[1]
The Appellants were
directors of DSL Communications Inc. (“DSL”). In the 2000, 2001 and 2002
taxation years, DSL failed to remit payroll source deductions withheld from the
wages of its employees. Also, between October 2000 and January 2003, DSL failed
to remit the net Goods and Services Tax (the “GST”) it had collected. The Appellants
were assessed pursuant to section 227.1 of the Income Tax Act (“ITA”)
and section 323 of the Excise Tax Act (“ETA”) for the amounts DSL
failed to remit, together with penalties and interest.
Issue:
[2]
The issue is whether
the Appellants, as the directors of DSL, are liable for the amounts DSL failed
to remit or whether they can avail themselves of the due diligence defence
contained in the directors’ liability provisions of the ITA and ETA.
Facts:
[3]
DSL was incorporated in
March 2000 as an internet service provider. It was one of the first companies
to work with Bell Canada (“Bell”) in Ontario
and Quebec, reselling the newly-available, high-speed
internet connections to the public. DSL was a subsidiary of Velocet
Communications Inc. (“Velocet”), another computer consulting corporation of
which the Appellants were directors.
[4]
DSL was formed with
financial assistance from CI Communications Inc. (“CI”). CI was also an
internet service provider that had access to millions of dollars. It invested
large amounts of money in the business ventures of DSL and Velocet and promised
future cash injections to pay certain anticipated costs, including DSL’s source
deductions and GST remittances. According to Mr. Heaney’s evidence, DSL’s
operations expanded quickly. Within months, the company employed 40
individuals.
[5]
When reselling Bell’s
services, the technology that DSL employed was essentially the service Bell uses today. To resell Bell’s
services, DSL was obliged to purchase Bell’s equipment,
including expensive modems, and lease them to DSL’s customers. The initial
modems were inadequate because they could not deliver the promised speeds. DSL
could not sell them, nor could these modems be returned to Bell. This was the beginning of DSL’s problems because it
owed hundreds of thousands of dollars on obsolete modems that had to be
replaced.
[6]
By late September 2000,
the Appellants were aware of two significant problems facing DSL. First, it had
network and billing issues with Bell. This was crucial because DSL’s business
was entirely dependant upon Bell’s infrastructure in order to provide
service to DSL customers. Second, DSL’s financing from CI was in jeopardy. DSL
learned that CI faced unexpected severe financial difficulties and might be
unable to fulfill its future financial commitments to DSL. In late 2000, CI
became bankrupt.
[7]
When the Appellants
became aware of these problems, they took immediate action to reduce DSL’s costs
and to locate new financing sources. DSL completely stopped advertising,
changed product offerings, laid off employees, reduced customer hours, engaged
Affinity Financial Group to assist in collecting receivables and worked with
accountants in seeking alternate investors or other financing. DSL also began
dealing with Bell in an attempt to negotiate equipment
purchases, including modems, together with expensive one-time costs such as
set-up fees. DSL also tried to correct the billing and invoicing errors that
were occurring with Bell so that DSL would obtain the resulting
credits to its accounts. DSL created an action register to track these.
[8]
Efforts to find new
financing were unsuccessful. Mr. Heaney attributed this to the so-called
“bursting of the internet bubble” that occurred at this time (Transcript, page
117, lines 23 to 24). On October 31, 2000, DSL’s first failure to remit GST
occurred. Around mid-December 2000, DSL’s first failure to remit payroll source
deductions occurred.
[9]
In December 2000, Bell sought payment from DSL on several overdue accounts,
some of which were described as “quite aged” (Exhibit A-1, Tab 2). On December
20, 2000, Bell demanded payment of over $145,000 to be
made in two instalments, with the first instalment due on December 22, 2000. A
failure to pay would result in the denial of “future growth” for DSL, which in
all likelihood meant that Bell would begin to refuse to process new DSL customers
(Exhibit A-1, Tab 2).
[10]
Mr. Heaney’s evidence
clearly outlined the consequences that would occur if DSL elected not to pay Bell. Without Bell’s services, it
could no longer operate. Mr. Heaney described the predicament for DSL as
follows:
Bell
became an absolute necessity. We could not get by without paying them. They
kept us on a very tight leash. Failure to pay them and the customers were off.
(Transcript, page 26, lines 6 to 9)
[11]
Consequently, DSL
elected to delay making remittances to the Canada Revenue Agency (the “CRA”).
The Appellants viewed this delay as a temporary measure because they expected
to find new financing which would allow DSL to meet its obligations to the CRA.
Throughout 2001, the Appellants continued unsuccessfully to search for new
partnerships, investors and other ways to recapitalize DSL.
[12]
Bell demanded payment of $195,000 in November
and December of 2001 and threatened disconnection of DSL’s services (Exhibit
A1, Tab 2). Without financing and with mounting debts, DSL made a proposal to
its creditors in February 2002 under the Bankruptcy and Insolvency Act
which was later approved by the Ontario Superior Court of Justice.
[13]
The Appellants
continued to search for new financing and, in October 2002, entered into
discussions with a company called Wiznet Inc. (“Wiznet”). Wiznet was run by
Fraser and Jeff Mason, two chartered accountants. The Appellants agreed to a
merger between DSL and Wiznet and, in November 2002, Wiznet acquired the assets
of Velocet and DSL. The Appellants became directors and shareholders of Wiznet.
Acting on the advice of Fraser Mason, DSL and Velocet defaulted on the proposal
to creditors and, in March 2003, made an assignment in bankruptcy. The intent
was for Wiznet to purchase the assets of Velocet and DSL for $185,000. The
Appellants’ understanding was that this was an amount “…CRA would be happy
with…” (Transcript, page 35, lines 15 to 16). To raise the $185,000,
Wiznet entered into what Mr. Heaney described as a “cash call” (Transcript,
page 85, line 11). The Appellants contributed $85,000 by borrowing from Mr.
Gilbert’s parents. The balance was advanced by Fraser Mason, who now had
control over the company as a result of these actions.
Analysis:
[14]
Section 227.1 of the ITA
and section 323 of the ETA are nearly identical provisions. Subsections
227.1(1) of the ITA and 323(1) of the ETA both provide that where
a corporation has failed to remit amounts, the directors of the corporation will
be jointly and severally liable, together with the corporation, to pay those
required amounts. Subsections 227.1(2) and (3) of the ITA allow
directors to avoid this liability if they establish a defence of care,
diligence and skill in preventing the failure. The provisions state:
227.1 (1) 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 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) A director of a corporation 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 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 the subsection has
been proved within six months after the date of the assignment or bankruptcy
order.
(3) A director of a corporation 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.
[15]
Subsection 323(3) of
the ETA also establishes that directors may avail themselves of this
defence in the appropriate circumstances. It provides:
323. […]
(3) 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.
[16]
There is no dispute
that the Appellants were directors throughout the relevant periods. They were
inside directors who were personally involved in the daily management of the
corporate activities. This is not in issue. The question is whether the
Appellants can benefit from the due diligence defence provided by subsection
227.1(3) of the ITA and subsection 323(3) of the ETA. Case law
has established that inside directors face the greatest challenge in
establishing the due diligence defence. It is presumed that they are in the
best position to know the potential problems facing the corporation and have
the power to take appropriate preventative steps to deal with those problems.
The duty to act in a proactive manner respecting corporate remittances arises
where a director knows, or ought to know, of potential problems. However, as
Justice Sharlow noted at paragraph 14 in Smith v The Queen, 2001
FCA 84, [2001] F.C.J. No. 448, “… the standard is reasonableness, not
perfection”. If a director’s efforts are reasonable, but nonetheless
unsuccessful, a director may still be able to take advantage of the defence of
due diligence.
[17]
Case law now supports
that the standard of care imposed by subsections 227.1(3) and 323(3) is the
objective standard laid down by the Supreme Court of Canada in Peoples
Department Stores Inc. (Trustee of) v Wise, 2004 SCC 68, [2004] S.C.J. No.
64. The Federal Court of Appeal recently confirmed the standard of care in Buckingham
v The Queen, 2011 FCA 142, [2011] F.C.J. No. 616. At paragraph 34,
Justice Mainville stated:
34. … I agree with the trial judge that the
"objective subjective" standard set out in Soper
has been replaced by the objective standard laid down by the Supreme Court of
Canada in Peoples Department Stores. I come to this
conclusion in light of the language used in subsection 227.1(3) of the Income Tax Act and in subsection 323(3) of the Excise Tax Act, and also by applying the principle of the
presumption of coherence between statutes.
However, the use of an objective standard does not
imply that the particular circumstances of a director should be ignored:
… These circumstances must be taken into account, but must be
considered against an objective “reasonably prudent person” standard. …
(Buckingham, paragraph 39)
[18]
Although Respondent Counsel
relied on the recent Federal Court of Appeal decision in Buckingham, he
failed to note the similarities between the facts in the present appeals and
those in Buckingham, where Mr. Buckingham was determined to have
exercised due diligence for a particular portion of the relevant period. After
analyzing Mr. Buckingham’s efforts to secure new financing and the steps taken
to reduce expenses, Justice Webb of this Court found, among other things, that
Mr. Buckingham had been diligent respecting unremitted payroll deductions
until February 2003, but not subsequent to this date. The Federal Court of
Appeal held that the same analysis was required for GST remittances as for
payroll source remittances. However, Justice Webb’s finding that Mr. Buckingham
had been duly diligent until February 2003 was not challenged on appeal.
Consequently, Mr. Buckingham was liable only for GST and payroll remittances,
which the corporation failed to remit, after his efforts became focussed on “curing”
the failures to remit in February 2003. The Federal Court of Appeal clearly
indicated, however, that directors will not be duly diligent in circumstances
where they condone the continued operation of a corporation by diverting
employee source deductions and GST remittances to other purposes. This is
exactly what occurred in the present appeals at the end of 2000.
[19]
Until the end of 2000,
the Appellants had a reasonable belief that their efforts to reduce corporate
expenses and locate new funding sources would allow DSL to meet its
obligations, particularly its obligations to remit GST and payroll deductions.
Once they became aware of DSL’s financial problems, they took positive action
based on a reasonable belief that they could prevent DSL’s failures to remit.
They stopped advertising, changed product offerings, laid off employees,
reduced customer hours, worked with accountants, addressed receivables,
negotiated with Bell and continued to search for financing
sources. Mr. Heaney’s evidence established, and I am satisfied, that the
Appellants were pursuing measures to deal with DSL’s remittances and they exercised
care and diligence with a view to preventing DSL’s failure to remit these
amounts until the end of 2000. However, after 2000, the conduct of the
Appellants no longer met the standard required by subsection 227.1(3) and
323(3) because their efforts then turned to remedying DSL’s remittance
failures. At the end of 2000, the Appellants made a decision to have DSL pay Bell instead of meeting its remittance obligations. As
occurred in Buckingham, the Appellants, at this point, lost the benefit
of the due diligence defence.
[20]
By October 2000, DSL
was unable to meet its financial obligations and, by December 2000, Bell was demanding payment.
[21]
On cross-examination,
Mr. Heaney’s evidence was straightforward. He admitted that the directors chose
to pay Bell and not other DSL creditors, including the
CRA. The evidence is not clear as to the exact date of the Appellants’ decision
to do so, but this practice occurred throughout 2001. At pages 67 to 68 of the
transcript, the following exchange occurred on cross-examination:
Q. Had you or
anyone at DSL taken a decision to say, "We have to delay or not make our
remittances to CRA on time?" Was there an actual point where you or any of
the other management at DSL went to the payroll people and said, "Hold off
on cutting the cheque to CRA?” Do you remember if that was a decision taken and
communicated to the accounting and payroll people?
A. I am sure there had been.
(Transcript, page 67, line 20 to page 68,
line 3)
Q. … Were you
aware throughout 2001 that the CRA remittances and the GST amounts were not
being paid when they should have been and that, in fact, you were in arrears?
A. Yes.
Q. Would it be
fair to say that you let that situation continue and it was tolerated as a last
resort to keep the business alive?
A. That's correct.
We expected it to be temporary. We certainly did not expect it to carry on as
long as it did. …
(Transcript, page 68, lines 14 to 25)
[22]
It appears that the
amounts of required remittances were calculated at the relevant times, whether
or not DSL had the funds to make those remittances. On cross-examination, Mr.
Heaney stated the following:
Q. … Ms Gilbert
and Ms Watters, the payroll and Controller -- it would have been their role to
make these remittances of source deductions and GST, but they were under
instructions from DSL to hold off and not make these remittances for a period
of time. Is that right?
A. The CRA cheques
probably went into a file with other cheques that just could not be paid.
(Transcript, page 69, lines 9 to 17)
[23]
Although the evidence
does not pinpoint an exact date when the decision to not pay the corporate
remittances was made, it is reasonable to conclude from the evidence as a whole
that it happened at or near the end of 2000, probably shortly after Bell’s
first demand for payment of over $145,000 on December 22, 2000 and the second demand
on January 15, 2001. Therefore, at the end of 2000, the Appellants’ efforts
were no longer directed toward avoiding failures to remit and, instead, had
shifted to curing these failures.
[24]
Subsection 227.1(3) of
the ITA and subsection 323(3) of the ETA are similarly drafted
and must be analyzed and applied in a similar fashion. Consequently, the
Appellants are liable for the payroll source deductions which ought to have
been remitted in the taxation years 2001 and 2002, together with the net GST
amounts which ought to have been remitted quarterly in 2001, 2002 and 2003.
[25]
Finally, I want to
address an outstanding question that arose at the end of the hearing respecting
the amount of DSL’s outstanding liability. Although not raised in the Notices
of Appeal, one of the Appellants’ complaints concerning the assessments was
that they understood that the $185,000 raised in the bankruptcy proceedings
would be sufficient to satisfy DSL’s liability. The CRA appeals officer, Kimmo
Riihimaki, testified that he remembered not only receipt of the $185,000, but
also authoring correspondence to the Appellants explaining the receipt of this
payment and its application to DSL’s tax debts (Transcript, pages 109 to 111).
In fact, both Mr. Riihimaki and Respondent Counsel understood the amounts
listed in the Replies to the Notices of Appeal to be the outstanding amounts
owed by DSL (Transcript, page 112). However, the Appellants advised that they
had never received such a letter from Mr. Riihimaki. Further, it appears from
the Replies that the amounts at issue in these appeals are those which DSL
failed to remit during the relevant periods and not some smaller amounts which took
into account payments made as a result of bankruptcy proceedings.
[26]
At the end of the
hearing, I requested that Respondent Counsel investigate this issue,
particularly in light of Mr. Riihimaki’s testimony, and report back to me. In
the Respondent’s response to this Court, Mr. Riihimaki recanted his testimony
and suggested that his evidence under oath respecting the $185,000 payment was
incorrect. It appears that, while Mr. Riihimaki was testifying before me
respecting these appeals, his attention was directed elsewhere and he was,
instead, thinking of “… a similar albeit completely separate taxpayer appeal
file he had worked on” (letter of Respondent Counsel, dated July 4, 2001).
[27]
Attached to the
Respondent’s letter of July 4, 2011 was an affidavit of Colette Ouimet, Mr.
Riihimaki’s team leader, confirming that the CRA had no record of the $185,000
payment.
[28]
The Appellants’
response contained copies of two cheques dated 08‑01‑06 confirming
payments of $45,199.29 and $2,398.69 to the Receiver General, together with a
statement of the Trustee in Bankruptcy confirming that a payment of $45,199.29
was to be paid to the CRA respecting these remittances. The problem with these
additional documents is that they were not introduced into evidence during the
hearing.
[29]
In a further response
dated September 7, 2011, the Respondent submitted statements of account
containing dates and amounts of any payments received by the CRA in respect to
DSL’s liability. These statements show no record of a payment of $185,000 but
do record a payment of $45,199.29 received on August 11, 2006 respecting the payroll
account.
[30]
Such statements of
account were not absolutely necessary for the purpose of reaching my decision
in these appeals because the Appellants will be jointly and severally liable
for DSL’s failures to remit in 2001, 2002 and 2003 whatever that liability is.
It is unusual for this Court to immerse itself in the details of how much a
taxpayer paid and when. However, it seems to me to be both just and reasonable
that the Appellants and this Court have a clear statement of the amounts that
ought to have been remitted and the actual amounts received by CRA.
[31]
Based on my conclusion
in these appeals that the Appellants exercised the requisite standard of due
diligence until the end of 2000, I am not allowing an award of costs. Even if I
had decided otherwise and dismissed these appeals entirely, I would feel
justified in exercising my discretion pursuant to Rule 147 of the Tax Court
of Canada Rules (General Procedure) to not award costs. The Respondent
added unnecessarily to both the duration and complexity of these appeals. He decided
to call and rely on a witness who incorrectly purported to have some memory of
events relevant to the appeals and who testified under oath, without the
benefit of any supporting documents or notes accompanying him in Court, that the
CRA was in receipt of $185,000 and that he had forwarded correspondence to the
Appellants that confirmed receipt of this amount. Clearly, none of this was
correct.
[32]
The appeals are allowed
on the basis that the Appellants are not liable as directors of DSL pursuant to
section 227.1 of the ITA and section 323 of the ETA for the
amounts that DSL failed to remit for the period prior to the end of 2000. The
Appellants are liable as directors of DSL, however, for those amounts the
corporation failed to remit for the relevant periods after the end of 2000. Penalties
and interest must be adjusted accordingly. I am making no award of costs.
Signed at Ottawa, Canada, this
3rd day of October 2011.
“Diane Campbell”
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