Citation: 2010 TCC 423
Date: August 11, 2010
Docket: 2008-2992(GST)I
BETWEEN:
RICHARD ALEXANDER ARSIC,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Campbell J.
[1]
The Appellant was a
director of Industrial Electrical Group Inc. (“IEG”), which was assessed on May
10, 2000 for a failure to remit net tax in respect to the periods ending August
31, 1998, November 30, 1998 and February 28, 1999. On July 23, 2007, the
Appellant was assessed pursuant to section 323 of the Excise Tax Act
(the “Act”) for net tax, penalties and interest. Subsection 323(1)
imposes liability upon a director, such as the Appellant, for a corporate
failure to remit net tax as required by subsection 228(2) of the Act. Subsection
323(1), as it related to these periods, provided:
323. (1) Liability of directors – Where a
corporation fails to remit an amount of net tax as required under subsection
228(2) or (2.3), the directors of the corporation at the time the corporation
was required to remit the amount are jointly and severally liable, together
with the corporation, to pay that amount and any interest thereon or penalties
relating thereto.
[2]
The primary issue is
whether the Appellant exercised the degree of care, diligence and skill to
prevent IEG’s failure to remit its net tax that a reasonably prudent person
would have exercised in comparable circumstances. This is commonly referred to
as the due diligence defence and if the Appellant can show he exercised the
required diligence then he can avail himself of the defence provided in subsection
323(3). It states:
323 … (3) Diligence – 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.
[3]
The Appellant also
raised the following Charter issues in the Notice of Appeal: whether the
Appellant’s rights to security of person under section 7 of the Canadian
Charter of Rights and Freedoms (“Charter”) and the right to be free
of unreasonable search and seizure under section 8 of the Charter have
been violated. These Charter issues need only be addressed if I conclude
that the Appellant cannot avail himself of the due diligence defence under subsection
323(3) of the Act.
[4]
The Appellant graduated
from St. Clair College in 1982 with an electronic technician’s diploma.
Following this he took a four year electrician program. For many years the
Appellant worked for different companies in the automation control industry. In
1990, he started his own business designing electrical control systems for
automated processing machinery, such as beverage bottling equipment. In 1992, he
incorporated Sevran Automation Group Inc. (“Sevran”) for which he was the sole
director and shareholder. Sevran never carried on business as it was formed to
conduct work for a specific client but the contract never materialized. He testified
that, when he operated his own business, he understood his obligations as a
director to collect and remit goods and services tax (“GST”) but as he had no
bookkeeping background or experience, he always relied on others and, in
particular, his accountant, Peter Williams, to complete all of the financial
and accounting aspects of his business, including remitting GST.
[5]
In late 1996 or early
1997, the Appellant met Edward Galick, who operated a company called EDJ
Packaging and Conveyors Inc. (“EDJ”). EDJ purchased, refurbished and resold
used packaging equipment. Since both individuals had complimentary strengths in
manufacturing, automation and supply of automated packaging equipment, they
began a joint business venture. Under this arrangement, EDJ continued its
business of refurbishing used packaging equipment for sale and the Appellant
worked in the field installing and wiring related electrical controls. They
used the Appellant’s dormant company, Sevran, for this business venture,
changing the name to IEG on August 28, 1997.
[6]
IEG operated out of the
EDJ business premises and by agreement used EDJ’s bookkeeper,
Trudy McClaskin. The Appellant testified that he directed Ms. McClaskin
to change and file the corporate documents of IEG to reflect that both the
Appellant and Mr. Galick were equal shareholders and directors, but only the
company name was changed and the Appellant remained as the sole shareholder and
director of IEG. When he later discovered that Mr. Galick had not been added as
a director, both he and Mr. Galick instructed Ms. McClaskin to file the
appropriate documentation. The Appellant never followed up again on
Ms. McClaskin’s actions as he thought she would comply with these
instructions. He found out that he was the sole director on the corporate
records in June of 2000 after he became aware of the remittance problems.
According to his testimony, he believes that Mr. Galick instructed the
bookkeeper not to change the directors of IEG.
[7]
The Appellant testified
that he and Mr. Galick were each to have a fifty per cent interest in IEG,
that Mr. Galick would be President with the Appellant as Vice-President, that
Mr. Galick would oversee the day-to-day operations of IEG from the EDJ premises
and manage the employees, including the bookkeeper, that the Appellant would work
in the field and that both signatures would be required on all cheques. The
accountant, Mr. Williams, confirmed that he attended a meeting with the
Appellant and Mr. Galick on February 25, 1998 where discussions occurred in his
presence confirming the aforesaid arrangements. In essence, Mr. Galick
agreed to oversee IEG’s day-to-day activities at the EDJ premises including
providing business leads and the Appellant agreed to provide the electrical
expertise at the work sites.
[8]
In addition to the
testimony of the Appellant and the corroborating evidence of Mr. Williams, the
banking documents of IEG suggest that Mr. Galick was a director in law if not
on the corporate records. Although the banking resolution listed Mr. Galick as
Vice-President and not President, the documents as a whole support that the
intent was that Mr. Galick would be an officer and President of IEG and would have
signing authority.
[9]
The source deduction
and GST remittance forms for IEG were completed by Ms. McClaskin, the
bookkeeper for both IEG and EDJ. She testified that she prepared the financial
reports for IEG and that Mr. Galick reviewed them but she did not recall if she
ever showed them to the Appellant. Although the Appellant attended at the IEG premises
on most occasions to sign cheques, Ms. McClaskin sometimes went to the work
sites to have the Appellant sign the cheques. According to the Appellant, he
attended at the premises between two to four times per month to review a folder
of payables prepared by Ms. McClaskin and sign the cheques accompanying the
invoices and remittance statements. Ms. McClaskin’s evidence confirmed this
arrangement.
[10]
The Appellant stated
that he never gave instructions to the bookkeeper except to instruct her to
remit GST. Ms. McClaskin testified that it was Mr. Galick who directed her on a
day-to-day basis and that he would instruct her on whether or not to send
invoices and bills. He also directed her to move money between the IEG and EDJ
accounts. She also stated that Mr. Galick would sometimes instruct her not to
forward cheques that the Appellant had already signed.
[11]
Mr. Williams, who began
working for the Appellant in 1993, testified that he always did all of the
accounting aspects of the Appellant’s business activities. He assisted Ms.
McClaskin with bookkeeping at EDJ beginning in late 1997 and, under the
direction of Mr. Galick, he also assisted her with IEG’s books. He prepared
IEG’s corporate returns and helped Ms. McClaskin occasionally with the GST
reports. He prepared IEG’s corporate return for 1999 after it ceased operations,
as well as the GST forms for that year.
[12]
By the end of 1998 or
January 1999, IEG had ceased operations. The Appellant thought IEG was doing
well because he was busy doing work for customers and money was coming in.
However, IEG was being cash starved over its short life span, because funds
were being diverted from IEG to EDJ. The Appellant later determined that Mr.
Galick had engaged in actions which had serious impact upon the company’s
finances. The Appellant also alleged that, without his knowledge, Mr. Galick
diverted funds, including GST remittance funds, from IEG to himself or his
company, EDJ. Invoices sent to IEG’s clients were also being reversed and
replaced by invoices from EDJ, although the actual work had been completed by
the Appellant. When the invoice was reversed, it stopped any potential payment
to IEG and redirected those funds to EDJ.
[13]
The Appellant testified
that he believed GST remittances and source deductions were being made consistently
because he was reviewing the remittance forms and signing the cheques. All of
the business and accounting records of IEG always remained in the possession of
Mr. Galick at the EDJ premises. When IEG ceased operating, the Appellant
requested the books and records from Mr. Galick on numerous occasions but was
told the documents plus a computer containing IEG’s records were missing after
an alleged break-in. He sought the assistance of Mr. Williams who was able to
complete final GST remittance forms from back-up documents he had retained in an
off-site computer. On March 18, 1999, the Canada Revenue Agency (“CRA”) sent a
Reminder Notice for overdue GST returns to the IEG offices. The Appellant
testified that he never saw this letter until a later date and that he first
became aware of the remittance problems when he received correspondence from the
CRA at his home later in 1999. On cross-examination, he testified that the
first official letter he received from the CRA regarding GST was on February
25, 2000 but he had discussions prior to this date, presumably with Bill Haire
from the CRA.
[14]
The Appellant and Mr.
Galick met with Mr. Haire on July 30, 1999 to discuss IEG remittance failures
and both agreed to pay the past due amount by post‑dated cheques. After
the first cheque was cashed, the Appellant became aware that there were
insufficient funds in the account so he contacted Mr. Haire and requested that
he not cash the remaining cheques. He then pursued further discussions with Mr.
Galick and they each agreed to send cheques to the CRA, splitting the amount
owed equally between them. The Appellant followed through on his part of this arrangement
but it appears that Mr. Galick did not pay his share.
[15]
The Appellant testified
that since the CRA never communicated with him between October 22, 2002 and
October 2006 he never thought that he was personally liable for the remaining
outstanding remittance amounts and he thought that the CRA was pursuing EDJ and
Mr. Galick. The Appellant discovered, during a meeting with the CRA in 2007,
that Mr. Galick had gone bankrupt in 2006.
[16]
The Federal Court of
Appeal in Soper v. The Queen, [1997] F.C.J. No. 881, 97 D.T.C. 5407, reviewed
the standard of care to be employed for determining whether a director has been
duly diligent in order to escape liability when the corporation fails to remit
tax. Although the Court in Soper was considering the ambit of subsection
227.1(3) of the Income Tax Act, the wording in that provision is almost
identical to the analogous subsection 323(3) of the Act. In describing
the standard of care as objective/subjective, at paragraphs 40 and 41,
Robertson J. made the following comments:
[40] For example, in some
instances the relevant issue will be whether an individual was in fact or in
law a director at the relevant time for purposes of imposing personal liability
or whether that individual ceased to hold office by operation of a valid
resignation. In other cases, such as those involving bankruptcy and
receivership, the central issue will be de jure control. Yet another cluster
of cases, including situations in which a dominant director is able to limit
others' influence over corporate affairs, will deal with de facto
control. I intend to focus on the category of cases respecting the distinction
between inside and outside directors since that line of authority is the most
pertinent to this appeal.
[41] At the outset, I wish to
emphasize that in adopting this analytical approach I am not suggesting that
liability is dependent simply upon whether a person is classified as an inside
as opposed to an outside director. Rather, that characterization is simply the
starting point of my analysis. At the same time, however, it is difficult to
deny that inside directors, meaning those involved in the day-to-day management
of the company and who influence the conduct of its business affairs, will have
the most difficulty in establishing the due diligence defence. For such
individuals, it will be a challenge to argue convincingly that, despite their
daily role in corporate management, they lacked business acumen to the extent
that that factor should overtake the assumption that they did know, or ought to
have known, of both remittance requirements and any problem in this regard. In
short, inside directors will face a significant hurdle when arguing that the
subjective element of the standard of care should predominate over its
objective aspect.
As noted by Bowie J. in Stafford v. The Queen, 2009
TCC 247, [2009] T.C.J. No. 180, at paragraph 14:
[14] …
That
decision [Soper] has since been reaffirmed by the Federal Court of
Appeal in Canada v. McKinnon and again in Hartrell v. The Queen. Directors are not held to the
standard of trustees. Mr. Stafford, of course, is an inside director, but even
as such he is not an insurer. The appropriate standard of care was described by
Robertson J.A. at paragraph 22 of Soper as that
"... expected from a person of his or her knowledge and experience."
…
[17]
The Federal Court of
Appeal again reviewed the standard of care imposed upon directors pursuant to subsection
323(1) in Smith v. The Queen [2001] F.C.J. No. 448, 2001 D.T.C. 5226. At
paragraphs 12 to 14, Sharlow J. discussed the implications of being an “inside
director” as opposed to an “outside director”:
[12] The inherent flexibility
of the due diligence defence may result in a situation where a higher standard
of care is imposed on some directors of a corporation than on others. For
example, it may be appropriate to impose a higher standard on an "inside
director" (for example, a director with a practice of hands-on management)
than an "outside director" (such as a director who has only
superficial knowledge of and involvement in the affairs of the corporation).
[13] That is particularly so
if it is established that the outside director reasonably relied on assurances
from the inside directors that the corporation's tax remittance obligations
were being met. See, for example, Cadrin v. Canada (1998), 240 N.R. 354, [1999] 3 C.T.C. 366, 99 DTC 5079 (F.C.A.).
[14]
In
certain circumstances, the fact that a corporation is in financial difficulty,
and thus may be subject to a greater risk of default in tax remittances than
other corporations, may be a factor that raises the standard of care. For
example, a director who is aware of the corporation's financial difficulty and
who deliberately decides to finance the corporation's operations with
unremitted source deductions may be unable to rely on the due diligence defence
(Ruffo v. Canada, 2000 DTC 6317 (F.C.A.)). In every case, however, it is
important to bear in mind that the standard is reasonableness, not perfection.
These comments are particularly pertinent to the
present appeal.
[18]
Contrary to the
Respondent’s submissions, I do not believe that the Appellant was an inside
director. He had no involvement in the day-to-day management of IEG. He was
working out in the field and attended at the IEG premises only when cheques
needed to be signed. He relied on the expertise of Mr. Galick and his
bookkeeper, Ms. McClaskin, to oversee the proper administration and management of
IEG. Although the Appellant was an officer and director of IEG and listed as
the only director on the corporate records, the evidence of all witnesses
supports the Appellant’s evidence that the intention was that Mr. Galick would
also be a fifty per cent owner and director of IEG. In fact, the almost
absolute control which Mr. Galick had over IEG’s activities is clearly
supported by the testimony of Ms. McClaskin. She took direction from Mr.
Galick, not the Appellant, and followed his instructions to redirect invoices
and funds to Mr. Galick’s own corporation, EDJ. Under Mr. Galick’s direction,
she did not forward cheques that the Appellant had signed and which he assumed
had been mailed or delivered. The Appellant’s evidence was that Ms. McClaskin
would not respond to any of his directives unless Mr. Galick first approved of
these.
[19]
Since the Appellant was
an outside director of IEG, the standard to be applied is a less stringent one
in these circumstances. The Appellant knew his limitations respecting his lack
of knowledge, education and experience with the financial and administrative
aspects of business activities. He had a history of relying on the expertise of
others to complete these aspects while he focussed on the technical side of the
electrical automation trade. His competence was in that aspect of the business.
He recognized that certain financial obligations had to be met, such as
remittances, and he always depended on Mr. Williams prior to engaging in the
business venture with Mr. Galick. After IEG began operating, he then properly
relied, as he was entitled to do, in making an informed and prudent business
decision, upon Mr. Galick, Ms. McClaskin and Mr. Williams. This was confirmed
by the testimony of both Ms. McClaskin and Mr. Williams. It is clear from all
of the evidence that Mr. Galick was the directing mind of IEG. He was a daily
presence at the business premises, made all the decisions, provided direction
to the bookkeeper and other employees and maintained the books and records. Mr. Galick
controlled all of the finances of IEG with the exception of the requirement of
the Appellant’s signature on cheques.
[20]
The Appellant knew the
corporate responsibilities concerning source deductions and remittances. To
ensure those obligations were being met and while acknowledging his limitations
in this area, he placed reliance on the practice he had of reviewing the
cheques together with the accompanying invoices and remittance statements
provided to him by IEG’s bookkeeper. He also knew that Mr. Williams assisted the
bookkeeper from time to time. He spent his time in the field and trusted
Mr. Galick with overseeing the day-to-day operations of IEG. He had no
reason to follow up to ensure that cheques were in fact being mailed after he
signed them because he trusted his partner, Mr. Galick, and he had no reason to
question the bookkeeper’s actions. It is not clear from the evidence that the
Appellant had access to the financial records but the lack of scrutiny of these
records by the Appellant was reasonable because the business was thriving,
money was coming in and the Appellant was busy in the field. Even if he had
looked at the records periodically, without any expertise or training in the
financial aspects, he may not have been able to detect possible suspicious
entries and problems. There is sufficient case law to support that the
Appellant will not be in breach of the standard of care imposed upon him as an outside
director of IEG, where he has permitted delegation of corporate remittance
obligations to apparently competent and experienced company officials and where
no suspicions of remittance problems exist. There is no imprudent behaviour on
the Appellant’s part in relying not only on his business partner, whom he
trusted and who had expertise in the managerial side of the business, but also on
a bookkeeper and an outside accountant. He also had prior dealings with Mr.
Williams in corporate operations in which he was involved. There were no
suspicious circumstances that would have caused the Appellant to question the
GST remittances. The business appeared to be busy and turning a profit, there
was a dual signing requirement on all cheques and other individuals, whom he
trusted, were available and giving the appearance of attending to the financial
aspects of IEG, where the Appellant had little or no skills. In these circumstances,
and without any indication of possible remittance problems, I do not believe
that the Appellant was required to confirm that the cheques were being cashed
by the Receiver General for Canada as the Respondent suggests.
[21]
Based on the evidence
before me, I conclude that, even after the Appellant became aware of Mr. Galick’s
mismanagement of corporate funds and his manipulation of IEG’s invoices, he
still had no reason to suspect that remittances were not current. It was
reasonable for him to expect that the cheques for GST remittances that he had
signed had been mailed after he signed them. Notice of the failure to remit
apparently first occurred on March 18, 1999 when the CRA sent a reminder notice
respecting overdue GST returns. The Appellant testified that he never saw this
letter probably because it went to the IEG premises where Mr. Galick
controlled the records. The evidence suggests that the Appellant first became
aware of the potential remittance problems several weeks prior to his meeting
with Bill Haire on July 30, 1999. Consequently, the Appellant’s knowledge of
the remittance problems occurred subsequent to the actual failure to remit by
IEG. The actions he took as an outside director, throughout the life of IEG’s
activities to ensure that GST remittances remained current, were in line with
that of a person with his level of knowledge and skill in financial and
accounting aspects. Because the evidence suggests that the Appellant became
aware of the remittance problems only when he was contacted by Mr. Haire, there
is no expectation of a positive duty to act on the Appellant’s part because
there would be little, if any, opportunity for him to be proactive in these
circumstances. In the end, I must attempt the difficult task of determining
what a reasonably prudent person should have done or would have done in
circumstances comparable to those in this appeal. It remains a question of fact
tempered with a good dose of even-handed common sense. It is always easy to
criticize the choices of a taxpayer when armed with the benefit of hindsight.
However, I believe that the Appellant’s course of action, which he relied upon
to ensure IEG’s remittances were paid, was reasonable in the circumstances and
a course which other reasonably prudent people might be expected to choose if
placed in a similar situation.
[22]
There is no doubt that
the Appellant acted honourably throughout. He cooperated with the CRA after the
failure, supplying post-dated cheques for his half share of the net tax owing,
as well as informing the CRA of incoming payments to IEG which the CRA could
access. However, these actions were taken to remedy past defaults and were not
actions taken to prevent the failure to remit by IEG. Consequently, I have not
given consideration to those actions in determining that he can avail himself
of the due diligence defence pursuant to subsection 323(3) of the Act.
In addition, because the Appellant has been successful, there is no need for me
to address the Charter issues which were raised.
[23]
The appeal is allowed
with costs and the assessment is vacated on the basis that the Appellant is not
liable pursuant to subsection 323(1) for payments that IEG was required to
remit on account of net tax as he has satisfied the due diligence provision
contained in subsection 323(3).
Signed at Charlottetown, Prince Edward Island, this 11th day of August 2010.
“Diane Campbell”
Email this Content