Citation: 2010 TCC 444
Date: 20100826
Docket: 2009-358(GST)I
BETWEEN:
GARY USTEL,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
AND
Docket: 2009-1443(IT)I
GARY USTEL,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
Introduction
[1]
The Minister of
National Revenue (the “Minister”) assessed Gary Ustel (the “Appellant”)
under section 323 of the Canada Excise Tax Act (the “ETA”) for
unremitted goods and services tax (“GST”) plus interest and penalties relating
thereto (the “GST assessment”) owed by Peachtree Gallery Art and Frame Shop
Inc. (the “Corporation”). In support of the GST assessment, the Minister
alleges that the Appellant was either a de jure or a de facto director
of the Corporation at the time of the assessment or at some point during the 24‑month
period preceding the assessment dated February 22, 2008 (the “Relevant Period”).
In addition, the Minister assessed the Appellant under subsection 160(2) of the
Federal Income Tax Act (the “ITA”) for income tax, penalties and
interest owed by the Corporation (the “ITA assessment”). In support of
the ITA assessment, the Minister alleges that, at a time when the
Corporation had unpaid income taxes under the ITA, the Appellant
received dividends aggregating $85,000 on shares that he held in the Corporation.
The appeals from the GST assessment and the ITA assessment were heard on
common evidence.
[2]
In his appeal with
respect to the GST assessment, the Appellant argues that at no time during the Relevant
Period was he a de jure director of the Corporation nor did he act as a de
facto director of the Corporation. With respect to his appeal from the ITA
assessment, the Appellant alleges that he received only income with respect to
services rendered to the Corporation. According to the Appellant, the
Corporation’s external auditor, Mr. MacDonald, reported incorrectly that
the Appellant had received dividends on the shares that he held in the
Corporation.
Factual Background
[3]
The Corporation was
incorporated in the province
of Ontario under the Ontario
Business Corporations Act (the “OBCA”) on September 25, 1991 for
the purpose of owning and operating a retail business selling prints and providing
picture‑framing services (the “business”). The business was started by
the Appellant and two close personal and family friends, Mr. and
Mrs. Pacheco. The evidence shows that the Appellant had prior experience
in the sale of picture frames and printed art work and in the operation of such
a business. Mr. Pacheco purchased 50% of the common shares of the
Corporation for $100,000. The Appellant acquired 50% of the common shares of
the Corporation in consideration of the skills that he brought to the operation
of the business.
[4]
The Appellant and his
wife and Mr. Pacheco and his wife were named directors of the Corporation
following its incorporation. At the same time, the Appellant became the president
of the Corporation and Mr. Pacheco became its secretary.
[5]
The evidence shows that
in the early years following the incorporation the Appellant handled sales and
performed administrative and financial duties for the business. Mrs. Pacheco
also handled sales and carried out administrative duties. Mr. Pacheco
worked in the back of the store as a manual worker assembling picture frames
and mounting art work.
[6]
The Appellant testified
that in the late 1990’s the business faced stiff competition from big box
stores such as Walmart, Rona and Home Depot, and it quickly encountered
financial difficulties. Mr. Pacheco was required to invest an additional
$35,000 to cover mounting losses.
[7]
Mr. Pacheco,
testifying at trial, corroborated the Appellant’s explanation of the
circumstances that led to the financial deterioration of the business. He added
an additional factor that was not mentioned by the Appellant. According to Mr. Pacheco,
the Appellant owned a Harley Davidson motorcycle (the “Harley”) that he was
fond of riding. Sometime in 1999, the Harley was stolen from the parking lot
located at the front of the store. According to Mr. Pacheco, the
Appellant’s behaviour quickly changed after he had become the victim of that criminal
act. He was frequently absent from work, and when he was there he would often refuse
to meet with clients. Mr. Pacheco believed that the Appellant was
suffering from severe depression. The Appellant’s and the Pachecos’
relationship deteriorated with the downturn in the business. The Appellant
testified that it became obvious that Mr. and Mrs. Pacheco and he could no
longer work together.
[8]
The Appellant alleges
that he met with Anna Pacheco on May 6, 2002 and gave her a copy of a
letter signed by him wherein he tendered his resignation as a director and
officer of the Corporation effective May 30, 2002. The Appellant explained
that he then informed Mr. MacDonald, the external auditor who looked after
the Corporation’s books and records and filed its tax returns, of his decision
to leave the management and administration of the business to Mrs. Pacheco.
On June 1, 2002, Mr. MacDonald’s staff filed Form 1 with the
Minister of Consumer and Business Services, removing the Appellant’s wife as a
director (she was not an officer), removing the Appellant as president and
removing Mr. Pacheco from the positions of secretary and director. The
Appellant alleges that Mr. MacDonald inadvertently failed to remove him as
a director because he had entrusted the work to a junior staff member. The
Appellant also alleges that Mr. MacDonald made numerous other errors in
looking after the minute books and filing the tax returns of the Corporation.
He believed that Mr. Pacheco and his wife and he himself were paid
salaries and wages for the services they rendered in the business and that Mr. MacDonald
took it upon himself to report these wages as dividends paid to the
co-shareholders. He claims that he did not understand the tax‑filing method
adopted by Mr. MacDonald, but trusted him to get it right.
[9]
At trial, Mr. Pacheco
made a similar comment during his testimony with respect to the tax filings of
the Corporation. According to Mr. Pacheco, he and the Appellant each
earned $500 a week for their work in the business. Mr. Pacheco and his
wife Anna would receive $250 each per week when they both worked in the business.
His wife was not a shareholder in the Corporation, therefore she could not
receive a dividend.
[10]
The Appellant produced
corroborating documentary evidence supporting his claim that he resigned as a
director of the Corporation effective May 30, 2002. On July 8, 2002,
a short time after the Appellant’s resignation as a director became effective
(May 30), Mrs. Pacheco applied for a new business account − with
electronic banking access and a small business overdraft facility − with
the CIBC branch in Oakville. The documents pertaining thereto were
introduced as Exhibit A‑3. The electronic banking application indicates
that Mrs. Pacheco was the sole person authorized to have access to the
corporate account. The overdraft application indicates that Mrs. Pacheco’s
ownership interest in the Corporation was 100%.
[11]
The agent for the Appellant
called Mr. and Mrs. Pacheco as witnesses. He did so with great reluctance
as it appears that the Canada Revenue Agency (“CRA”) has issued a similar GST
assessment against Mrs. Pacheco and an income tax assessment based on
subsection 160(2) against Mr. Pacheco. At trial, Mrs. Pacheco’s demeanour
suggested that she was well aware of the fact that it was in her best interest
to claim that the Appellant remained a director of the Corporation during the
Relevant Period. At times she claimed that she did not recall receiving the
Appellant’s resignation letter. Yet she appeared to acknowledge that she did
sign the banking documents that gave her sole authority over the banking
affairs of the Corporation following the Appellant’s resignation. Mr. Pacheco’s
testimony on the mental state of the Appellant and his apparent lack of interest
in the business buttresses the Appellant’s claim that he resigned as a director
on May 30, 2002. Finally, the Respondent’s counsel admitted that he
received a copy of the Appellant’s resignation letter from Mr. MacDonald’s
accounting firm. The fact that Mr. MacDonald’s firm had the letter suggests
to me that the Appellant did formally resign as a director and that Mr. MacDonald
should have been aware of that fact.
Analysis: GST Assessment
[12]
The ETA does not
define when a person ceases to be a director. As the Corporation was
incorporated under the OBCA, the provisions of that statute are relevant
in determining when the Appellant ceased to be a director of the Corporation. Subsection 121(2)
of the OBCA provides that a resignation of a director becomes effective
at the time a written resignation is received by the corporation or at the time
specified in the resignation, whichever is later. In light of the evidence
noted above, the Appellant has established on a balance of probabilities that
he did formally resign in writing in a letter that was received by another
officer of the Corporation. As a result, he ceased to be a de jure
director of the Corporation on May 30, 2002.
[13]
This brings me to a consideration
of the Respondent’s alternative argument that the Appellant remained a de
facto director of the Corporation during the Relevant Period because his
conduct was similar to the conduct of a person who was qualified to act as a
director of the Corporation. The Respondent points out that the Appellant acknowledges
that he signed the 2002 and 2003 tax returns of the Corporation. The Appellant
is described as a director of the Corporation next to the signature line on
those tax returns. The Respondent argues that this conduct coupled with the
fact that the Appellant was not removed as a director in the Corporation’s
official record created a bona fide belief on the part of the Minister
and his delegates that the Appellant was a director of the Corporation.
According to the Respondent, it was incumbent upon the Appellant to dispel this
belief after displaying conduct which would have led a reasonable person to
believe he was a properly qualified director of the Corporation. He should therefore
be barred from raising as a defence to the assessment the argument that he was
not a legally qualified director during the Relevant Period.
[14]
I accept the
Appellant’s submission that the failure of the Corporation to register with the
competent authorities any change regarding the directors is not fatal to his claim
that he resigned as a director.
However, it is a well‑established principle of Canadian law that one
cannot avoid liability for actions purported to have been carried out by one as
a director by arguing that one was not legally qualified to act in that
capacity.
The Appellant complains that it is entirely Mr. MacDonald’s fault that he
signed the Corporation’s 2002 and 2003 tax returns filed with the CRA and that
next to the signature line on those returns it is stated that he was a director
of the Corporation.
[15]
The Appellant admitted
that he resigned as a director, inter alia, to limit his liability for
the Corporation’s unpaid tax liabilities. It is true that it was not entirely
within the Appellant’s powers to ensure that the Corporation duly filed a
notice confirming his resignation with the competent provincial authority. That
is one thing; however, it is entirely another thing to sign a tax return on the
same line that states your position to be that of director. The Appellant
should have read what he was signing, and to the extent that his position with
the Corporation had changed, he should have pointed it out to Mr. MacDonald
so that he could have the change registered.
[16]
The above finding,
however, does not dispose of this matter. The Appellant signed the 2002 and
2003 tax returns on July 31, 2003 and September 14, 2004 respectively.
The GST assessment was issued on February 22, 2008, more than two
years after the second of those two tax returns was signed. The argument can therefore
be made that the taxpayer ceased to act as a de facto director on or
about September 14, 2004.
[17]
In my opinion, the
evidence in the record does not support such a contention. The Appellant
admitted that he remained active in the actual operation of the business after
he resigned. At no time prior to the issuance of the GST assessment did the
Appellant take any steps to advise the CRA that he had ceased to be a director
of the Corporation. The evidence shows that the Appellant’s son and a business
partner operated a similar business under the Peachtree name (the second Peachtree
business). The Corporation ceased operating its business in late 2004 or
thereabouts. However, the Corporation itself remains in existence today. No
steps have been taken by the shareholders to dissolve it.
[18]
It would make a mockery
of the indoor management rule to allow the Appellant to escape liability under
section 323 of the ETA when the evidence shows that he did not take
proactive steps to ensure that his resignation was publicized in the corporate
records and that he continued to hold himself out as a director by signing the
Corporation’s tax returns in his alleged capacity as director. It would be
inappropriate to accept that the onus should fall upon the CRA to verify
whether the taxpayer may have secretly resigned or to enquire on a continuing
basis into whether the taxpayer’s conduct is indicative of the fact that the
situation may now have changed. In my opinion, the onus to adopt appropriate
conduct and to prove that he was not a director fell squarely on the
Appellant’s shoulders.
[19]
It was incumbent upon
the Appellant to establish on a balance of probabilities that he ceased to act
as a so‑called de facto director of the Corporation after September 14, 2004.
The CRA had reasonable grounds to believe that he continued to serve in that
capacity and the Appellant should have taken steps to disabuse the CRA of that
belief.
[20]
Accordingly, I find
that the Appellant has failed to establish that he was not a director of the
Corporation during the Relevant Period. Consequently, the Appellant’s appeal
against the GST assessment is dismissed.
Analysis: Income Tax Assessment
[21]
The Appellant was
assessed under section 160 of the ITA, which provides that
the transferee (in this case, the Appellant) and transferor (in this case, the
Corporation), if they are not dealing at arm’s length, are jointly and
severally liable to pay the transferor’s tax up to an amount equal to the
lesser of (a) the amount by which the fair market value of the property at the
time it was transferred exceeds the fair market value at that time of the
consideration given for the property, and (b) the amount of the transferor’s
tax liability (defined as all amounts owing under the ITA) for the taxation
year in which the property was transferred or a preceding taxation year.
[22]
In her pleading the
Respondent alleges that during its taxation years ended September 30,
2001, September 30, 2003 and September 30, 2004 the Corporation
declared and paid to the Appellant dividends in the amounts of $18,000, $24,000
and $43,000 (the “dividends”) respectively when the Corporation owed $1,917.18,
$9,841.25 and $12,892.87 for its 2001, 2003 and 2004 taxation years
respectively. The Appellant argues that the Corporation did not pay any dividends
to him on the shares he owed and, in the alternative, if it did, he received
only the amount of $7,500 in the Corporation’s 2004 taxation year, and so he
was liable only for that amount.
[23]
In her pleading the
Respondent admits that the Appellant reported nil income for his 2001 taxation
year, $13,300 of employment income for his 2002 taxation year, $30,000 of
dividend income for his 2003 taxation year and $7,500 of net business income
for his 2004 taxation year.
[24]
The Appellant testified
that John MacDonald prepared his personal tax returns along with those of the
Corporation. On cross-examination, the Appellant admitted that his wife, Judy
Ustel, declared dividend income of $22,500 paid to her by the Corporation although
she was not a shareholder. He agreed that that income belonged to him. It is
clear from this evidence that Mr. MacDonald made numerous mistakes in
preparing the corporate returns of the Corporation and the personal tax returns
of the Appellant. The characterizations of the income are inconsistent. Mr. Pacheco
and Mr. Ustel both testified that they received employment or business
income in 2003 and 2004.
[25]
While the evidence is
not perfect, I find, on the basis of the testimony of the two witnesses, that the
Appellant has succeeded in establishing on a balance of probabilities that he
did not receive dividends for 2003 and 2004 on his shares in the Corporation.
In view of the financial situation of the Corporation, it is doubtful that it
could have paid dividends while meeting the corporate solvency test applicable
in those years.
[26]
More importantly,
dividend income is taxed at a lower effective tax rate than employment and
consulting income because of the gross‑up and dividend tax credit
mechanism. It is highly improbable that the Appellant would have had himself taxed
on employment and consulting income if it was intended that he receive dividend
income. On this basis, I conclude that the Corporation did not pay the
Appellant dividends on his shares for the 2003 and 2004 taxation years.
[27]
The Appellant elected
to have his appeal heard under subsection 17(2) of the Tax Court of
Canada Rules (Informal Procedure). The Appellant has agreed to
restrict his appeal to an amount of $12,000 assessed against him, excluding
interest. Under section 2.1 of the Tax Court of Canada Act, the term
“amount” does not include interest. The total amount assessed against the
Appellant by the Minister is $24,651.30, comprising $16,190.51 in federal tax,
penalties of $635.10 and total interest of $7,825.69. The Appellant thus remains
liable for $4,825.61 of the amount assessed against him pursuant to
subsection 160(2).
Conclusion
[28]
For the reasons set out
above, the Appellant’s appeal against the GST assessment is dismissed and his
appeal against the income tax assessment is allowed in part, and as regards this
latter assessment, the matter is referred back to the Minister of National
Revenue for reconsideration and reassessment in accordance with these reasons
for judgment.
Signed at Toronto, Ontario, this 26th day of August 2010.
"Robert J. Hogan"
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