Citation: 2009TCC57
Date: 20090126
Docket: 2005-193(IT)G
BETWEEN:
ANTHONY COMPARELLI,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
V.A. Miller, J.
[1]
The Appellant appeals
from an assessment which imposed liability for unpaid payroll source deductions
of federal and provincial income taxes, employment and Canada Pension Plan
premiums, as well as interest and penalties. The amount outstanding was
$302,850.03. The Appellant was assessed on the basis that he was a director of Mindthestore.com
Inc. (“MTS”) at the time it failed to make remittances to the Receiver General
in 1999, 2000 and 2001.
[2]
The issues in this appeal are
whether the Appellant exercised the degree of care, diligence and skill to
prevent the failure that a reasonably prudent person would have exercised in
comparable circumstances and whether the amount of the assessment is correct.
Facts
[3]
At the hearing of this appeal,
evidence was given by the Appellant, two former directors of MTS, Walter Bowen
and Sebastian Zeppieri, and three officers from the Canada Revenue Agency
(“CRA”).
[4]
The Appellant is a software
developer and a consultant. He graduated in 1982 from the DeVry Institute of
Technology with a computer science and systems analysis course. Prior to the
incorporation of MTS, he worked as a consultant with many government
departments and financial institutions to design and develop various software
systems. The Appellant became interested in developing software involving
real-time retail point of sale which could be used with the internet. On
January 8, 1996, MTS was incorporated to carry on the business of developing
this software.
[5]
The Appellant was appointed a
director of MTS in 1996, and continued to be a director at all times relevant
to this appeal. He was President of MTS until June 27, 2000. On August 23,
1999, he was elected Chairman and Chief Executive Officer (“CEO”) of MTS.
[6]
The Appellant worked for MTS
through his consulting company, J-Cann Enterprises Ltd. (“J-Cann”).
[7]
The Appellant described the
history of MTS and the events that occurred which caused it to be placed into
bankruptcy in January, 2002. He stated that in 1996 and 1997 the business of
MTS was primarily research and development. It employed between 10 and 15
employees who were programmers. In 1996, the Appellant managed the business of
MTS through J-Cann. I gather that his role changed in 1997. He began to travel
to various investment bankers, brokerage firms, market makers and third party
companies to establish an awareness of the technology that MTS was developing
and to raise funds for MTS.
[8]
The evidence disclosed that from
1996 until 2001, MTS financed its business, primarily, from the sale of its
shares through investment bankers and from debt.
[9]
The Appellant stated that by February
1997, MTS had no money; it was not generating revenue.[1] MTS signed an agreement
with AIBC Investments (“AIBC”) to raise US$5,000,000 through the sale of shares
of MTS. This investment was supposed to close on December 15, 1998. However,
prior to that date, AIBC was charged with securities fraud, racketeering and
conspiracy to commit fraud. MTS then turned to another investment bank called
TerraNova Capital Partners Inc. (“TerraNova”). In 1999 MTS signed a consulting
agreement with TerraNova. TN Capital Equities, Ltd, a subsidiary of TerraNova,
became the Placement Agent to obtain investors for the purchase of MTS’
securities. In this appeal, I will refer to these companies as TerraNova. In
June 1999, TerraNova was successful in making an equity placement and MTS
received US$5,000,000. The Appellant stated that as a condition of the
placement of shares, TerraNova requested that it be able to place two
representatives on the Board of Directors; and, that MTS hire a Chief Financial
Officer (“CFO”). Ruth Sheridan, a chartered accountant, was hired as CFO in
September 1999.
[10]
It was the Appellant’s evidence
that in 2000, MTS was well capitalized; and the technology was moving forward.
He and the Board of Directors had the vision to take MTS to a public offering.
His role was to promote MTS by speaking at seminars and trade shows and he
traveled extensively to accomplish this. He stated that he was in the office
less than 20% of the time.
[11]
I question whether MTS was well
capitalized in 2000. In a Private Placement Memorandum dated August 15, 2000
(exhibit R-2) under Risk Factors, TerraNova wrote the following about
MTS:
Limited Operating History
Since its inception in 1996, the
Company has focused a substantial portion of its financial and other resources
on developing its technology, software and marketing strategy, including
negotiating joint venture and similar arrangements, and obtaining capital. The
Company does not have an established history of actual operations of its
current business upon which an investor can base an investment decision, and
the likelihood of success of the Company must be considered in view of all of
the risks, expenses and delays inherent in establishing, operating and
expanding a new business, including, but not limited to, unforeseen expenses,
complications and delays, the uncertainty of market acceptance of new services,
intense competition from larger, more established competitors and other
factors.
Limited Revenues, Continuing
Losses and Accumulated Deficit
For the fiscal year ended
December 31, 1999, the Company had sales of US $578,217, a net loss of US
$(2,024,909), and an accumulated deficit of US $(6,589,647).
Going Concern Qualifications
Note 1 to the Company’s audited
financial statements for the fiscal year ended December 31, 1999, which are
attached as Appendix C, contains an explanatory paragraph indicating that the
Company’s ability to continue as a going concern is uncertain. The Company has
an immediate need for, and is wholly dependent on, the net proceeds of this
Offering, or other financings, to survive and to implement its strategy.
Unaudited financial Statements
The financial statements of the
Company for and at the three (3) month period ended March 31, 2000, which are
attached as Appendix D to this Memorandum, are unaudited, have been prepared by
the Company, and have not been reviewed by the Company’s auditors. In the event
that such financial statements had been reviewed by the Company’s auditors in
conformity with generally accepted accounting principles, the disclosure may
have materially differed.
No Material Revenues; No
Assurance of Profitability
To date, the Company has not
generated any material revenues and it is anticipated that it will continue to
incur substantial losses as it pursues its growth strategy. There can be no
assurance as to when, if ever, the Company will be profitable. It is
anticipated that until the Company is able to generate significant revenues,
the Company will continue to incur substantial losses.
…
Undercapitalization
The Company is
dependent upon the proceeds of this Offering in order to commence and expand
its business as planned. Unless the Company can obtain significant financing
from this Offering, or from other sources, it will be unable to conduct the
business described herein, to fully establish its operations, to profitably
carry on its business, or to otherwise carry out all of the proposed activities
described herein. Should the Company require substantial equity capital within
the next 16 months, no assurance can be given that any additional financing
will be available or, if available, that it would be available on terms
acceptable to the Company. Furthermore, any issuance of additional securities
would result in dilution to then existing shareholders. If adequate funds are
not available, the Company may lack sufficient capital to pursue its business
plan fully, which may have a material and adverse effect upon its business,
financial condition and results of operations.
[12]
In 2000, MTS had little to no
income. It was the Appellant’s evidence that it generated revenues of less than
$5,000 per month from technology which it had placed on the internet. It relied
on debt financing to continue its operations. MTS received loans from various
parties including, the Appellant, J-Cann and TerraNova. The evidence showed
that in 2000 and 2001, MTS received debt financing of $2,825,000 and $1,200,000
respectively. There was no evidence that MTS generated any income in 2001.
[13]
It was the Appellant’s evidence
that in early 2001, TerraNova advanced no funds to MTS; and, MTS was
financially in dire straits. By letter dated April 25, 2001, the Appellant
threatened to resign from MTS unless TerraNova advanced the funds which it had
promised. In this letter he stated that the funds were necessary to pay rents,
employees’ salaries and the arrears to CRA. I note that in this letter, the
Appellant also threatened to place MTS into bankruptcy and/or to start another
company that would compete with MTS. It was the Appellant’s evidence that he
did not resign because TerraNova threatened to sue him; and, the other
directors asked him to remain with MTS. In May 2001, MTS terminated the
exclusive banking relationship that it had with TerraNova.
[14]
It was the Appellant’s evidence
that after May 2001, MTS took several steps to promote its financial survival.
It hired another agent to raise money for MTS; this agent was not successful in
raising any financing. In an attempt to reduce its overhead until it received
financing, MTS reduced its office space and its staff from 40 to 6 employees.
[15]
Schedule B to the agenda for the
Board of Directors meeting of October 16, 2001 shows that MTS received debt
financing in the amount of $400,000 from May to September 2001.
[16]
The Appellant also outlined the
efforts that he took to keep MTS in business. In 2001, the Appellant personally
wrote cheques to MTS which totaled $17,013.05. In July, 2001, by way of three
cheques, J-Cann gave MTS $83,000 to pay its rent and other expenses. He began
negotiations with Microsoft to sell them MTS. These negotiations were
unsuccessful. He contacted all of the investment banking firms, private equity
funds and companies that he had met over the years, which he thought would be
interested in investing in MTS.
[17]
On January 15, 2002, MTS did
receive an offer of intent to invest from Hira Financial Corporation (“Hira”)
who was prepared to invest US$2,500,000 in MTS in exchange for 20% share
ownership of the company. One of the conditions of the proposed investor was
that TerraNova had to agree to a debt restructuring and a postponement of its
debt. At this point in time the debt outstanding to TerraNova was US$1,975,000.
TerraNova did not agree with this condition. The Appellant then tried to sell
the technology that MTS had developed up to that time. It was his evidence that
Hira was willing to pay $950,000 for the technology.
[18]
On January 23, 2002, the Board of
Directors (“the Board”) of MTS resolved to sell the technology. It was the
Appellant’s evidence that when TerraNova heard of the Board’s resolution, it
threatened to sue the members of the Board. The Board decided to appoint a
receiver to put MTS into receivership or bankruptcy and MTS filed an assignment
in bankruptcy on January 30, 2002. Schwartz Levitsky Feldman Inc. was appointed
Trustee.
[19]
Sebastian Zeppieri, a real estate
broker, became a director of MTS in 1999. He confirmed that MTS made little
money from 1999 to 2001; and, that it depended on investment bankers and
investors for its stream of income. It was his evidence that control of MTS
rested with TerraNova as it had control of MTS’ finances.
[20]
Walter Bowen, a lawyer with
Cassels Brock, was a director of MTS from 1999 until he resigned on July 4,
2001. He was Secretary of MTS until 2000. It was his evidence that the
Appellant was the largest significant shareholder of MTS; but, he was not a
majority shareholder as shares were always being issued. In cross-examination
he agreed that the Appellant had 24% of the shares. It was also his evidence
that the Appellant as CEO was responsible for the day-to-day management of MTS.
He shared this responsibility with Mrs. Sheridan, the CFO, Ms. MacDonald, the
Director of Finance, and Mr. Munro, the Executive Vice-President and General
Manager.
[21]
When counsel for the Respondent
asked Mr. Bowen about MTS’ failure to remit payroll source deductions in 2001,
he stated that he asked the Appellant on two or three occasions whether source
deductions were being made to CRA. The Appellant’s response was that they would
be made in the ordinary course or that they would be paid in the ordinary
course.
[22]
Nicholas Cholfe, a Collection
Enforcement Officer, and Jacqueline Cohen, a Complex Case Collections Officer,
both with CRA, testified that MTS had failed to remit payroll source deductions
in 1996, 1997, 1998 and 1999.
[23]
When Mr. Cholfe started to work on
MTS’ remittance account in June 1998, MTS was in arrears $196,668.35. When Ms.
Cohen started to work on the account in September 1998, the outstanding balance
was $283,851.69. They both stated that they dealt directly with the Appellant
and that he was very cooperative. He gave CRA postdated cheques at various
times. The outstanding balance was eventually paid off by June or July 1999.
[24]
Hillary Fox, a Resource and
Complex officer for Insolvency with the CRA, stated that on February 20, 2002,
the CRA finished its payroll audit of MTS, and the following claims were filed
with the Trustee regarding unremitted payroll source deductions:
Property Claim (ss. 227(4) of the Income Tax Act)
re: Unremitted
Deductions at Source:
|
Date of Assessment
|
Tax Year
|
Federal Tax
|
Provincial Tax
|
C.P.P. (Employee)
|
E.I. (Employee)
|
Total
|
|
15-Dec-01
|
1999
|
$2,176.33
|
$0.00
|
$0.00
|
$0.00
|
$2,176.33
|
|
15-Feb-02
|
2000
|
2,104.05
|
0.00
|
0.00
|
0.00
|
2,104.05
|
|
15-Feb-02
|
2001
|
0.00
|
0.00
|
1,550.58
|
841.00
|
2,391.58
|
|
19-Feb-02
|
2001
|
173,332.31
|
68,388.27
|
27,253.46
|
15,206.60
|
284,180.64
|
|
|
|
$177,612.69
|
$68,388.27
|
$28,804.04
|
$16,047.60
|
$290,852.60
|
Property Claim (ss. 227(4) of the Income Tax Act)
re: Unremitted
Deductions at Source:
|
Date of Assessment
|
Tax Year
|
C.P.P. (Employer)
|
E.I. (Employer)
|
Penalties
And Interest
|
Total
|
|
15-Jan-02
|
1999
|
$0.00
|
$0.00
|
$470.00
|
$470.00
|
|
15-Jan-02
|
2000
|
0.00
|
0.00
|
218.00
|
218.00
|
|
15-Jan-02
|
2001
|
1,550.58
|
1,177.40
|
310.00
|
3,037.98
|
|
19-Feb-02
|
2001
|
27,253.46
|
21,289.23
|
21,070.00
|
69,612.69
|
|
|
|
$28,804.04
|
$22,466.63
|
$22,068.00
|
$73,338.67
|
[25]
On February 21, 2002 the Trustee
accepted an offer from Hira to purchase MTS’ tangible assets for $100,000.
After payment, the outstanding balance with respect to MTS’ unremitted payroll
source deductions was $302,850.03.
Law
[26]
The relevant provisions
of the Income Tax Act (the “Act”) are subsections 227.1(1), (2) and (3)
which read as follows:
227.1 (1) Liability of directors for failure to deduct -- 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 or has failed to pay 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) Limitations on liability -- A director is not liable under subsection
(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 that subsection 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 that subsection has been proved within six months
after the date of the assignment or bankruptcy order.
(3) Idem
-- A director 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.
[27]
The Federal Court of Appeal has
stated that the standard of care set out in subsection 227.1(3) of the Act is
inherently flexible. It is an objective-subjective standard[2].
[28]
In Smith v. R.[3], the Federal Court of
Appeal gave an outline of the main elements of the due diligence defence as
follows:
9 The
Soper decision, supra, established that the standard of care
described in the statutory due diligence defence is substantially the same as
the common law standard of care in Re City Equitable Fire Insurance Co.
(1924), [1925] 1 Ch. 407 (Eng. C.A.). It follows that what may reasonably be
expected of a director for the purposes of subsection 227.1(1) of the Income
Tax Act and subsection 323(1) of the Excise Tax Act depends upon the
facts of the case, and has both an objective and a subjective aspect.
10 The
subjective aspect of the standard of care applicable to a particular director
will depend on the director's personal attributes, including knowledge and
experience. Generally, a person who is experienced in business and financial
matters is likely to be held to a higher standard than a person with no
business acumen or experience whose presence on the board of directors reflects
nothing more, for example, than a family connection. However, the due diligence
defence probably will not assist a director who is oblivious to the statutory
obligations of directors, or who ignores a problem that was apparent to the
director or should have been apparent to a reasonably prudent person in
comparable circumstances (Hanson v. R. (2000), 261 N.R. 79, [2000] 4
C.T.C. 215, 2000 D.T.C. 6564 (Fed. C.A.)).
11 In
assessing the objective reasonableness of the conduct of a director, the
factors to be taken into account may include the size, nature and complexity of
the business carried on by the corporation, and its customs and practices. The
larger and more complex the business, the more reasonable it may be for
directors to allocate responsibilities among themselves, or to leave certain
matters to corporate staff and outside advisers, and to rely on them.
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 c. R.
(1998), 240 N.R. 354, [1999] 3 C.T.C. 366, 99 D.T.C. 5079 (Fed. 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 payroll source deductions may be unable to rely on the due diligence
defence (Ruffo c. R., 2000 D.T.C. 6317 (Fr.) (Fed. C.A.)). In every case,
however, it is important to bear in mind that the standard is reasonableness,
not perfection.
Analysis
[29]
It was agreed that the Appellant
was an inside director. He was the founder of MTS and he was involved in the
day-today management of MTS, first, as its President and then as its CEO.
[30]
I note from exhibit R-1 that the
Appellant had previously asserted that he was not involved in the day-to-day
management of MTS. This argument was not made at the hearing of this appeal. In
fact, counsel for the Appellant admitted that, although the Appellant traveled
a great deal, he was still involved in the day-to-day management of MTS.
[31]
The Appellant is intelligent and
was experienced in business matters. He has been the director of five
companies. According to exhibit R-2, from 1982 to 1995, he founded and operated
several companies.
[32]
The Appellant was well aware of
his responsibilities under the Act. The evidence established that he had dealt
with the CRA in prior years when MTS had failed to remit on time. He had given
a proposal letter to set up a payment schedule for the unpaid source deductions
that MTS owed in 1996, 1997 and 1998.
[33]
It was the Appellant’s position
that TerraNova had control of MTS, both on the Board, and in its shareholdings.
[34]
I accept Walter Bowen’s evidence
that TerraNova did not control the Board of Directors or the shareholdings of
MTS. He stated that TerraNova had only one representative on the Board,
Geoffrey Workman. I note that the Consulting Agreement between TerraNova and
MTS dated December 20, 1999 allowed for TerraNova to have one designee on the
Board and this designee was only an observer. Mr. Bowen stated that no one
controlled him and he was not aware of anyone controlling the Board.
[35]
It was also Mr. Bowen’s evidence
that MTS was always in control of how it spent its money.
[36]
Counsel argued that when TerraNova
“squeezed off the funds, the arrears started”. However, I note that MTS was
never financially sound. According to exhibit R-2, it was anticipated that MTS
would continue to incur substantial losses. The Appellant was always aware of
MTS’ precarious financial position. It is my opinion that the Appellant assumed
the risk that at some time MTS would not be able to remit its payroll source
deductions. He cannot now blame the failure to remit on a third party.
[37]
It was also the Appellant’s
position that he took several steps to ameliorate MTS’ finances and prevent
further failures, after he learned about the failure to remit. He relied on the
Federal Court of Appeal’s decision in Worrell v. R.[4] to state that this
amounted to due diligence.
[38]
According to Hillary Fox, the
failure to remit in 1999 and 2000 was due to T4 discrepancies. The failure to
remit in 2001 started with the February 15th period.
[39]
The Appellant knew or ought to
have known in February or at the latest in March 2001 about this failure. As
the CEO, he ought to have known in February about MTS’ financial state. I infer
that the Appellant did know about MTS’ financial state in March 2001. He wrote
a cheque to MTS dated March 20, 2001 for $3000. It was his evidence that the
cheque was to help cover expenses of MTS.
[40]
The evidence was that in April
2001, the Appellant wrote two further cheques to MTS to help cover its
expenses. These cheques totaled $14,013.05. As well, in July 2001, J-Cann wrote
three cheques to MTS which totaled $83,000. There was no evidence that he
directed MTS to pay any of these amounts to CRA. The Appellant’s efforts were
directed at keeping MTS in operation and not at preventing the failure to remit
payroll source deductions.
[41]
Counsel for the Appellant has
argued that but for TerraNova, the Appellant would have been successful in
arranging an infusion of US$2,500,000 into MTS’ finances. This would have been
enough to pay the arrears and prevent further failures to remit.
[42]
The letter of intent to make an
investment in MTS was dated January 2002. By this time, MTS had failed to remit
payroll source deductions for almost a year. The defence in subsection 227.1(3)
of the Act requires a director to exercise reasonable care, diligence and skill
to prevent the failure to remit. It was not reasonable, in the
circumstances of this case, where MTS always had financial problems, that the
Appellant continue to finance MTS’ operations with unremitted payroll source
deductions in the hope that funds would be found.
[43]
The facts that existed in the Worrell
decision are very different from those in the present case. In Worrell,
the company had been in business for thirty years and did not suffer financial
problems until the fall of 1992. The failure to remit occurred when the bank
dishonoured the company’s October 1993 remittance cheque. The directors
“continued to prepare remittance cheques in the hope that the bank would honour
them, which, on a few occasions, it did on a discretionary basis”[5]. The court found that
almost all of the company’s debt to Revenue Canada for unremitted source deductions accrued after the
bank started to exercise control over the cheques issued by the company.
[44]
In the present case, no third
party exercised control over the manner in which MTS spent its funds. There was
no evidence to show that MTS prepared remittance cheques in a hope that it
could pay its source deductions. The Appellant had authority to sign cheques on
MTS’ bank account.
[45]
The Appellant did make efforts to
find investors for MTS. However, according to his evidence this occurred in the
summer and fall of 2001 almost five months after the failure to remit had
occurred. I find that the Appellant has not shown that he exercised the requisite
standard of care “to prevent” the failure to remit in 1999, 2000 and 2001.
[46]
The Appellant also argued that MTS
was owed a GST refund of $ 66,467.90 for the period June 1, 2001 to August 31,
2001. He asked that this amount be credited to MTS’ liability.
[47]
Hillary Fox testified that she had
searched CRA’s records and there was no GST refund owing to MTS. As well, the
Respondent filed exhibit R-4, the Goods and Services Tax return for MTS for the
period June 1, 2001 to August 31, 2001. The return was filed by the Trustee on
July 22, 2003 and it was a nil return.
[48]
The appeal is dismissed with costs
to the Respondent.
Signed at Ottawa, Canada, this 26th day of January 2009.
“V.A. Miller”
Email this Content