Citation: 2012 TCC 22
Date: 20120118
Docket: 2009-3300(GST)G
BETWEEN:
HAROLD DAVID BABAKAIFF,
appellant,
and
HER MAJESTY THE QUEEN,
respondent.
REASONS FOR JUDGMENT
Hogan J.
I. CONTEXT
[1]
Section 323 of the Excise Tax Act (the “ETA”) provides that a director may be found
liable for a corporation’s failure to remit goods and services tax (“GST”)
unless the director can show that he or she exercised due diligence to prevent
the failure. The appellant, Harold David Babakaiff, is appealing a director’s
liability assessment issued against him on October 23, 2008 for a
corporation’s unremitted GST in the amount of $400,323.12.
II. FACTUAL
BACKGROUND
[2]
The appellant is the
sole director of New Street Developments Inc. (“New Street Developments”),
which formerly operated under the name Excite Homes Inc. The corporation was in
the business of building and selling residential properties, although it later
tried to shift its business to land development.
[3]
As a GST registrant,
the corporation was responsible for collecting GST on all taxable supplies. The
GST in question consisted mainly of GST collected on the sale of new homes.
Like all GST registrants, the corporation was also able to claim input tax
credits for GST paid or payable on goods and services acquired for use, consumption, or supply in its commercial activities. In
the course of its business of selling new homes, the corporation was also at
times assigned a purchaser’s right to the GST new housing rebate, thereby
reducing the amount of GST the corporation had to remit.
[4]
New Street
Developments was late in filing its monthly GST returns for the following
periods:
·
May 1-31,
2006, due June 30, 2006, filed on February 16, 2007;
·
June 1-30,
2006, due on July 31, 2006, filed on March 1, 2007;
·
July 1-31,
2006, due on August 31, 2006, filed September 7, 2007;
·
September 1-30,
2006, due October 31, 2006, filed on September 7, 2007;
·
October 1-31,
2006, due on November 30, 2006, filed on September 7, 2007; and
·
March 1-31
2007, due on April 30, 2007, filed on May 21, 2008.
[5]
When New
Street Developments did file its GST returns, the corporation reported its
total GST collectible for those periods as being $463,592.62 and claimed total
input tax credits of $98,895.41, for a net total of $364,697.21 owed. Of that
amount, the corporation only remitted $22,800.00, which left an outstanding
balance of $341,897.21. The total amount of $400,323.12 assessed against the
company and, subsequently, its sole director, namely, the appellant, Harold
David Babakaiff, includes related penalties and interest.
III. ISSUES
[6]
Is the appellant liable
for the corporation’s unremitted GST, or did he satisfy the requirements of the
due diligence defence under subsection 323(3) of the ETA?
IV. APPELLANT’S POSITION
[7]
The appellant invokes
the due diligence defence under subsection 323(3) of the ETA submitting that,
as the sole director of New Street Developments, he exercised the degree of
care, diligence and skill that a reasonably prudent person would have exercised
in comparable circumstances to prevent the failure of the corporation to remit
the GST owed.
[8]
The appellant alleges
that the corporation’s failure to remit GST was directly caused by the
negligent actions of two lawyers hired to take care of closing the
corporation’s sales of residential properties. According to the appellant, the corporation’s
lawyers neglected to complete the closing documentation for the residential
real estate sales in a timely fashion.
[9]
In the spring of 2006,
the appellant claims, the company’s first lawyer, Shaun Langin, became
negligent in his handling of real estate sales closings and in delivering the
closing documents to the corporation. Without the closing documents specifying
the amount of GST paid or payable and indicating whether the buyer had assigned
the GST new housing rebate, the corporation could not properly complete its GST
returns and calculate the GST to be remitted. The appellant asserts that he
made multiple efforts to obtain the closing documents from Mr. Langin, but,
faced with the lawyer’s continued negligence, ceased using his services at the
end of the summer of 2006. The appellant submitted evidence that the Law Society
of Alberta sanctioned Mr. Langin on October 12, 2006 for failing on
numerous occasions to fulfil his commitments to his clients.
[10]
After ceasing to use
Mr. Langin’s services, in September 2006 the corporation found another
lawyer, Doug Welder, who, according to the appellant, also became negligent in
providing closing documents and completing his work. The appellant also
provided evidence that Mr. Welder was suspended for three months after
being found guilty of professional misconduct by the Law Society of British
Columbia for failing to remit GST and employee source deductions.
[11]
The appellant submits
that he sought and obtained professional accounting assistance, as he had done in
his other business ventures, to guide him in the financial management of the corporation.
He hired Tracy Welch, an experienced certified general accountant, and
they met regularly to discuss the company’s finances. When the problems arose
with the lawyers, the appellant and Ms. Welch carefully considered how to
proceed each month and decided, as each return became due, that they could not
complete the returns and swear to the truth of their content, considering the
missing information.
[12]
According to the
appellant, he had reasonable grounds to believe that the New Street Developments
corporation was in a net GST refund position until the information needed to
complete the late GST returns became available over the period from February 2,
2007 to May 21, 2008. Up until the time that the late returns were
completed and filed, the corporation had been mainly in a GST refund position
because its input tax credits exceeded the amount of GST that it was required
to collect and remit. The appellant alleges he did not know that the
corporation was in financial trouble until the late summer of 2006. He assumed
that once the late GST returns were filed he would owe very little GST for the
reasons outlined above.
[13]
The appellant believed
he could meet the GST liability, if any, of the corporation by causing it to
sell a large property it owned in Nanaimo, British Columbia.
These efforts failed because of the abrupt and serious downturn in the Canadian
real estate market that occurred in the middle of 2006. The holder of the mortgage
on the Nanaimo property sold that property under an order
for conduct of sale and as a result there was nothing left over to pay the
corporation’s GST liability.
V. RESPONDENT’S POSITION
[14]
The respondent argues
that the appellant knew his corporation was in trouble as of March 2006,
as evidenced by his lawyer’s response, provided with respect to an undertaking given
at discovery, that New Street Developments stopped making payments on the Nanaimo property as of March 1, 2006. The
respondent submits that this date is an indication that the corporation was in
financial trouble almost six months before the appellant claims he became aware
of the corporation’s financial difficulties, in the late summer of 2006, and that
the appellant should therefore have taken significant steps much earlier to
avoid the failures to remit.
[15]
The respondent contends
that, once the appellant realized he did not have the information required to
complete the GST returns, he could have taken the necessary action to obtain
this information and prevent future failures to remit. The corporation could have
obtained such information from a simple statement of disbursements or
adjustments prepared at the time of sale.
[16]
The respondent argues
that the appellant provided no evidence to support his claim that the
corporation received very little in the way of proceeds which it could use to
remit the GST because the mortgage creditors sold the property under an order
for conduct of sale. Instead, at discovery, the appellant provided responses
indicating that the corporation used the proceeds from sales to pay off
builders’ liens and judgments registered on properties. The onus is on the
appellant to prove that these sales occurred under duress, and here, the
respondent asserts that the appellant failed to meet his burden in this regard.
[17]
The respondent also
notes that the appellant, as a director and officer of the corporation, did not
take any steps to cause the corporation to segregate the GST funds from its
general account. The respondent argues that the appellant knew the corporation
was in financial trouble, and that his lack of due diligence is demonstrated by
his failure to instruct his lawyers to segregate funds and ensure that any
incoming funds would be used to pay the GST owed rather than paying other
creditors.
[18]
According to the
respondent, the appellant gambled on the GST position of his corporation,
hoping that the Nanaimo property would act as “insurance” to cover
any debt. The respondent argues that such a gamble does not demonstrate
appropriate care taken to ensure the fulfilment of the company’s GST
obligations.
VI. ANALYSIS
[19]
Subsection 323(1) of
the ETA outlines the liability of directors where a corporation fails to remit
net tax owed:
Liability of directors
323. (1) If a corporation fails to remit an amount of net
tax as required under subsection 228(2) or (2.3) or to pay an amount as
required under section 230.1 that was paid to, or was applied to the liability
of, the corporation as a net tax refund, the directors of the corporation at
the time the corporation was required to remit or pay, as the case may be, the
amount are jointly and severally, or solidarily, liable, together with the
corporation, to pay the amount and any interest on, or penalties relating to,
the amount.
[20]
The appellant invokes
the due diligence defence that is available under subsection 323(3) of the ETA
to a director who has been assessed on the basis of liability for a
corporation’s unremitted tax. Subsection 323(3) states the following:
Diligence
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.
[21]
In Buckingham v. Canada, the Federal
Court of Appeal confirmed that an objective standard must be applied in
considering a director’s due diligence defence under both subsection 323(3) of
the ETA and subsection 227.1(3) of the Income Tax Act (the “ITA”).
Before Buckingham, the leading authority on the applicable test was Soper
v. Canada,
a case in which the Federal Court of Appeal determined that the
objective-subjective standard was the appropriate test.
[22]
In Buckingham,
the Federal Court of Appeal outlined how to apply the objective standard and set
out the underlying rationale given by the Supreme Court of Canada in Peoples
Department Stores Inc. (Trustee of) v. Wise
for imposing such a standard:
38 This
objective standard has set aside the common law principle that a director's
management of a corporation is to be judged according to his own personal
skills, knowledge, abilities and capacities: Peoples Department Stores
at paras. 59 to 62. To say that the standard is objective makes it clear that
the factual aspects of the circumstances surrounding the actions of the
director are important as opposed to the subjective motivations of the
directors: Peoples Department Stores at para. 63. The emergence of
stricter standards puts pressure on corporations to improve the quality of
board decisions through the establishment of good corporate governance rules: Peoples
Department Stores at para. 64. Stricter standards also discourage the
appointment of inactive directors chosen for show or who fail to discharge
their duties as director by leaving decisions to the active directors.
Consequently, a person who is appointed as a director must carry out the duties
of that function on an active basis and will not be allowed to defend a claim
for malfeasance in the discharge of his or her duties by relying on his or her
own inaction: Kevin P. McGuinness, Canadian Business Corporations Law, 2nd
ed. (Markham, Ontario: LexisNexis Canada, 2007) at 11.9.
[23]
This evaluation should
not be undertaken, however, without considering the particular circumstances
facing the corporation and the appellant. The Federal Court of Appeal, in Buckingham,
asserted that contextual factors are part of an objective analysis:
39 An
objective standard does not however entail that the particular circumstances of
a director are to be ignored. These circumstances must be taken into account,
but must be considered against an objective "reasonably prudent
person" standard. As noted in Peoples Department Stores at
paragraph 62:
The
statutory duty of care in s. 122(1)(b) of the CBCA emulates but does not
replicate the language proposed by the Dickerson Report. The main difference is
that the enacted version includes the words "in comparable
circumstances", which modifies the statutory standard by requiring the
context in which a given decision was made to be taken into account. This is
not the introduction of a subjective element relating to the competence of the
director, but rather the introduction of a contextual element into the
statutory standard of care. It is clear that s. 122(1)(b) requires more
of directors and officers than the traditional common law duty of care outlined
in, for example, Re City Equitable Fire Insurance, supra [[1925]
1 Ch. 407].
[24]
Here, the context
includes the economic conditions in the housing market that ultimately led to
the corporation’s demise, and the corporation’s unfortunate experiences with
two negligent lawyers. When evaluating what a reasonably prudent person would
have done in similar circumstances, the Court cannot ignore the particular
challenges facing the appellant’s corporation.
[25]
The Federal Court of
Appeal in Buckingham specifically notes that, in applying the test under
subsections 227.1(3) of the ITA and 323(3) of the ETA, one must consider
a director’s actions undertaken to prevent a failure to remit. The Court states:
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.
[26]
It is not sufficient to
take actions to remedy failures to remit net tax. The concern in a due
diligence defence is what actions were taken to prevent failures to remit in
the first place. A director cannot, as the appellant does in this case, claim
due diligence on the basis of having another asset on hand that could serve as
insurance to pay off debts to the Crown. A corporation cannot gamble with money
it holds for the Crown. Unlike others, the Crown is an involuntary creditor
that is unable to decrease its exposure to risk according to a corporation’s
evolving financial state. As stated in Buckingham:
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.
. . .
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.
[27]
The appellant contends
that he should not be required to bear the corporation’s GST liability because
the corporation’s failure to remit the GST occurred without his knowledge and was
due to circumstances beyond his control. When he discovered the failure, it was
too late for him to do anything about it.
[28]
According to the
appellant, the corporation’s GST liability of $364,697.21 arose during the
period from May 31, 2006 to April 30, 2007. The appellant
claims that during that period he could not complete the corporation’s monthly
GST returns because the corporation’s lawyers were negligent in providing him
the closing documents and the information necessary to complete the returns. He
discovered for the first time that the corporation was behind in remitting GST
only when he was able to complete the GST return for the May 1‑31, 2006
reporting period, that is, in February 2007. The extent of the problem
only became fully apparent when all of the late GST returns were finally filed.
[29]
In my opinion, it is
wrong to lay the blame for the appellant’s lack of knowledge of the
corporation’s GST liability on the alleged negligent actions of the
corporation’s lawyers. Indeed, the evidence reveals that a statement of disbursements
was prepared prior to the sale of each property. This statement showed the sale
price, the GST (to the extent that GST was not included in the price), the GST
rebate, the assignment of the GST rebate to the seller, and all other disbursements
relating to the closing. The purchase price could not be disbursed by the
lawyers without this information. Exhibit R-3 is a good example of the type of
statement that the corporation’s officers could have relied on in order to
prepare the corporation’s monthly GST returns.
[30]
The statement of disbursements
contained all of the information necessary for the corporation to complete its
monthly GST returns. Nothing prevented the appellant from returning to the office
after each closing with that statement in hand. Had the appellant requested the
statement he would have known the extent of the corporation’s GST liability
soon after each month‑end.
[31]
The appellant also claims
that the corporation stopped filing its GST returns on time on the advice of Ms. Welch,
the corporation’s internal accountant. According to the appellant, Ms. Welch
tried but failed to obtain the information necessary to complete the GST
returns and then instructed the appellant not to file them until they could be
properly completed. The appellant offered no explanation why Ms. Welch was
not called as a witness to substantiate this allegation. I draw a negative
inference from Ms. Welch’s absence at trial.
[32]
The evidence also
reveals that the corporation stopped paying the mortgage on the Nanaimo property in March 2006. This should have put the
appellant on notice that the corporation had entered a period of financial
turmoil. It was at that point in time that the appellant should have taken
steps to ensure that the GST collected in trust from the buyers of the
corporation’s homes was segregated from the corporation’s other funds.
[33]
While there is no doubt
that there was some negligence on the part of the lawyers with regard to
completing the formalities of each closing in a timely fashion, that does not
explain the appellant’s failure to take decisive action to ensure that the
corporation continued to remit GST. In fact, evidence was presented which
showed that, instead, the appellant used funds received to pay off debts to
other creditors, giving those debts priority without taking sufficient action
to determine the GST owed to the Crown and ensure that it was remitted.
[34]
Nor does the context of
the failing housing market offer the appellant any relief. As noted above, there
is evidence pointing to the fact that the appellant had knowledge of the
corporation’s financial difficulties by the spring of 2006 when it defaulted on
its payments on the Nanaimo property. It was at that moment that a
reasonably prudent person would have taken concrete steps to ensure that the GST
was remitted.
[35]
The appellant’s
knowledge and background add nothing to his due diligence defence. As an
experienced business person with a lot of knowledge of the housing industry,
the appellant knew or ought to have known by the spring of 2006 that the
corporation was no longer building at the same rate as in prior years, which
resulted in a significant decrease in its input tax credits. I find it hard to
believe that the appellant did not appreciate that the corporation would soon
find itself in a net GST remittance position as it liquidated its inventory
after having stopped building due to a lack of new funding. Considering all of
the evidence, I suspect that it is not entirely coincidental that the
corporation stopped filing its GST returns after it defaulted on its payment
obligations with respect to the Nanaimo property. What appears to have been
happening is that the corporation was selling its residential real estate at a
price less than the corporation’s costs. GST collected in trust for the Crown
was diverted to pay mortgage creditors and other stakeholders, with the hope
that the sale of the Nanaimo property would allow the corporation to
settle its GST liability.
[36]
The appellant claims
that upwards of 30% of the corporation’s properties were sold under duress by
the corporation’s mortgage creditors pursuant to court orders authorizing them
to conduct the sales on behalf of the corporation without the intervention of
its directors or officers. According to the appellant, the proceeds of these
sales were disbursed without his knowledge and intervention. Except with regard
to the Nanaimo property, no documentary evidence was
provided to support this claim, although the appellant asserted on
cross-examination that the corporation was in possession of documents that
could prove the claim. The appellant did not identify the properties subject to
the conduct of sale procedure, nor, for that matter, did he quantify the amount
of GST that may have been diverted by the corporation’s creditors. The onus is
on the appellant to prove his claim in this regard. I find that he has failed
to do so.
[37]
A successful due
diligence defence requires evidence of a director taking concrete actions to
prevent failures to remit. The main evidence presented here was a number of
emails in which the appellant expressed his frustration with the lawyers’
ability, and none of these emails even specifically address GST concerns. When
the negligence of his lawyers and the corporation’s financial difficulties
became evident, the appellant could have ensured the segregation of GST funds.
He could also have insisted on receiving more information sooner, for each
sale, as to the GST collected or collectible or as to the GST rebate assigned.
Such are the actions a reasonably prudent person might take to avoid failures
to remit. None of these measures were carried out by the appellant. Applying
the objective standard enunciated in Buckingham, I conclude that the
appellant did not exercise the care, diligence and skill a reasonably prudent
person would have exercised to prevent the failures to remit.
[38]
For all these reasons,
the appeal is dismissed.
Signed at Ottawa, Canada, this 18th day of January 2012.
“Robert J. Hogan”
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