Paul Black v. Her Majesty the Queen, [1993] 2 CTC 2825

Bonner, T.C.C.J.:— The appellant appeals from an assessment of liability arising under subsection 227.1(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") in respect of failures by Northumberland Cedar Log Homes Inc. ("Company") to remit taxes withheld pursuant to section 153 of the Act from wages paid to employees.

The directors of a corporation are made vicariously liable for such failures by subsection 227.1(1) which reads:

Where a corporation has failed to deduct or withhold an amount as required by subsection 135(3) 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 liable, together with the corporation, to pay that amount and any interest or penalties relating thereto.

Directors may escape such liability under subsection 227.1(3) which affords them the so-called "due diligence” defence. That provision reads:

A director is not liable for a failure under subsection (1) where he exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.

In this appeal, the appellant relies on the due diligence defence and, in addition, he asserts that the assessment is invalid because the notice of it which was sent to him was incomplete.

The appellant gave evidence at the hearing of the appeal. Subject to reservations expressed later in these reasons, I accept his testimony as substantially accurate. He testified that as a student in high school he studied industrial electricity. He took no accounting courses. Upon graduating from high school in 1972, he commenced work as a labourer. He received no formal education beyond the high school level.

In 1985, the appellant built a log home for himself. He did so using a kit consisting of logs cut and shaped for the purpose. He then started to work on a part-time basis for the firm from which he had bought the kit. That firm encountered financial difficulties and the appellant decided to form a new company to engage in the business of manufacturing such kits. The appellant retained a firm of chartered accountants to prepare a feasibility study and to apply for a government grant in support of his project. As well, he retained a lawyer to incorporate the company. The company commenced operations in 1987 with five employees including a bookkeeper.

The appellant testified that he had no idea as to his duties as a director of a corporation. He said that the lawyer explained to him the differences between a proprietorship, a partnership and a corporation and that he was not personally liable for the obligations of the company.

The company retained the accounting firm to record financial data on its computer on a monthly basis. It does not appear that the firm was asked to do anything more. Specifically, it was not suggested that the accountants were retained to supervise the financial operations of the company on an ongoing basis.

The company was under capitalized from the outset. Two persons who were supposed to join with the appellant in the ownership of the company failed to do so, and, as a consequence, their capital contributions did not materialize. The financial difficulties which affected the company resulted at least in part from under capitalization. The appellant said that “right from the start" the company “fell behind” on the operating line of credit which it had established at the bank.

The remittances which the company failed to make and which gave rise to the assessment under appeal were due in June 1987 and in the months of August to December of that year. A cheque issued by the company to Revenue Canada for the June remittances was returned by the bank. It was not suggested that an attempt was made to remit the amounts due during the August to December period.

During the last seven months of 1987, a succession of three bookkeepers worked for the company. It was said to be the duty of the company bookkeeper to administer the payroll and to remit source deductions. The first bookkeeper left the company in mid-August. The second, a bookkeepermanager was fired in the middle of November when he was caught stealing from the company. The third was hired in the middle of December. Approximately one month after she was hired, she informed the appellant of the difficulties with Revenue Canada. That action may have been provoked by a visit to the company's office by a Revenue Canada collections official.

The appellant's personal life was thrown into turmoil in the middle of August 1987 when his wife left him. He then became solely responsible for the care of four young children and experienced difficulty in making satisfactory babysitting arrangements until sometime during December 1987. As a result, the appellant's ability to devote time to the business of the company was restricted during the period which, as it turns out, is of critical importance for present purposes.

In argument, counsel for the appellant took the position that subsection 227.1(3) sets a partially subjective standard. She submitted that the appellant's knowledge and experience are to be taken into account in fixing the standard of conduct against which his actions are to be measured. In the appellant's world, she said, that standard is met by the simple act of hiring a bookkeeper and telling him to look after the payroll.

In support of this submission, counsel relied on Cybulskiv. M.N.R., [1988] 2 C. T.C. 2180, 88 D.T.C. 1531 (T.C.C.), Fancy v. M.N.R., [1988] 2 C.T.C. 2256, 88 D.T.C. 1641 (T.C.C.) and Edmondson v. M.N.R., [1988] 2 C.T.C. 2185, 88 D.T.C. 1542 (T.C.C.). In Cybulski, this Court considered the common-law standard, being that of the “ordinary” person who ”. . . need not exhibit a greater degree of skill than may be reasonably be expected from a person of his knowledge and experience” and the statutory standard, being that of the “reasonably prudent" person. The Court observed, at page 2185 (D.T.C. 1535):

In enacting subsection 227.1(3) Parliament established an exonerating standard of conduct the presence of which is to be determined in particular cases by the actual relevant facts and not by fixing to a taxpayer knowledge of a somewhat esoteric point of corporation law that in reality is probably not within the actual knowledge of a good number of legal practitioners.

For present purposes, it may be said that nothing in Fancy, or in Edmondson, usefully adds to the analysis of subsection 227.1(3) found in Cybulski. The question is, however, whether a shaky grasp or complete ignorance of the requirements of the Act will excuse inaction and afford a subsection 227.1(3) defence to a director.

The appellant admitted that he was aware, at least in a general way, of the obligation of an employer to withhold income tax at source and to remit the amount withheld to Revenue Canada. He had worked for years at a paper mill and was aware of the deductions made at source from his wages. He claimed however, that he had no detailed knowledge of the requirements of the Act. He asserted that the responsibility for source deductions rested with the bookkeepers. There was no clear evidence regarding the qualifications of the bookkeepers. The appellant testified that the first was told to look after payroll and that she said that she knew how to do that. He stated that he could not tell her how to discharge that duty because he did not himself know how. The appellant said that the man who served as manager and bookkeeper during the period of August to mid-November 1987 was highly recommended by a man who worked at a building supply store. It appears that the appellant did not make any other inquiries as to this person's suitability to fill the role. The third bookkeeper had apparently taken a bookkeeping course in high school and, as well, a one year secretarial course. It was not suggested that in hiring these employees, the appellant made any attempt to determine whether they were capable of dealing with source deduction procedures.

It is noteworthy that all three bookkeepers appear to have been capable of making the required source deductions. It seems unlikely that persons who knew how to deduct failed to remit because they were unaware of the requirement to. It is at least possible that they failed to remit because they were told not to do so. The fact that the company was short of money cannot be overlooked.

In my view, the appellant was not nearly as unsophisticated in business matters as he was portrayed to be. I note that he was astute enough to learn of the existence of government grants and assertive enough to take the necessary steps to secure one. I observed him as he gave evidence and concluded that there was an element of posturing in his attempts to distance himself from the payroll function. Although the onus was on the appellant he failed to call any of the bookkeepers to give evidence.

The appellant cannot take shelter under subsection 227.1(3) by claiming that his actions met the standard of a reasonably prudent person who was ill- informed as to the requirements of the Act. A reasonably prudent person who is aware that he is a director but who is uncertain as to the extent of his responsibilities as director is under a duty to at least attempt to discover what is required of him and to discharge that duty. Cybulski does not assist the appellant. It was a case in which the appellant believed on reasonable grounds that he was not a director and therefore had none of the obligations of a director.

The decision of this Court in Pidskalny v. M.N.R., [1991] 2 C.T.C. 2192, 91 D.T.C. 1046, appears to suggest that subsection 227.1(3) protects a director who failed to try to prevent a failure to remit because he had no knowledge of the rights, responsibilities and obligations of a directorship and was uninvolved with the management of the company. If that were the ratio of the decision it would be very difficult to reconcile with the language of section 227.1. Nothing in that language suggests the existence of a legislative intention to offer relief to a director who fails to act because he is ignorant of and indifferent to his responsibilities and those of his company. It is illogical for example to suggest that a person who drives his vehicle in heavy traffic with his eyes firmly shut cannot be negligent because he is unaware of the existence of a duty to those he is about to injure. It is equally illogical to suggest that a director who is ignorant of his responsibilities and who fails to attempt to identify and fulfil them can meet the 227.1(3) standard. However a careful reading of the reasons in Pidskalny especially at page 1049 indicates that the outcome rests on an application of the decision of the Federal Court-Trial Division in Robitaille v. Canada, [1990] 1 C.T.C., 121, 90 D.T.C. 6059, to a finding that Mr. Pidnalski was unable to do anything to prevent the failure.

The purpose of section 227.1 cannot be ignored. In clear language subsection (1) imposes liability on all directors and not just on those who are aware of the relevant provisions of the Act. Subsection 227.1(3) offers protection to those who exercise the degree of care that a reasonably prudent person would have exercised in comparable circumstances. It is illogical and inconsistent with the evident purpose of the section to suggest that the legislature contemplated that the standard of a reasonably prudent person is met by directors who make no effort to discover what the law requires of them and to comply with it.

Counsel for the appellant suggested that one of the circumstances to be considered was the departure of the appellant's wife and his responsibility for care of the children. Counsel failed however to show that there was any linkage between the appellant's personal circumstances and the failures to remit. Although personal circumstances which impinge on a director's ability to discharge his duties are relevant under subsection 227.1(3), the evidence falls short of showing that it would be unreasonable to expect the appellant to have looked after both his children and his business during the period in question.

Counsel for the appellant advanced an additional argument on the question of due diligence in relation to the June 1987 remittance. She submitted that a cheque had been sent and that the appellant, when he learned that it had bounced, sent a replacement cheque. The appellant's testimony on this point was unsupported by any note or record or cancelled cheque. He appeared to be uncertain as to the amount of the replacement cheque and when it was sent. There was no suggestion that it bore a payroll number or other reference to the account to which it was to be applied. I am not persuaded that the replacement cheque was in fact sent. The evidence is simply too vague.

I turn next to the question of the adequacy of the notice of assessment. The notice of assessment in issue is dated July 23, 1992. It is stated to be a notice of an assessment in respect of:

The liability under subsection 227.1(1) of the Income Tax Act and section 36.1 of the Provincial Income Tax Act, section 21.1 of the Canada Pension Plan and section 54 of the Unemployment Insurance Act, 1971, in the amount of $24,452.82 being the amount of the unpaid deductions, interest and penalties payable by Northumberland Cedar Log Homes Inc. in respect of a notice of assessment dated July 23, 1992. The attached Exhibit A forms part of this notice of reassessment.

Exhibit A, entitled "Reconciliation of corporate assessment to section 227.1 assessment" furnishes precise dollar amounts of federal tax and penalty for “bank chargeback current year cheque (June remit)” and “ ailure to remit from August/December 1987”. As well, it furnishes particulars of certain penalties and interest charges under the Act and certain other statutes. Counsel for the appellant contended that the notice is inadequate because, for the August to December period, it furnishes only total amounts due and unpaid under the Act. She submitted that because the liability was vicarious in nature the exact amount of each individual failure to remit must be set forth in the notice of assessment. Counsel relied on the decision of this Court in Leung v. M.N.R., [1991] 2 C.T.C. 2268, 91 D.T.C.1020.

Leung stands for the proposition that a notice of assessment which does not set forth the amount assessed under the Act does not meet the procedural requirements of the Act. The decision goes no further. In the course of the reasons for judgment in Leung, reference is made at page 1027 to remarks made in Crossley v. M.N.R., [1991] 2 C.T.C. 2082, 91 D.T.C. 827 (T.C.C.). Those remarks pointed out that a failure to disclose the precise timing of each failure to remit can adversely affect the fairness of the appeal process. It was not suggested that in this appeal the appellant was impeded in the presentation of his case by the absence of particulars of the date of each such failure. Furthermore, the appellant could readily have obtained such information on discovery. In Leung at page 1028, Rip, J. set out the minimum disclosure required in a notice of assessment as follows: “An assessment must state clearly the amount assessed so as to make the taxpayer aware of it”. That remark echoes what was said by Pratte, J. in a different context in Stephens (W.R.) Estate v. The Queen, [1987] 1 C.T.C. 88, 87 D.T.C. 5024 (F.C.A.). At page 89 (D.T.C. 5025), the following appears:

Subsection 152(2) requires the Minister to "send a notice of assessment" to the taxpayer. Nowhere in the Act do we find prescriptions relating to the form of that notice. It follows, in our view, that the form of the notice does not matter and that the subsection merely requires that the notice be expressed in terms that will clearly make the taxpayer aware of the assessment made by the Minister.

I am of the opinion that the notice of the assessment under appeal meets that minimum requirement. It is desirable that further information be given in a notice of assessment under section 227.1 but failure to give it does not invalidate the notice.

For the foregoing reasons, the appeal fails and will be dismissed.

Appeal dismissed.