Michael G. Lindthaler v. Minister of National Revenue, [1992] 2 CTC 2570, 92 DTC 2222

Mogan, T.C.C.J.:— On November 19, 1987, a notice of assessment was issued to the appellant in his capacity as a director of Lincoln Pub Ltd. (” Lincoln Pub”) with respect to unremitted source deductions owing when Lincoln Pub went out of business in September, 1986. The appellant disputes his liability as a director 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") on three separate grounds. First, he claims that he ceased to be a director by the middle of 1985 and the two-year period referred to in subsection 227.1(4) had ended before November 19, 1987. Second, he claims that, at the very latest, he ceased to be a director before May of 1986 when the arrears began to accumulate. And third, he claims that, if he did not cease to be a director, the so-called “due diligence” test under subsection 227.1(3) was met because he was not in a position to influence the affairs of Lincoln Pub.

The appellant began working in the food and beverage hospitality industry when he was 14 years of age. He is a trained chef and baker. In 1974, he arrived in Nova Scotia and set up his own restaurants known as Privateers’ Warehouse which was a combination of three restaurants situated in an historic building. Heritage Restaurants Ltd. (“Heritage”) was the corporation which operated the restaurants at Privateers’ Warehouse.

The appellant became entangled in the affairs of Lincoln Pub through David Bryson whom he met in 1982. The appellant had previously acted as a consultant in the food and beverage hospitality industry, and Bryson needed the appellant's services because he wanted to establish a pub in a shopping mall which he owned in Truro, Nova Scotia. He had tried to obtain a liquor licence but was unsuccessful. He asked the appellant to help him obtain a liquor licence and start up the pub. The appellant was to advise on such matters as furniture, fixtures and menu.

Heritage had certain financial difficulties in 1981 and 1982. At first, the appellant rejected Bryson's request because he felt he could not take on any more work. When Bryson offered to help the appellant solve his cash flow problem by negotiating on his behalf with the bank, the appellant agreed to help Bryson establish the pub at Truro which became Lincoln Pub. In a letter dated May 13, 1982, the appellant confirmed with Bryson their agreement that Heritage would provide certain management services. In particular, it would set up procedures to produce monthly financial statements like those at Privateers’ Warehouse and train key staff members.

What was intended to be a short-term relationship in which the appellant was a consultant became a broad business relationship between the appellant and Bryson who became a major financial partner in Heritage and The Fishing Admiral Ltd., another restaurant in which the appellant had an approximate one-third interest. Bryson acquired 49 per cent of the common shares in Heritage while the appellant and his wife held 51 per cent. Bryson also acquired a number of special preferred shares which could be voted under certain circumstances and would thereby give him control of Heritage. Bryson was to bring to this business relationship his financial management and recordkeeping skills while the appellant was to bring his restaurant management skills. Accordingly, they agreed that Bryson would have management control over the cash flow and record-keeping for Heritage, The Fishing Admiral Ltd. and Lincoln Pub (as well as other companies run by Bryson).

All the cash would be deposited into one account which Bryson controlled. He would determine how and when the bills would be paid.

Lincoln Pub was incorporated on August 14, 1984 by Bryson. He made a "gift" of some 25 per cent or 30 per cent of the shares of Lincoln Pub to the appellant in recognition of the work which the appellant had done to get Lincoln Pub started. The appellant became a shareholder, officer and director of Lincoln Pub. The first directors were Kim Murrell, Bryson and the appellant. Murrell was president, Bryson was secretary and the appellant was vice- president. The internal organization of Lincoln Pub was as follows: Murrell was to run the day-to day activities of the business; Bryson was the majority shareholder who was to control the cash; and the appellant was to expedite the application for the liquor licence and to advise on non-financial management matters. When Lincoln Pub opened for business in November of 1984, the market became very competitive. It could not meet its obligations to creditors from its own revenue. Bryson took the cash generated by all the companies involved, but especially from Heritage as it was one of the more profitable companies, and he paid Lincoln Pub’s bills and remitted source deductions. The total operating loss of Lincoln Pub from its opening to its closing exceeded $350,000.

The appellant was physically on hand for the first week of Lincoln Pub's operation. He then called once each week but gradually stopped calling or taking an interest in Lincoln Pub because he regarded it as Bryson's company. He testified that he was not in a position to influence the business affairs of Lincoln Pub and he could not control payment of the source deductions. In fact, he was never involved in paying the creditors of Lincoln Pub or in remitting its source deductions. The appellant did participate as a director in the removal of Kim Murrell as president of Lincoln Pub in the spring or summer of 1985. No directors’ meetings were held concerning Lincoln Pub after that time.

In the summer of 1985, Bryson and the appellant had a falling out because large sums of money from Heritage were being used to keep Lincoln Pub afloat. By September of 1985, they were no longer on speaking terms. Consequently, the appellant either did not receive monthly financial reports with respect to Lincoln Pub or, when he did receive them, he could not understand their significance without Bryson's help. In December, 1985, the relationship between the appellant and Bryson further soured over their dispute as to who was responsible for the arrears in rent of Lincoln Pub. Heritage had leased the premises out of which the Lincoln Pub operated. The landlord of those premises was Colchester Developments Ltd. (“Colchester”), a corporation controlled by Bryson. Colchester had difficulty in obtaining financing for fixtures of Lincoln Pub. Therefore, it was decided that Heritage would be the lessee because it represented better security than either Colchester or Lincoln Pub. The appellant became aware of this significant liability of Heritage only in December, 1985.

In late December, 1985, the appellant received calls from Revenue Canada, Taxation and the Nova Scotia Health Services Tax authorities who were concerned with the failure of Heritage to remit source deductions and hospital tax, respectively; Bryson had failed to remit source deductions for Heritage. When the appellant met with Revenue Canada officials, he became aware that there were payroll remittance problems for other companies in which Bryson had an interest. Revenue Canada refused to discuss these other problems, however, because the appellant was not the managing operator of those other companies.

The appellant became concerned that the cash drain caused by the failure of Lincoln Pub would affect the ability of Heritage to pay its suppliers and remit its payroll deductions as they became due. In January, 1986, the appellant set up separate accounts for Heritage with respect to its obligations to Revenue Canada and key suppliers. He thereby took back control of some of the cash management of Heritage. It was agreed that Bryson would continue to do the accounting functions and the appellant would report to him on the cheques which had been issued. In February, 1986, in addition to setting up separate accounts for Heritage, the appellant attempted to negotiate the purchase of Bryson's interest in Heritage and at the same time divest himself of any interest in Lincoln Pub. This was evidenced by a letter from Willard Strug (the appellant's lawyer) to Bryson's lawyers. Nothing came of these negotiations. After February, 1986, the appellant no longer involved himself in the business of Lincoln Pub although he remained a director. He viewed himself as having no ability to interfere or make decisions with respect to Lincoln Pub.

In September, 1986, the appellant issued a cheque for bonuses which he honestly believed were due to him from Heritage. At that point, Bryson claimed voting rights on his preference shares and then went to court with a series of injunctions and other actions. Meetings to resolve their disputes stopped after court proceedings were commenced with respect to Heritage. The court actions launched by Bryson resulted in the appellant being forced out of Heritage. The appellant never severed his ties with Lincoln Pub. The idea of resigning as a director of Lincoln Pub slipped through the cracks in the context of the greater problem between the appellant and Bryson. The appellant knew of the financial difficulties that Lincoln Pub was experiencing but he did not know that Lincoln Pub was in arrears with respect to remitting its source deductions until the notice of assessment was issued in November 1987.

I will consider the appellant's first two arguments together because they rely on the same reasoning. Counsel for the appellant submitted that the test of ceasing to be a director under subsection 227.1(4) or subsection 227.1(1) is broader than the legal test of whether the person is still in law a director: the fact that an individual was not in a position to cause source deductions to be remitted or to influence the affairs of a corporation determines whether that individual has ceased to be a director. In support of his submission, counsel referred to Perri v. M.N.R., [1990] 1 C.T.C. 2071, 89 D.T.C. 723 (T.C.C.) where Associate Chief Judge Christie, in absolving the directors from liability, stated at page 2074 (D.T.C. 725):

As I understand it, it is the intention or object of subsection 227.1(4) to fix a citation period that runs from a time when an individual ceases to be in a position in law and in fact to exercise the powers of a director to rectify the failure of the corporation to deduct or remit or both. I regard that as being the correct meaning of the phrase "ceased to be a director” in subsection 227.1(4). To hold that those words in all circumstances mean that there must be a lapse of two years from the date an individual ceases to hold office as a director in accordance with the provisions of the relevant Corporation legislation would in some instances, such as those under consideration, render the limitation period devoid of meaningful substance. What could the appellants do qua director in relation to Olympics' default after the receiver-manager was appointed? Nothing.

Counsel also referred to Nantel v. M.N.R., [1990] 2 C.T.C. 2362, 90 D.T.C. 1702 in which Lamarre Proulx, J. stated at pages 2363-64 (D.T.C. 1703):

I would perhaps have been more reluctant to accept the fact that the directors had resigned, had it not been for the total inaction of the appellants as directors. Their conduct was in accordance with the legal situation they described.

These two cases taken together with what was said by the Federal Court in Robitaille v. Canada, [1990] 1 C.T.C. 121, 90 D.T.C. 6059, about the importance of the exercise of freedom of choice, it was submitted, broadens the legal test of whether a director ceases to be a director for the purposes of subsection 227.1(1). In Robitaille, Addy, J. stated at pages 125-26 (D.T.C. 6062):

. .. I would be prepared to hold that, even without considering section 227.1(3) there would be no liability under section 227.1(1) because the latter obviously contemplates that the corporation is freely acting through its board of directors. The exercise of freedom of choice on the part of the director is essential in order to establish personal liability.

In my opinion, these decisions do not apply to the circumstances of this appeal. The appellant failed to show that he had ceased to be a director in law or in fact. He was a director from the inception of Lincoln Pub and never ceased to be a director. There was no evidence that he tried to resign; that he signed over his shares; or that his powers as a director were taken away by the action of some outside force—events which might start the clock under subsection 227.1(4) or might relieve a director from his vicarious liability under subsection 227.1(1).

What is crucial in those cases which have considered subsection 227.1(4) is that a director had in fact taken certain action to give up his directorship or he had his powers taken away by some outside force. In Perri, a receiver-manager was appointed to administer the affairs of the company and, accordingly, the directors had lost their ability to control the company. Therefore, the Court recognized that for the purposes of subsection 227.1(4) the directors had ceased to be directors as of the date of the appointment of the receivermanager, although they were still the named directors in the corporate records. In Nantel, the directors testified that they had resigned as directors, but were not able to produce the document to support their testimony. The Court found that their inaction as directors corroborated their testimony and they were held to have ceased being directors at the alleged time of resignation. The Nantel decision does not apply in this situation because the appellant did not argue that he resigned and there was no such evidence produced. I cannot find any basis for giving effect to the planned separation of the business relationship because the deal did not go through. Nothing was agreed to. The letter of Mr. Strug does not specifically deal with the appellants resignation as a director of Lincoln Pub or surrender of any shares.

The Robitaille decision considers freedom of choice as an essential ingredient in director's liability cases. Robitaille, however, dealt with the influence of an outside force. The facts of this appeal do not suggest an outside force at work which would relieve a director of liability. In fact, the internal arrangement concerning the duties of Bryson and the appellant were mutually agreed to and were not thrust upon them. A director does not cease to be a director merely because he believes that he does not have the ability to influence the affairs of a corporation. I find that the status of the appellant as a director of Lincoln Pub did not cease or change.

I turn to the appellant's third argument. He claims that because he had no ability to influence the affairs of Lincoln Pub, he exercised the degree of care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances to prevent the failure by Lincoln Pub to remit its source deductions. He further claims that he had no freedom of choice concerning the remittance of the source deductions. This is not a situation where, through the operation of law, the appellant was excluded from exercising any influence on the operations of Lincoln Pub. Indeed, there was nothing that prevented him legally or factually from trying to influence its affairs. The appellant had freedom of choice. He simply chose not to have anything to do with Lincoln Pub.

The appellant did not perform any positive action to meet the test in subsection 227.1(3): he took no steps which would indicate that he showed the degree of care, diligence and skill of a reasonably prudent person. He knew that moneys from Heritage were being used to pay the bills of Lincoln Pub. He should have known that by cutting off the cash flow from Heritage, Lincoln Pub would be in serious financial difficulty. A reasonably prudent director would have tried to prevent the failure to remit by setting up a cash reserve, by asking all directors for personal guarantees, or by resigning as a last resort. The appellant did none of these.

The appellant knew of Bryson’s failure to remit source deductions for Heritage as a result of his meetings with officials of Revenue Canada, Taxation. He also knew of the financial difficulties surrounding Heritage. I refer to the following comments of Rip, J. in Balasubramanian v. M.N.R, [1991] 2 C.T.C. 2812, 91 D.T.C. 1271 (T.C.C.) at pages 2816-17 (D.T.C. 1274) (decided after this case was heard):

. . .a director cannot assume that because source deductions were remitted previously on time they will continue to be so remitted in the future. A director must have a basis to his confidence that source deductions will be remitted as required by law. He must satisfy himself that the system the corporation has in place ensures payments to the Receiver General of Canada as and when required by the Act and its Regulations.

Subsection 227.1(1) provides for joint and several liability of the directors of a corporation. There is a burden on each director to show why he should escape liability. At all relevant times, the appellant was a director of Lincoln Pub and he was aware that he was one of its directors. He also knew that he had a significant financial interest in Lincoln Pub: he was a shareholder and Heritage (a corporation which he regarded as his own) held its lease and liquor licence. He knew that Lincoln Pub was in serious financial difficulties. When he took back control over the Heritage cash flow, he knew that Lincoln Pub would have difficulty paying its creditors and source deductions. Although the appellant did not have control over the cash for Lincoln Pub, he had freedom of choice and the ability to influence control over the cash for Lincoln Pub, he had freedom of choice and the ability to influence the affairs of Lincoln Pub. He could have done more than he did (which was nothing) with respect to making sure that Lincoln Pub remitted its source deductions.

The appellant failed to take any positive action to prevent the arrears. He closed his eyes to the affairs of Lincoln Pub and made no inquiries as to its financial status. Being a passive director is not enough to escape liability; and the prospect of a dispute with Bryson was not enough to excuse the appellant from his director's responsibilities of being aware of what was happening within the corporation. The appellant did not take the necessary steps either to resign or to prevent the default. Also, he had no reasonable basis for believing that Bryson would ensure the timely remittance of source deductions for Lincoln Pub. It was argued that the appellant had no knowledge of the arrears. This is no excuse. Subsection 227.1(1) speaks to all directors of a corporation and not just those directors who knew of their responsibilities or a specific problem like unremitted source deductions.

Although counsel in this case did not submit any argument concerning the validity of the assessment or, specifically, whether the notice of assessment dated November 19, 1987 was adequate, subsequent cases cause me to question whether the purported assessment under appeal is complete. In Leung v. M.N.R., [1991] 2 C.T.C. 2268, 91 D.T.C. 1020 (T.C.C.), Rip, J. held that an assessment which discloses only an aggregate amount assessed under four different statutes is not complete. Under section 152 of the federal Income Tax Act, a taxpayer is entitled to be informed in the notice of assessment of the particular amount which has been assessed against him under that Act alone. The notice of assessment issued to the appellant and dated November 19, 1987 showed only one amount of $8,066.93 and the following note was typed on the face of the document:

The liability under subsection 227.1(1) of the Income Tax Act, section 36A of the Income Tax Act of Nova Scotia, section 68.1 of the Unemployment Insurance Act 1971, and section 22.1 of the Canada Pension Plan in the amount of $8,066.93 being the amount of the unpaid deductions, interest and penalties payable by the Lincoln Pub Ltd. in respect of a notice of assessment dated October 30, 1986.

The appellant could not by this notice of assessment determine his liability under any one of the four statutes named. In Wallace v. M.N.R., [1991] 2 C.T.C. 2341, 91 D.T.C. 1134 (T.C.C.), Rip, J. stated at page 2344 (D.T.C. 1137):

. . in communicating with taxpayers, the respondent has an obligation to ensure that such communication is unambiguous and capable of being understood by the average taxpayer.

The fact that in the reply to notice of appeal the Minister of National Revenue provides a breakdown of the amount of liability under the four named statutes does not render the assessment complete. All assessment must be capable of being understood when it is issued. If a purported assessment is not complete, the Minister must correct the assessment by way of a notice of reassessment: Kirby v. M.N.R., [1991] 2 C.T.C. 2639, 91 D.T.C. 1453 (T.C.C.). Because the notice of assessment herein is substantially the same as that found in Leung, I find that it was not a complete assessment and should be vacated. For this reason alone, the appeal is allowed.

Appeal allowed.