Michel Seguin and Barbara Seguin v. Minister of National Revenue, [1992] 1 CTC 2711, 92 DTC 1502

Taylor, T.C.C.J.:—These are appeals heard in Toronto, Ontario on November 28 and 29, 1991 against income tax assessments struck in part for a liability applicable to both Michel Seguin and Barbara Seguin, under section 221.1 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") dealing with the liability of directors of a corporation—in this matter allegedly arising out of the provisions of Part VIII of the Act; and a further assessment against Michel Seguin respecting alleged appropriations as a shareholder under paragraphs 15(1)(b) and (c) of the Act for the taxation years 1983, 1984 and 1985. The appeals were heard on common evidence, that is it was agreed by both counsel that although the issues were different, the total evidence would be put in at the hearing and argument relative to the critical points could be separated, and dealt with in that manner by the Court. I shall turn first to the issue surrounding the Part VIII liability.

The Notice of Appeal for Michel Seguin, (virtually the same for Barbara Seguin) reads as follows:

The appellant appeals from a Notice of Confirmation of Notice of Assessment #572570 dated October 19, 1990.

STATEMENT OF FACTS

— the appellant was a director of Cambridge Systems Inc. at all material times. — Revenue Canada assessed Cambridge Systems Inc. for Part VIII tax, together with interest, in the amount of $112,671.01, on November 6, 1986.

— Revenue Canada assessed the appellant under subsection 227.1(1) for $112,671.01 on December 4, 1986.

— In December 1986, Revenue Canada seized the house of the appellant's spouse and sold it for $133,000.

— The appellant at all times acted on the advice of professional advisors with respect to the issuance of the Scientific Research Tax Credits as well as with respect to the qualification of Cambridge Systems Inc.'s expenditures as qualified scientific research and development expenditure and honestly believed that Cambridge Systems Inc.'s entire Part VIII tax liability for the 1985 taxation year was satisfied.

REASONS FOR APPEAL

The appellant exercised the degree of care, diligence and skill to prevent the failure of Cambridge Systems Inc.’s remittance that a reasonably prudent person would have exercised in comparable circumstances.

In the Reply to the Notice of Appeal the following may be found:

— In assessing the appellant with respect to subsection 227.1(1) pursuant to subsection 227(10) of the Income Tax Act, R.S.C. 1952, c. 148, as amended (the “Act), the respondent relied, inter alia, upon the following findings or assumptions of fact:

(a) the appellant was a director of Cambridge Systems Inc. (Cambridge) at all material times;

(b) Cambridge was incorporated on June 14, 1984;

(c) the appellant and his wife were the incorporators and first directors of Cambridge;

(d) on June 14, 1984, Cambridge filed a T2113 return designating $266,100 under Part VIII of the Income Tax Act, resulting in a tax liability of $133,050;

(e) on November 16, 1985, Cambridge filed a T2115(E) return showing a balance due of $133,050;

(f) on January 16, 1986, Cambridge filed an amended T2115(E) return showing a balance due of nil, claiming that it had spent the eligible expenditures to earn a Part VIII refund of $133,050;

(g) of the $133,050 claimed as a refund under Part VIII, only $42,178 was allowed, the balance of $90,872 being with respect to $181,744 of ineligible expenditures, being for the purchase of technology rather than required research and development, as follows:

Expenditures incurred by Cambridge Heating and Air

Conditioning Ltd.	$159,588
Capital Expenditures incurred by Cambridge	$ 14,979
Personal Expenditures of Shareholder	$ 7,177
TOTAL:	$181,744

(h) on October 22, 1986, a certificate for the amount of Cambridge's liability was registered in the Federal Court of Canada under section 223 of the Income Tax Act;

(i) on November 6, 1986, a Nulla Bona report was returned from the Deputy Sheriff of the County of Wellington;

(j) on December 4, 1986, the appellant was assessed under section 227.1 of the Income Tax Act for $112,671.07, being taxes of $90,872 plus interest of $21,799, the amount owed by Cambridge;

(k) the appellant knew or ought to have known that the purchase of technology would not qualify for the purposes of generating a refund pursuant to Part VIII of the Income Tax Act and the Part VIII liability would not be eliminated;

(l) the appellant directed the payment of funds from Cambridge so that it was not able to pay the Part VIII tax;

(m) the appellant did not exercise the degree of care, diligence and skill to prevent the failure of Cambridge to pay the amount of tax required under Part VIII.

— The respondent relies, inter alia, upon section 227.1 and subsections 195(2) and 227(10) of the Income Tax Act, R.S.C. 1952, c. 148, as amended (the "Act").

— The respondent submits that the appellant has been properly assessed pursuant to subsection 227(10) of the Act as he was a director of Cambridge at the time that the company was required but failed to pay the amount of $90,872 in accordance with subsection 195(2) and Part VIII of the Act. The appellant is, accordingly, jointly and severally liable to pay the sum of $90,872, together with applicable interest pursuant to subsection 227.1(1).

— The respondent submits further that the appellant did not exercise the degree of care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances to prevent the failure of the company to pay the amount owed.

In view of the determination I am prepared to make on this point, it does not appear to me that a great deal of the detail arising out of the evidence and testimony needs to be recounted. I would however, emphasize that in reading over the documentation, and the Reply to the Notice of Appeal (above), it must be kept in mind that Cambridge Heating and Air Conditioning Ltd. (referenced therein) is not the same corporation as Cambridge Systems Inc. ("Cambridge"), the entity critically involved with this appeal. I would also add that there were other corporate names which entered into the evidence—Climate Control Products Inc. and Cambridge Manufacturing Ltd., for example as well as references to the unincorporated business operated at an earlier point in time by Michel Seguin called simply Cambridge Heating and Air Conditioning. Shortly after the times directly relevant to these appeals, Michel and Barbara Seguin according to the testimony, apparently liquidated assets in Canada, transferred the funds to the United States, dissolved the corporation and presently live in Orlando, Florida. The implication which the respondent seemed to draw from those events was that they did occasion difficulties for Revenue Canada in keeping in contact with the appellants and arranging for service and/or collection procedures. While that aspect of the matter may have some relevance to Revenue Canada, it should not enter into this issue before the Court. As I see it counsel for the respondent in her argument summarized the significant point for the Court, and I shall quote extensively therefrom but unless essential to the points I wish to make, I shall not amplify the remarks with details of exhibits, etc.:

Your Honour, there are very few cases—I think there are only two in the reports— dealing with Part VIII and really the facts in this particular situation speak for themselves, and this case has to be decided on the merits of its own particular facts. Some of the comments in some of the decisions that have been referred to by my friend and are in his case book are helpful in terms of deciding the definition of"due diligence”, and certainly the Minister relies on all the cases that have been provided by my friend.

With respect, first of all, to the due diligence defence, the evidence, as disclosed yesterday, was that the appellants were conducting a business. They came into contact with a Mr. John Lee who represented to them or told them that they would be able to get financing for their business by taking advantage of the SRTC program. They expressed an interest and because of that interest, he in turn put them in contact with people that he knew that could provide them with the information so that they could make a decision whether or not to take advantage of the program. He put them in contact with accountants and other individuals and, as the result of that contact, they decided that they would take advantage of the program.

The next step was to structure the transaction, and the transaction was structured on the basis that $159,600 of research and development expenditures had already been incurred in the period after April 19th, 1983 to April 30th, 1984.

Exhibit A-2 is a letter from one of those professionals from whom they received advice, a Mr. Douglas Jackson, Certified General Accountant, and you can see by Exhibit A-2, that he is operating under the assumption that Cambridge Systems (Inc.) is already incorporated. And I believe the date of that opinion is May 24th. And he is operating, at this point when he provides this opinion, on the basis that incorporation has been already established and in the prior year had incurred those expenditures.

This underlying assumption, which was completely erroneous, is also reflected in Exhibit R-5, the designation. The designation says that the corporation has already incurred expenditures in the prior year to the extent of $196,500—I think it was— and it's quite clear that the underlying assumption was that there was a corporation.

At the time of the closing, it was discovered—and based on the testimony, particularly, of Mrs. Seguin—that Cambridge Systems was not a corporation, and suddenly on that day a corporation had to be created. Well, that, unfortunately, changed the picture dramatically with respect to the expenditures that had already been made because they then did not qualify.

On June 14th, 1984, then, the date of the closing, the appellants suddenly became directors of the new corporation. At that time, they sought no further advice, even though—to use the expression used in the Byrt decision—the bells should have gone off and they should have realized that there was a problem. One of the very fundamental aspects of this whole transaction was missing; there was no corporation. And, at that point in time, their concern should have been to stop the process, to seek other advice and to be certain at that point in time that there was not going to be a tax liability.

Their concern, as expressed yesterday, was that they were worried the deal wouldn't go through but they were assured that it would go through. And a corporation was created, the deal went through, and they received $106,500* [1] as the result of that.

They did not seek any advice from Revenue Canada with respect to these prior expenditures. They did not seek the advice of Bay Street lawyers, as suggested by my friend in his argument. There's no evidence of any advice being sought by anybody except for those people who were benefiting from the SRTC. The people that they were seeking advice from were benefiting in the terms of fees and moneys that they would receive as a result of the transaction.

They knew that the expenditures, the $159,600 worth of expenditures were incurred by Cambridge Heating and Air-Conditioning, and the exhibits that were produced yesterday in Court, the tax returns of Mr. Seguin for 1982 and 1983 clearly show expenditures having been made. They knew that those expenditures were not incurred by a corporation and they should have, at that point, realized that they would not qualify.

The expenditures that were in fact relied upon were incurred prior to the period (of incorporation); they were incurred in 1982,1983 and then in 1984 as well, up to April of 1984.

The way the Minister approached this—is that the corporation claimed that these prior amounts had been paid by it in the year before.

Now, on the date of the transaction, June 14th, 1984, the new directors of the corporation received $106,500 from the T-D Bank; that was the net amount that they received and, as you can see on the designation that was made on the same

day, the directors indicate that the amount is going to be dedicated to research and development and will be spent on research and development in the following year. And that designation is Exhibit R-5.

After the paying down of the mortgage on the home, the house was transferred on June 8th, 1985 from Michel Seguin and Barbara Seguin to Barbara Seguin herself, and I suggest that the explanation for that was unclear and not satisfactory.

On October 9th, 1985, a mortgage was placed on the residence and a U.S. bank draft of $104,567.39 made out to Mrs. Seguin was then cashed in the United States and that money was left in the United States.

$70,000 worth of Canada Savings Bonds were cashed between February and April of 1986.

Finally, the appellants left Canada and moved to the United States. The corporation was dissolved and it has no assets.

[Emphasis added.]

As I understand it, the substantive point being made by counsel is that these appellants should have known at the time the expenditures of some $159,600 had not been made by the corporation filling out the designation, (because there was no such corporation during the period of making such expenditures) and that therefore they were instantly incurring a tax liability in connection therewith for the corporation initially but not for themselves. Presumably counsel would argue that they should have stopped the effort right at that point. I would also add that counsel for the appellants, on this point, agreed that the earlier (unincorporated) expenditures of some $159,600? [2] above did not qualify for consideration under Part VIII of the Act. Without going into detail, I would also suggest that there was little if any evidence provided at the trial of expenditures out of the above $106,500 portion of the original $266,000 allocated to the appellants (more specifically to the corporation just formed) which was used for scientific research. The purchase of investment bonds (some $75,000), an automobile—a new Fiero—television set, video recorder, a vacation trip, house mortgage paid off etc. by the appellants seemed to be far more prominent and primary than items which could be easily associated with research. This comment is provided in relation to the fact that $42,178 of expenditures were considered eligible for such research categorization (see reply to notice of appeal above) and that is the basis upon which the assessments were calculated. Some effort was made by counsel for the appellants to expand this amount of $42,178 (thereby reducing the disallowed portion of $90,872—see reply to notice of appeal, above)—but I find no merit in that effort. However, irrespective of the somewhat complex and tangled history of this matter, that does not change the single issue in this part which could be stated as—"Does the contention of the appellants that they were advised and were of the opinion while they were directors of Cambridge, that expenditures before the date of the incorporation of that company were "eligible", relieve them of the result of the assessments by virtue of the "due diligence” provisions of the Act?".

In my view the determination of this issue rests on an examination of three documents filed with Revenue Canada by the corporation described in the notice of appeal above, and indexed as (d), (e) and (f) and provided to the Court as Exhibits R-5, R-7 and R-8. These were documents signed by at least one of the two directors assessed in this matter. R-5 is reproduced in its essential elements:

DETAILS OF SHARES OR DEBT OBLIGATIONS ISSUED OR RIGHTS GRANTED

Describe Security Issued Or Right Granted
1984 Fully Registered R & D Note
1. Month of issue June/1984 Amount of consideration received	$266,100
2. Amount designated (not to exceed the amount shown on line
1)	266,100
1)
3. Part VIII tax payable (50% of the amount shown on line 2)	133,050
4. Amount of penalty if applicable pursuant to subsection 194(8)
	Nil
of the Act
5. Part VIII tax and penalty (if applicable) payable to the Receiver
General by cheque or money order to be attached to this
form.
	00
(Total of lines 3 and 4)

No amount on account of Part VIII tax is enclosed. The corporation has expended $159,600 after April 19, 1983, on research and development and will expend an additional $106,500 prior to its current fiscal year end to satisfy any liability for Part VIII tax.

June 14,1984	Michel Seguin	President
Date		(Position or Title)

On this point, it is difficult indeed to imagine that these two directors were so naive during the planning for the designation of the scientific research credits, the application for the amount involved, and the ultimate incorporation of Cambridge that they did not know the difference between expenditures already made (the $159,600) and future expenditures for which they were committing the corporation. But whatever may have been their earlier impressions as at the date of incorporation they recognized the actual situation— there was a liability of $133,050. I am not impressed by their protestations that they did not know what that meant. Further, it is perfectly clear from the Act the requirements to avoid paying this tax—it is certainly not automatically avoided. It might be useful to add at this point, that aside from the critical fact the $159,600 had been expended before incorporation, there was little if anything in the modest amount of information provided at the trial regarding the nature of these expenditures which would qualify them for consideration as research costs. They were operating a straight, normal heating and air conditioning business—that is all.

Moving ahead to Exhibit R-7, this document clearly indicates that at that point the situation had not changed—but the problem now was one of inability to pay the amount owing. The bank had retained $159,500, and the appellants had received and spent, in my view almost entirely on items not relevant to science or research, practically the entire balance. Mr. Seguin's explanation was that he did not know why he had signed the documents indicating amounts were unpaid. I do not accept that as any explanation. R-7, the corporation return under Part VIII of the Act indicates that the entire $266,100 received had been spent according to the regulations, and that the corporation was entitled to a credit of $133,050. The problems remained the same however—Mr. Seguin stated that $161,619 of this had been expended in the previous year after April 19, 1983 (the small difference between this amount and the corresponding amount reported in R-5 above was not contested). This document however still showed the corporation owing $133,050.

Finally, Exhibit R-8—an amended TZ115(E)—simply eliminated the obligation of $133,050 by taking a tax credit based on the entire amount of $266,100 having been spent. Nothing fundamental had been changed between Exhibit R-5 and Exhibit R-8. The corporation claiming the tax credit had not been in existence in the" previous year”, and in any event the major part of the $159,600 claimed as expended by for research in the "previous year" had actually been expended by a sole proprietorship in 1982 and early 1983.

It would not be difficult to reach the conclusion that the entire process lacked any indication of effort to deal with and under the Act for purposes of claiming the tax credit involved. Such a conclusion is not required from the Court in order to dispose of this matter. There is certainly no indication of diligence, let alone due diligence in either paying the amount owing, or adhering to the relevant rules and regulations provided for the credit claimed. The appellants remain jointly and severally liable for the tax assessed. That part of the appeals will be dismissed.

To consider the second aspect of this matter—that dealing with the appropriations contended by the respondent, will take less effort. The evidence established that all the amounts stated by the respondent came from business funds, and the use appeared to be in connection with demands of the shareholder Michel Seguin rather than for legitimate business purposes. The only problem I have is that all amounts, including that of $6,670 applicable to the 1983 fiscal year were treated in the assessments at issue as appropriation by the shareholder. I am satisfied that the amounts relevant to 1984 and 1985, $68,815 and $4,341 respectively, were properly identified as appropriations qua shareholder. Counsel for the respondent agreed that the amount should have been more accurately described as for "personal living expenses" in the amount of $6,670 rather than an appropriation. Counsel also supported the basis of the amount as payments on account of a personal home mortgage. The appellant provided nothing in the way of information or assistance which would negate that view, and agreed that it had been deducted apparently as a business expense—albeit from his incorporated business. In the circumstances of these appeals, there is no reason to disturb even that part of this assessment.

The appeals are dismissed.

Appeals dismissed.