Ronald L Larocque, James H. Brener and Michael L. Tucker v. Minister of National Revenue, [1991] 2 CTC 2151

Brulé, T.CJ.:— These appeals were heard on common evidence and involve assessments by the respondent against each of the appellants. The assessments are dated January 26, 1989 and involve the three appellants as former directors of Hankin Management Services Ltd. ("the Company"). The assessments were issued pursuant to 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"), paragraph 36(a) of the Income Tax Act (Ontario), R.S.O. 1980, c. 213 as amended, section 22.1 of the Canada Pension Plan Act and section 68.1 of the Unemployment Insurance Act, 1971 for $24,396.78. This amount was alleged to be the deductions, penalties and interest which had not been paid.

At the outset of the trial the respondent consented to judgment deleting the penalty of $200 assessed to the Company pursuant to subsection 235(1) of the Act in respect of the late filing of a T-4 summary for the Company's 1986 taxation year and included in the appellant's assessment under section 227.1 of the Act.

Facts

The three appellants resigned as directors of the Company on January 26, 1987. Until a payment due on January 15, 1987 there had never been any difficulties with remittances due to Revenue Canada.

Commencing in early 1985 the company began to experience serious financial difficulties. Despite these problems payments to Revenue Canada were always made on time except as noted above when the Company was in a position that it could not make any payments without the approval of its bankers. This was not given and a default occurred.

On January 20, 1987 a receiver was appointed, and then the directors resigned. They continued to assist the receiver in collecting funds with one result being that the receiver in February 1988 paid Revenue Canada a sum of $32,244.31 but presumably this did not include any employer's [portion] on certain amounts due.

There followed the assessments to each of the appellants referred to above, on January 26, 1989.

Issues

The appellants pleaded certain reasons why the assessments should be vacated. These were as follows:

(a) The assessment exceeds the amount of the certificate registered in the Federal Court of Canada.

(b) The former director(s) exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.

(c) That a notice of assessment is not an action or a proceeding.

(d) That the action or proceeding has been launched after the two-year limit defined in the Act.

Appellants' Position

In dealing with the first issue the Court was directed to subsection 227.1(2) of the Act which reads in part:

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 of Canada under section 223 and execution for such amount has been returned unsatisfied in whole or in part;

The Court was told that the amount noted in the certificate registered in the Federal Court of Canada was in the sum of $12,076.44 while the assessments issued by Revenue Canada were for $24,396.78. It is because of this difference and the fact that Revenue Canada did not provide any evidence that the execution for the amount involved was returned unsatisfied that the assessments were wrong and no liability should attach to the appellants.

As to the second issue the appellants claimed that they complied with the provisions of subsection 227.1(3) of the Act in that they exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. Reference was made to the cases of Fancy v. M.N.R., [1988] 2 C.T.C. 2256; 88 D.T.C. 1641 and Kenneth Merson v. M.N.R., [1989] 1 C.T.C. 2074; 89 D.T.C. 22.

Reference was made to Information Circular 89-2 which did not appear until May 1, 1989. Nevertheless the appellants said they had followed the steps suggested in paragraph 7 of that circular even though such was not in existence at the time of the default in January 1987. Paragraph 7 of the Information Circular 89-2 reads as follows:

7. Under the due diligence provision, a director is not liable if that director exercises the same degree of care, diligence and skill that a reasonably prudent individual would have exercised, in comparable circumstances, to ensure that the corporation deducts, withholds, remits or pays the amounts due. A director may take positive action towards this end by

(a) establishing controls to account for withholdings from employees and remittances;

(b) calling upon financial officers of the corporation to report regularly on the continued implementation of these controls; and

(c) obtaining regular confirmation that withholdings and remittances have in fact been made during all relevant periods.

It was maintained that all of the above were followed and confirmed at regular meetings of the directors. Only when the bank refused to allow the January 1987 payment did a problem arise. The bank had held funds of the Company, albeit they were to protect loans, no prior notice of any problem was given by the bank and subsequently the receiver did pay out of funds part of the amount owing.

In conclusion the appellants through Ronald Larocque said:

We suggest that in January 1987 Revenue Canada did not have a clear understanding of what was meant by subsection 227.1(3). This is not surprising because the statement is ambiguous and subject to many different interpretations. It seems to us that as a matter of law, the rules of construction as applied to interpretation of documents should apply to this situation. Goldsmith, in his book, "Canadian Building Contracts,” Third Edition, makes the following comment on Page 34:

It is important, however, to remember that in case of ambiguity the courts will construe a document against the person who prepared it.

The third and fourth points in issue, as set out above, involve subsection 227.1(4) of the Act which reads:

No action or proceedings to recover any amount payable by a director of a corporation under subsection (1) shall be commenced more than two years after he last ceased to be a director of that corporation.

The appellants stated that there is nothing in the subsection that states that a notice of assessment is "an action or proceeding". Further it was pointed out that Webster's Dictionary contains a number of definitions of "notice" but none of them suggest “notice” is an action or proceeding. If this was intended the section should so state.

As to the last point the appellants claimed that their resignations were effective on January 26, 1987. As a result they stated that any action (if a notice can be described as such) was not commenced until the first day of the third year after the directors resigned. January 26, 1989 had to be the first day of the third year because it is not possible to have three January 26ths in a two-year period.

Minister's Position

To clarify the first point in issue the respondent submitted that the appellants' notices of assessment reflected amounts certified by two writs, one filed in the Federal Court-Trial Division with respect to liabilities of the Company under the Income Tax Act, the Canada Pension Plan, and the Unemployment Insurance Act and one filed in the Supreme Court of Ontario under the Income Tax Act (Ontario), R.S.O. 1980, c. 213 as amended. As at August 12, 1988, when the writs were filed, the total liability under all four statutes which was certified was $23,249.42. As at January 26, 1989, when the appellants were assessed, interest on that sum had accrued to bring the indebtedness to $24,396.78.

Counsel for the respondent claimed that the appellants had been properly assessed pursuant to subsection 227(10) of the Act as they were directors at the time that the Company was required to remit the amount which it had deducted in accordance with subsection 153(1) of the Act but had failed to remit to the Receiver General of Canada, contrary to subsection 153(1) of the Act and section 108 of the Income Tax Regulations, and, therefore, the appellants are jointly and severally liable to pay the unremitted amounts, and any interest and penalties relating thereto, pursuant to section 227.1 of the Act.

It was further submitted that the appellants did not exercise the degree of care, diligence and skill that reasonably prudent persons would have exercised in comparable circumstances to prevent the failure of the Company to remit the employee source deductions.

In support of this the Court was referred to the cases of Bronson Short v. M.N.R., [1991] 1 C.T.C. 2464; 91 D.T.C. 67, Henderson (H.) Estate v. M.N.R., [1990] 2 C.T.C. 2086; 90 D.T.C. 1618 and Clark v. M.N.R., [1990] 1 C.T.C. 2212; 90 D.T.C. 1094.

The question[s] as to whether or not a notice of assessment [is an action or proceeding] and [as to] the two-year limitation period found in subsection 227.1(4) of the Act should be answered by saying that the Minister's assessments conformed to the statute. As proof of this reference was made to the following cases: Lawrence B. Scott v. M.N.R., [1960] C.T.C. 402; 60 D.T.C. 1273, Robert D. Green v. M.N.R., [1991] 1 C.T.C. 2110; 90 D.T.C. 1898, and Jose Cortes Manago v. M.N.R., [1990] 2 C.T.C. 2459; 90 D.T.C. 1889.

Analysis

I am satisfied that the Minister's explanation as to the assessments in relation to the certificate registered in the Federal Court is quite satisfactory insofar as federal income tax in concerned, and I do not intend to deal with this issue any further. This Court only has jurisdiction to deal with the claim for federal income tax.

With respect to the appellants' claim that the assessments were not in accordance with subsection 227.1(4) of the Act I would, first of all, like to consider the words in the subsection "no action or proceeding to recover. . .”. It is readily admitted that an assessment is not an action but the term "proceeding" has a very broad meaning.

In Black's Law Dictionary, 6th edition, 1990 we find:

Proceeding: . . . Regular and orderly progress in form of law, including all possible steps in an action from its commencement to the execution of judgment. Term also refers to administrative proceedings before agencies, tribunals, bureaus, or the like ”. . . Term “proceedings” may refer not only to a complete remedy but also to a mere procedural step that is part of a larger action or special proceeding.

Similar definitions are found in Words & Phrases, Legally Defined, 3rd Edition, The Oxford English Dictionary, 2nd Edition, 1989, and The Living Webster, 1972 edition.

In the case of Re Norris, [1989] 2 C.T.C. 185; 89 D.T.C. 5493 the Ontario Court of Appeal supported Revenue Canada’s view that a notice of assessment under section 227.1 of the Act is prima facie valid under subsection 152(8) of the Act until varied or vacated on objection or appeal. The assessment while not a legal proceeding is an administrative one aimed to ultimately recover an amount of money. This latter statement is supported by the cases of Flemming Estate v. M.N.R., [1983] C.T.C. 321; 83 D.T.C. 5329 and the Norris case, supra.

The matter is dealt with in some detail by Kempo, T.C.J. in Jose Cortes Manago, supra. The conclusion is that an assessment is an action or proceeding to recover any amount payable by a director.

The issue of this assessment being launched after the two-year limit defined in subsection 227.1(4) of the Act is quickly settled by reference to the time period involved. The resignation of the directors was accepted as being January 26, 1987, while the assessment to recover amounts owing was on January 26, 1989. While the appellants' argument that there cannot be three January 26ths in a two-year period may seem correct in order to determine a legal period of time reference may be made to the Interpretation Act, R.S.C. 1985, c. 1-21. There subsection 27(5) provides:

Where anything is to be done within a time after, from, of or before a specified day, the time does not include that day.

Hence in this case by discarding the one January 26, the time limitation in the statute has not been breached.

This leaves the issue of a due diligence defence by the appellants. Many cases have been decided since the provision in subsection 227.1(3) was introduced in 1981. This states:

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

As was stated by Judge Christie in the case of Cybulski v. M.N.R., [1988] 2 C.T.C. 2180; 88 D.T.C. 1531, at page 2185 (D.T.C. 1535):

While at first blush subsection 227.1(3) suggests a requirement for positive assertion on the part of a taxpayer in order to bring himself within its ambit, this is not necessarily so in all situations. It may well be that a taxpayer would not take positive steps in some circumstances and still be correctly regarded as having “exercised” that degree of care, diligence and skill expected of a reasonably prudent person that creates the protection from liability afforded by the subsection.

In the Cybulski case, supra, Christie, A.C.J.T.C. discussed the due diligence defence provided for in subsection 227.1(3) at page 2184 (D.T.C. 1534) and in so doing, referred to the following passage from Canadian Business Corporations, by lacobucci, Kilkington and Prichard. This passage discusses the nature of the common law duty imposed on directors, at page 287:

The common law standard of care and skill which a director must meet is generally expressed as an objective standard: he must exercise the reasonable care and skill which an ordinary person might be expected to exercise in the circumstances on his own behalf. However as Mr. Justice Romer indicated, in the leading case of Re City Equitable Fire Insurance Company [1925] Ch. 407 at p. 428, affd [1925] Ch. 500 (C.A.), the common law standard is also partly subjective: a director need not exhibit a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. At common law the degree of care and skill demanded of a director varies with the type and size of the company he serves.

The appellants by their spokesman Mr. Larocque, cited the cases of Fancy and Merson, supra. In the former case the bank prevented the Fancys from dealing with the cash flow and the Court allowed the appeal. It was stated by Couture, C.J.T.C. at page 2261 (D.T.C. 1644):

The personal liability of directors created by subsection 227.1(1) is not an absolute liability. It is conditional upon their personal conduct in respect of the circumstances linked to the omission by their company to remit the deductions from its employees' salary. The exercise of care, diligence and skill referred to in subsection 227.1(3) exempts them from that personal liability.

In the Merson case, supra, the appellant had been actively involved in ensuring the company's survival. When a failure to remit occurred the appellant was not in a position to have payment made as a receiver took over. Up until that time the appellant had been diligent. The Court held that the circumstances did not require any further positive action on the part of the taxpayer to bring himself within the Act; he did all that could reasonably be expected of him. The appellants said the same situation existed here.

The cases of Short, Henderson and Clark, supra, relied upon by the respondent can all be distinguished in fact from this case.

In the Short situation long periods passed before remittances to Revenue Canada were made. There was not just one payment missed. Previous decisions not to remit were voluntarily made. The one in the present case which wasn't honoured was due to the bank's involvement.

The Henderson case involved a situation where, as here, the Company was experiencing a slow decline. There was nothing sudden or unexpected about the bank ceasing to honour cheques for deductions, as the Court pointed out at page 2089 (D.T.C. 1620) of the judgment. In contrast to the present case while the Company was having difficulty the bank's position not to honour the January 15, 1987 cheque was sudden and unexpected.

The directors in Clark also faced a financial crisis but neither took any position action to make sure that source deductions were remitted to Revenue Canada during a period of many months. In the case here the directors met in an attempt to overcome the financial crisis. They developed a plan to sell some assets and to collect receivables. They assumed that while the bank was concerned over money owing to it they never believed that the one payment to Revenue Canada would not be honoured until the date before the due date. At that time the Company could not make any payments without the bank's approval.

It is interesting to note comments made in the case of Lucette Robitaille v. Canada, [1990] 1 C.T.C. 121; 90 D.T.C. 6059 by Addy, J. at page 125 (D.T.C. 6062):

Although that burden would, in the vast majority of cases, fall upon any director seeking to escape liability under subsection 227.1(1) by qualifying as an exemption under 227.1(3), I cannot accept that it is an inflexible rule of universal application regardless of the facts of any case. There exist, as was decided by Chief Judge Couture, of the Tax Court of Canada in the reported case of Fancy & Fancy v. M.N.R., supra, certain exceptional situations where a distinction can and should be made. Be that as it may, the “circumstances” referred to in subsection (3) must be those which, either directly or indirectly, would have an effect on the actions or on the inaction of the person sought to be held liable under subsection (1).

At page 136 (D.T.C. 6063) Addy, J. goes on to say: "The exercise of freedom of choice on the part of the director is essential in order to establish personal liability.”

The absence of freedom of choice renders the charging provisions of subsection 227.1(1) inapplicable.

In the present case there was no choice the appellants could make. They had acted prudently throughout and are therefore held to come within the provisions of subsection 227.1(3) of the Act.

The result is that the appeals are allowed with costs, if any, and the matters are to be returned to the Minister for reconsideration and reassessment.

Appeals allowed.