William Frazer Zwierschke v. Minister of National Revenue, [1991] 2 CTC 2783, 92 DTC 1003

Mogan, T.CJ.:— This is an appeal from an assessment issued 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"). The appellant was born in 1925 and left school before completing grade 9. In 1964, he went into business for himself using a backhoe and dumptruck for trenching and construction work. As his business expanded, he hired three or four employees whom he would supervise at the job sites while his wife did most of the paper work connected with the business. His wife did the payroll after getting the "hours" from the appellant. They withheld the required source deductions and made the monthly remittances to the Receiver General of Canada.

In 1978, the business was transferred to a corporation, Frazer Zwierschke Construction & Trenching Ltd. (the "Company") of which the appellant was the only director. After the business was transferred, the appellant managed it in the same manner as he had prior to incorporation. In the early 1980s, the Company had five or six employees. At all relevant times, the Company used the Niagara Credit Union Ltd. (the “Credit Union") as its banker. The Company would purchase equipment with a down payment from the Credit Union and would finance the remainder of the cost with a finance company. The Company had a line of credit at the Credit Union which it used to pay wages, purchase materials and pay other business expenses. The line of credit was increased from time to time as the company acquired bigger contracts and needed more operating funds.

The Company's principal business was to dig foundations for buildings and to dig trenches for Consumers' Gas and other utilities. Consumers' Gas had a policy of paying in the middle of a particular month for work performed in the preceding month. Therefore, any work which the Company performed for Consumers' Gas had to be financed during the month of construction and until the middle of the following month. This practice would sometimes cause a severe shortage of cash within the Company.

Mr. Disley, the manager of the Credit Union branch from 1982 to 1987 where the Company maintained its account testified at the hearing. He identified an Application for Business Loan completed in January 1984 to increase the Company's line of credit from $50,000 to $90,000. Mr. Disley's note on the applica- tion stated that the Company had experienced severe cash flow difficulties for six months, and he had serious concerns regarding the appellants management. Nevertheless, the line of credit was increased to $90,000 and the Credit Union accepted as security a General Security Agreement from the Company and personal guarantees from the appellant and his wife. Subsequent business loan applications by the Company demonstrated Mr. Disley's continuing concern about the Company's ability to pay down its loan and overdraft.

When the Company's line of credit was in overdraft, Mr. Disley would have discretion as to whether a particular cheque would be honoured or returned NSF. He thought that the appellant and his wife usually would not know when issuing a cheque whether it would be honoured. Mr. Disley did not know if any of the Company's cheques to the Receiver General of Canada for source deductions were returned NSF after March 1985 and he stated that a business organization should not have to be told by its bank what its cash position was at any point in time.

After the Company had overdrawn its line of credit at the Credit Union, the appellant knew that the Company's cheques for net wages would be honoured and that cheques to the Receiver General for source deductions would sometimes be returned NSF. The appellant did not know when issuing a particular cheque to the Receiver General that it would be returned NSF but he hoped that enough receivables could be collected in the next few days to support the cheque when it was presented for payment.

In November 1985, the Credit Union appointed a receiver who seized all of the Company's equipment and took it to a yard from which it was sold over an 18-month period. When the proceeds of sale were remitted to the Credit Union, there was not enough excess to pay the amount which the Company owed to the income tax department for source deductions. On April 13, 1988, a notice of assessment was issued to the appellant as the sole director of the Company levying the amount of $17,793.63. The appellant puts forward two defences. First, that he exercised the required degree of care, diligence and skill under subsection 227.1(3). And second, that the assessment was issued more than two years after he last ceased to be a director of the Company.

In my view, the appellant has no defence at all under subsection 227.1(3) because he did not exercise any degree of care, diligence or skill to prevent the failure (i.e., the failure to remit the amounts withheld by the Company as source deductions). The appellant managed the Company's business and he knew more about its business affairs than any other person. He knew when the Company's line of credit was in overdraft and that a cheque issued to the Receiver General for source deductions could easily be returned NSF if he did not collect enough receivables in time to cover the cheque. Subsection 227(4) of the Income Tax Act provides that amounts withheld from salaries and wages are deemed to be held in trust for the Crown in the right of Canada. Therefore, the Company (under the appellant's management) from time to time used funds held in trust for the Crown to finance its business. It was for these circumstances that subsection 227.1(1) was enacted. The appellant (as sole director of the Company and the manager of its business) did nothing within the meaning of subsection 227.1(3) to escape liability under subsection 227.1(1).

I turn now to the second defence. The appellant entered as Exhibit A-15 a form of resignation addressed to the Company, dated March 11, 1986, and signed by the appellant stating: “I hereby tender my resignation as President of the Corporation, such resignation to take effect immediately.”

If that form of resignation was effective, then the appellant can rely on the two- year limitation period in subsection 227.1(4) to escape liability under subsection 227.1(1) because the assessment under appeal herein was not issued until April 13, 1988. The respondent relies on the following provisions of the Ontario Business Corporations Act, 1982, S.O. 1982, c. 4 to argue that the appellant's purported resignation as a director is not effective:

119. (1) Each director named in the articles shall hold office from the date of endorsement of the certificate of incorporation until the first meeting of shareholders.

(2) No director named in the articles shall be permitted to resign his office unless at the time the resignation is to become effective a successor is elected or appointed.

121. (1) A director of a corporation ceases to hold office when,

(a) he dies or, subject to subsection 119(2), resigns;

(b) .. .

The appellant is named in the Company's Articles of Incorporation (Exhibit A-6) as its first director. Certain shareholder resolutions (in lieu of annual meetings) re-elected the appellant on a number of occasions as the Company's sole director. There is no evidence that any other person was elected or appointed a director of the Company on March 11, 1986 as successor to the appellant to comply with subsection 119(2) of the Ontario Business Corporations Act. Also, there was no evidence as to what circumstances existed in March 1986 which might have caused the appellant to resign as a director of the Company at that time. Because a director's resignation under paragraph 121(1)(a) of the Ontario Business Corporations Act is clearly subject to the election or appointment of a successor under subsection 119(2), I conclude that the appellant's purported resignation as a director of the Company on March 11, 1986 was not effective.

The appellant also relied on the appointment of the receiver on November 22, 1985 as effectively terminating the appellant's function as director of the Company. In support of this proposition, the appellant cited the decision of this Court in Perri v. M.N.R., [1990] 1 C.T.C. 2071; 89 D.T.C. 723. The appellants in Perri were directors of a company incorporated under the British Columbia Company Act, R.S.B.C. 1979, c. 59 which provided in sections 109 and 110:

109. . . . any person may be appointed by the court, as a receiver manager of all or any part of the undertaking of a corporation, and, in either case, on being so appointed he may carry on any business of the corporation and have access to its records concerning that part of the undertaking for which he is appointed.

110. Where a receiver manager is appointed, the powers of the directors and officers of the corporation cease with respect to that part of the undertaking for which he is appointed until he is discharged.

In the Perri decision, Associate Chief Judge Christie held that, after a receiver manager was appointed, the power of the appellants (in that case) to act in their capacity as directors ceased by operation of section 110 of the British Columbia Company Act. Therefore, the two-year limitation period in subsection 127.1(4) of the Income Tax Act could commence for directors of a company incorporated under the British Columbia Company Act on the day when a receiver manager was appointed. Counsel for the appellant could not draw my attention to any provision in the Ontario Business Corporations Act similar to section 110 of the British Columbia Company Act. Because the power of the directors of a corporation and the termination of such power is determined primarily by the legislation under which the corporation is incorporated, the decision in Perri is of no assistance to the appellant who was the director of a company incorporated in Ontario. Accordingly, the appointment of a receiver and manager of all the business undertaking and property of the Company on November 22, 1985 did not start the two-year period for the purposes of subsection 227.1(4) of the Income Tax Act.

In Cybulski v. M.N.R., [1988] 2 C.T.C. 2180; 88 D.T.C. 1531, this Court considered a situation in which the appellant in that case had resigned as a director but the resignation become irrelevant when it was decided that Mr. Cybulski had exercised the required degree of care, diligence and skill within the meaning of subsection 227.1(3) of the Income Tax Act. Counsel for the appellant in this case suggested that a director should be liable under subsection 227.1(1) only where there was evidence of bad faith or impropriety on his part. There is no foundation for that argument in section 227.1. Quite the contrary; Parliament has created a vicarious liability for directors in subsection 227.1(1) and provided a due diligence test in subsection 227.1(3) without any reference to bad faith or improper conduct.

In this case, the appellant was managing an incorporated business that was seriously undercapitalized. As a result, the Company was frequently required to use source deductions from salaries and wages to finance its business. Each time when the Company failed to remit the source deductions or issued a cheque to the Receiver General which was returned NSF, the appellant no doubt believed and hoped in good faith that enough receivables would be collected to remit the required amount a few days late but the appellant, as president and sole director, did not exercise the required degree of care, diligence and skill to ensure that those source deductions would be remitted to the Receiver General. The appeal is dismissed.

Appeal dismissed.