Kodandaram Balasubramian v. Minister of National Revenue, [1991] 2 CTC 2812

Rip, T.CJ.:—The appellant, Kodandaraman Balasubramanian, appeals from an income tax assessment, notice of which is dated June 30, 1988, pursuant to subsection 227(10) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the 'Act") for an amount payable by him under section 227.1. The respondent assessed the appellant on the basis that the appellant was a director of Process Piping Specialty Inc. ("Process") during the period July, 1985 to July, 1986, being the time the corporation was required to remit, but did not remit, amounts the corporation had withheld from salary and wages of its employees on account of income tax ("source deductions") in accordance with subsection 153(1) of the Act.

The appellant is a professional engineer. Prior to July 1976 he was an Assistant General Manager in charge of manufacturing for Crane Canada Ltd. His job required him to travel to his employer's plants throughout Canada. In July, 1976 the appellant accepted an offer of employment in Montreal from a Mr. Louis Bakelmun ("Bakelmun") who controlled Process. Process was in the business of making special valves for ships. The appellant was in charge of manufacturing and production at Process. Bakelmun was in charge of Process’ management and administration.

Soon after the appellant commenced his new job in August, 1976 he realized Process required capital. He at first offered to acquire shares in the company. However, a loan by the appellant to Process for $40,000 was negotiated ana Bakelmun promised the appellant he would have the right to acquire forty per cent of the issued shares of the company over one or two years. The company grew over the next two years and Bakelmun suggested the appellant invest another $40,000 in the company, and he did. At approximately the same time five promissory notes from the appellant to Process were prepared, each in the principal amount of $5,000 with interest on the principal at ten per cent per annum. It was understood that the appellant would acquire five per cent of the shares of Process as each note was satisfied. This, the appellant reminded the Court, was different from the original deal. In any event in July 1980 the appellant paid $5,000 on a note, requested a share certificate but received nothing. The appellant stopped making any payments on the notes in 1982, telling Bakelmun he would not pay until he received a certificate for five per cent of the shares.

To his mind and Bakelmun's mind, said the appellant, he owned five per cent of the shares. He stated Bakelmun had instructed the company's lawyer to prepare documents reflecting such ownership. As well an application by Process for a loan to a Quebec Industrial Development Corporation stated Bakelmun was the owner of 95 per cent of the shares and the appellant 5 per cent.

By letter date October 21, 1985 to Bakelmun the appellant indicated he no longer wished to act as an officer of Process. At trial he stated the word "officer" included "director". However, he did not resign at the time since he wished to reconsider the situation. Apparently two of Bakelmun's sons had entered the business and the appellant was of the view too many people were involved in the business.

In carrying on its business Process purchased all of its raw material from one supplier, Wilson Brass, which operated from Scarborough, Ontario. Wilson Brass prepared the casts for the pipes. In August 1985 Wilson Brass closed its operations and Process was without a source of supply. The appellant made arrangements with the creditors of Wilson Brass to purchase its assets and to this end incorporated Montreal Bronze Ltd. ("Bronze"). Bakelmun and the appellant agreed the appellant would continue to manage Process' manufacturing plant in Montreal and at the same time commute to Scarborough to supervise the preparation of the castings. The appellant spent two days a week at Process in Montreal and four days at Bronze in Scarborough. His family continued to live in Montreal.

Beginning in March 1986 Process had cash flow problems and was unable to meet its obligations to its banker, the National Bank of Canada. The appellant testified Bakelmun would tell him "the bank called and something has to be done". The first time the appellant became aware that source deductions were not being remitted to the Receiver General was in April 1986 when an official of the respondent informed him Process was "two—three months behind” in remitting the source deductions. The appellant asked the official to meet with him at the company's plant.

The meeting took place during the second week of April. In attendance were the appellant, Bakelmun, who was responsible for source deductions, and the Revenue Canada official. The meeting took place in Bakelmun's office. The appellant and Bakelmun agreed to rectify the situation and give post-dated cheques to the official: a cheque dated May 1, 1986 in the amount of $8,000, two cheques dated June 1 and July 1, 1986 in the amount of $12,000 each and a cheque dated August 1, 1986 for $9,955. The purpose of the cheques was to bring the source deductions up to date.

The cheque for May 1986 was cashed. The appellant said he heard nothing further from Revenue Canada until July 1986.

In the meantime he said he had an understanding with Bakelmun that from then on all remittances would be made on time. He generally was not involved in the administration of Process unless "Bakelmun discussed (it) with me”. He relied on Bakelmun for all administrative matters.

Bakelmun was very "cash conscious" according to the appellant. If he had cash he paid his bills. The appellant testified that during the period September 1985 to the end of January 1986 Process had monthly sales of approximately $150,000 and at the time problems began the company had a backlog of orders aggregating $600,000. He said he personally tried to bring sales to their usual levels and "assumed Louis was doing his work". On this basis the appellant was of the view source deductions would be remitted.

The appellant acknowledged he was aware of his liability as director under section 227.1 of the Act. He stated Process had no problems with source deductions before 1986. When trouble began "we" intended to use the same system used at Bronze which was working well. The system at Bronze was not described.

The appellant admitted he had access to Process' books and records but never asked to see them "because (there was) no need”.

At the end of April or the beginning of May 1986, according to the appellant, Process had "overdraft problems" with the banker. During the second week of May a bank inspector was sent to Process to verify the company's inventory and accounts. The inspector's report was unsatisfactory. The bank demanded a financial statement be prepared immediately or that it would cause an outside auditor to prepare the statement. The company's accountant prepared a statement for the seven-month period ending on April 30, 1986.

While the statement was being prepared the bank advised Process it “would hold the account 'as is' and not honour any further cheques above the overdraft". Cheques in circulation were in jeopardy. "We no longer had control over cheques we had issued,” the appellant said. By mid-June the bank was returning cheques.

A meeting with the bank employees was held on the 2nd or 3rd of July 1986. Three days later the bank sent a firm of chartered accountants, Raymond, Chabot, Martin & Paré ("Raymond, Chabot”) to audit Process. "Basically," the appellant explained, "the company's operations were seized . . . We couldn't do anything . . . We signed cheques but Raymond, Chabot decided which cheques the bank would honour. . . .” In the meantime, the appellant declared, he “specifically told the National Bank not to refuse Revenue Canada cheques". In the first week of July an employee of the respondent informed the witness that one of the post-dated cheques had been returned.

Raymond, Chabot eventually determined the company was not viable. Subsequently an official from the respondent attended at Process and requested details of customers, accounts receivable, orders and other matters. Revenue Canada was advised that Process had a receivable of $50,000 due from the Department of National Defence. The appellant testified he was told Revenue Canada would "try to seize the government receivable and apply it to source deductions" before the bank acted.

Two days after the appellant met with Revenue Canada, the bank, on July 23, 1986, called in its loans and seized the company's receivables under section 178 of the Bank Act. This included the $50,000 receivable from the federal government. Ms. Patricia Alferez, a Collections Officer with Revenue Canada, testified a third party demand was made on July 21, 1986 to the Commanding Officer of Canadian Forces Base St. John’s, but only $8,651 was collected. She had “no idea" for the reason not all the money due the respondent was collected before the bank exercised its rights.

The appellant said he had telephoned the Commanding Officer at CFB St. John's and was advised the $50,000 was to be withheld. Process had completed its contract for the Department. However, once the bank took action on July 23, the bank had priority, the appellant said.

By September 1986 Process was bankrupt. The appellant's loans of $80,000, were lost.

The payroll of Process had been prepared by the National Bank with funds from the company's line of credit; the last payroll it prepared was that of June 20, 1986. Subsequent payables were made with Process' own cheques as directed by Raymond, Chabot, stated the appellant.

Process' bookkeeper, Jocelyne Lacoste, maintained the books of account for Process including invoices, payables and receivables and prepared cheques. She also dealt with the bank. Cheques were usually signed by Bakelmun and if he was absent, by the appellant.

Process was housed in a building owned by Bakelmun until it had to move in July 1986 because the property had been sold. At the time of the move in July the appellant saw cancelled cheques payable to Lacoste purporting to bear his signature but which he had not signed; the amount represented by the cheques for the past year was $80,000. Criminal charges were laid against Lacoste but she was acquitted. Copies of several of the cheques bearing the appellant's forged signature were adduced as evidence.

Civil action was taken against Lacoste as well but was withdrawn once she became bankrupt.

Bakelmun did not testify. He and the appellant are not on speaking terms, the appellant said. The appellant stated that when an action between Process and the Canadian Imperial Bank of Commerce, its former banker, was settled on September 15, 1986, the cheque for the settled amount was deposited by Bakelmun in the account of Process Piping Canada Ltd., and not that of Process. The appellant revealed he became aware of the settlement one and a half years after the settlement and had not known Bakelmun had received funds. He testified that at one time he and Bakelmun agreed that any money from the Canadian Imperial Bank of Commerce would be applied to the debt with Revenue Canada.

The appellant also testified that he learned from Raymond, Chabot that some of Process' customers had been paying their accounts directly to Bakelmun rather than to Process; the receivables paid to Bakelmun were estimated to be between $30,000 and $40,000.

Mr. Pierre-André Lavoie, an auditor with Raymond, Chabot helped audit Process in 1986. He testified that from July 11 to July 18 the firm was working at Process to determine the feasibility of the company continuing operations. His firm's approval for cheques was not required during this period, he said. However, the bank honoured only "indispensable" cheques, such as payroll, suppliers, C.O.D. for necessary material, even if they were for amounts above the line of credit. Sometimes he would advise the bank to accept certain other cheques.

Mr. Gaétan Bouffard, at time of trial an employee of Bronze, worked at Process from 1974 to 1986. He corroborated the appellant's evidence that Bakelmun was in charge of administration at Process and that the appellant worked on a regular and daily basis at the production section.

No source deductions had been remitted by Process to the Receiver General during the period July 1985 to July 1986. The assessed amount in issue is a liability under subsection 227.1(1) of the Act and represents the amount of unpaid deductions, interest and penalties payable by Process in respect of notices of assessment dated November 23, 1985, May 16, 1986, July 23, 1986 and December 31, 1986. It is clear from the notice of assessment that the assessed amount is in respect of a liability under the Act only and does not represent any liability under any other statute such as the Unemployment Insurance Act.

Subsections 227.1(1) and (3) read as follows:

(1) 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.

(3) 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.

The appellant says he exercised the degree of care, diligence and skill to prevent the failure by Process that a reasonably prudent person would have exercised in comparable circumstances.

There is absolutely no evidence the appellant did anything before April 1986 to prevent Process' failure. In fact he could not have done anything before that time because he was unaware of the failure or that any failure to remit was imminent. He was unaware of the failure because Bakelmun was responsible for administration, including the remission of source deductions to the respondent, and he did not interfere in Bakelmun's bailiwick. The appellant and Bakelmun had delegated to each other certain management functions which each carried on without interference by the other. The only occasions the appellant would address his mind to an administrative matter was when invited to do so by Bakelmun.

The appellant testified that Process had no difficulty in remitting source deductions prior to 1985. This may be true, but 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 of the source deductions to the Receiver General of Canada as and when required by the Act and its Regulations. I am not satisfied that the appellant prior to April 1986 was even familiar with Process' practise of remitting source deductions. The appellant was not in the same situation as the director in Merson v. M.N.R., [1989] 1 C.T.C. 2074; 89 D.T.C. 22; where source deduc tions continued to be made even after the corporation's banker intervened.

At the same time it is true that a director, barring any reason to the contrary, is entitled to have some confidence in the ability and integrity of fellow directors, in particular when the directors are also employed by the corporation in capacities other than as a director; however, there must be a reasonable basis for the confidence.

After the meeting in Bakelmun's office in the second week of April 1985, when post-dated cheques were delivered to Revenue Canada, the appellant and Bakelmun agreed the situation would not be repeated. They intended to use a new system to ensure source deductions would be remitted on a timely basis. The appellant said he was endeavouring to increase Process' cash flow and assumed Bakelmun was doing the same.

However within a month of the meeting with the Revenue Canada official, the bank was reviewing Process' finances and was not honouring all the cheques issued by the bank. The appellant asked the bank to honour the cheques representing the amounts of source deductions but the bank ignored his request.

Each appeal from an assessment under section 227.1 is to be considered on its own particular set of facts. In the appeal at bar the appellant has failed to convince me that he exercised any degree of care, diligence and skill to prevent any failure by Process to remit amounts it was required to remit with respect to wages paid during the months ending prior to March 1986.

However the appellant did use his best efforts in attempting to prevent any further failure by Process once the meeting in April 1986 [1] took place. He and Bakelmun together undertook that Process would commence to remit on a timely basis. The appellant's obligations to Process and Bronze forced him to be away from Process' offices in Montreal during the majority of the work week and at the time he had no reason to believe Bakelmun would not honour their mutual undertaking. His absence from Montreal and his original disinterest in administration may have influenced Process to default in remitting the source deductions prior to April 1986. However, after the meeting of April, the appellant believed he had come to an understanding with Bakelmun which would ensure that Process would remit source deductions on a timely basis. His belief was reasonable in the circumstances. In order to achieve the level of conduct described in subsection 227.1(3), a director need not act on the assumption the other directors will fail to do what they have undertaken to do unless there are circumstances which warrant such an assumption. The appellant did what a reasonable person would be expected to do bearing in mind the business required his presence in Toronto. In fact the appellant continued to try to ensure Process would remit source deductions once the bank entered the scene by instructing the bank to honour cheques for source deductions.

After meeting with the officer of Revenue Canada during the second week of April 1986 the appellant exercised the same degree of care, diligence and skill to prevent the failure by Process that a reasonable person would have exercised in similar circumstances. This would apply to amounts required to be withheld after February 1986 and to be remitted on April 15, 1986 and subsequently.

The appeal will be allowed with costs [2] and the assessment will be referred back to the respondent to reassess accordingly.

Appeal allowed in part.