James White v. Minister of National Revenue, [1990] 2 CTC 2566, 91 DTC 54

Taylor, T.C.J.:—This is an appeal heard in St. John's, Newfoundland, on August 23, 1990, against an assessment dated December 29, 1987, under subsection 227(10) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). The above assessment also includes amounts with reference to the Newfoundland Income Tax Act, R.S. Nfld. 1970, c. 163, Canada Pension Plan, R.S.C. 1985, c. C-5 and the Unemployment Insurance Act, 1971, S.C. 1970-71-72, c. 48 but the only matter at issue in this appeal is that part of the assessment dealing with employees' income tax deductions covered by section 153 of the Income Tax Act.

One paragraph from the notice of appeal sets out the position of the appellant:

The basis for Mr. White's appeal is that he has exercised the degree of care, diligence and skill to prevent the failure to remit that a reasonably prudent person would have exercised in comparable circumstances. Mr. White was only peripherally involved in the management of the Company's financial resources. Mr. White's expertise and knowledge lies in the area of the mechanical trades and his involvement for the most part in Green's Pond Fish Processors Ltd. revolved around the maintenance and up-keep of the physical plant of the Company. He was involved in the physical aspects of buying and processing fish. Mr. White has very limited financial capabilities and was not involved in any of the financial decisions or decision making of the Company.

The respondent in the reply to notice of appeal detailed the history and record of the dispute:

— Greenspond Fish Processors Ltd. (hereinafter "the Company") is a company which operated a fish plant at Greenspond, Newfoundland. The Company has fish buying stations located at St. Georges, Ramea, Burgeo and Belleoram, Newfoundland.

— At all relevant times the Appellant was a director, officer and shareholder of the Company.

— The Company paid wages and salaries to its employees and officers, inter alia, during 1985.

— The Company deducted or withheld amounts in respect of federal income tax from the wages and salaries it paid in 1985 in accordance with section 153 of the Income Tax Act.

— The Company was liable to remit the said amounts deducted or withheld (hereinafter "source deductions") to the Receiver General of Canada and failed to remit the entire amounts deducted for 1985.

— The Company informed the Respondent that it had failed to remit source deductions in the amount of $115,148.25 for June, 1985. By letter dated September 20, 1985, the Company proposed arrangements to pay the amount of $115,148.25, which proposal was accepted by letter dated October 17, 1985.

— On October 10, 1985, the Company was assessed for the source deductions in the amount of $115,148.25 which had not been remitted in respect of June, 1985. On July 10, 1986, the federal tax outstanding with respect to the source deductions not remitted for June, 1985 was in the amount of $23,863.84.

— The T4F forms (summary of fishermen's earnings) filed by the Company for 1985 were compared with the source deductions remitted by the Company for 1985, and it was found that the Company had failed to remit source deductions for 1985 in the amount of $23,069.26.

— On August 15, 1986, an additional assessment was issued to the Company for the source deductions not remitted for the 1985 year together with penalties and interest. The quantum of federal taxes contained in that assessment was:

Federal Tax	$16,324.77
Provincial Tax	9,794.86
Federal Penalty	1,632.48
Provincial Penalty	979.49
I n te rest	1,478.00
Total	$30,209.60

— As a result of a payroll audit performed in October, 1986, the Company was further assessed on October 28, 1986 for additional source deductions not remitted for the 1985 year together with penalties and interest. The quantum of the federal taxes contained in that assessment was:

Federal Tax	$14,418.29
Provincial Tax	8,650.97
Federal Penalty	1,441.83
Provincial Penalty	865.10
Interest	3,139.00
Total	$28,515.19

— A certificate for the federal portion of the liability of the Company was registered with the Federal Court of Canada on April 27,1987 and a writ fieri facias was returned by the Sheriff of Newfoundland, unsatisfied in whole or in part.

— The Company never kept amounts deducted or withheld separate and apart from its own moneys.

— During the relevant period of time, the Appellant, as a director of the Company, did not exercise the degree of care, diligence and skill to prevent the failure to remit employee source deductions that a reasonably prudent person would have exercised in comparable circumstances.

— The Appellant was assessed by a Notice of Assessment dated December 29,1987 and numbered 556899. The Notice assessed the Appellant in respect of the 1985 source deductions unremitted by the Company together with penalty and interest thereon. The federal taxes, interest and penalties assessed were as follows:

Federal Tax	$54,606.90
Provincial Tax	18,445.83
Federal Penalty	3,074.31
Provincial Penalty	1,844.59
I n te rest	23,721.58
Total	$101,693.21

Schedule "A" (below), represents the discrepancies in the source deductions required to be remitted by the Company and the actual source deductions remitted on a monthly basis for 1985.

Schedule A

1985

	Source	Source
Source Deductions	Deductions	Deductions
Per Month	Required	Remitted	Discrepancy
January	—	—		—
February	$14,557.80	$14,557.80		—
March	15,796.26	15,300.07	$	496.17
April	18,561.08	10,543.62		8,017.46
May	4 3,224.83	23,320.67		19,904.16
June	77,347.98	—		77,347.98
July	93,025.63	92,529.59		496.04
August	37,321.84	—		37,321.84
September	30,750.56	29,915.88		834.68
October	18,748.88	15,221.76		3,527.12
November	10,702.15	—		10,702.15
December	5,689.52	—		5,689.52
Total	$365,726.53	$201,389.39	$164,337.14
Discrepancy Assessed
October 10, 1985			$115,148.25
August 15, 1986				26,119.63
October 28, 1986				23,069.26
Total			$164,337.14

— The Respondent assessed the Appellant, inter alia, on the basis of the facts admitted or alleged above and on the basis that the Appellant, as a director of the Company at the time it was required to remit the amounts of source deductions in issue, is jointly and severally liable, together with the Company, to pay the amounts and any interest or penalties relating thereto.

Evidence

Counsel for the appellant provided full and complete information to the Court, including the testimony of Mr. White, as well as the testimony of a Mr. Fred C. Noel, who had also been a director of the Company, and who had financed the effort to establish and operate the fish processing plant, at a cost, by virtue of the eventual loss of everything—of about one million dollars to him. Mr. White, on the other hand, while dedicated and tireless in efforts to accomplish the same objectives, did not have a major contribution to the project from a financial viewpoint. His initial capital involvement of some $50,000 was by way of a bank loan guaranteed by Mr. Noel, who is his brother- in-law. The elements of the testimony and evidence which counsel for the appellant regarded as significant were reviewed in his argument, and I would summarize them as follows:

— Mr. White was generally ignorant of income tax matters.

— He had worked all his life at Public Works (Canada).

— He laid out the plans for the Greenspond building, supervised its construction, and maintained it and the adjoining wharf, the plant freezers, etc. He was essentially a construction and maintenance man.

— He did not participate in the financing arrangements which were necessary over the years.

— During his time at Public Works, he had received a regular pay chequeindicating deductions, etc.

— He probably received some similar pay record from Greenspond during the years it was operating.

— He was unaware when Greenspond began to be in arrears for the deductions remittances.

— Mr. Noel realized at some point that there were arrears to Revenue Canada, and made an arrangement for payment of the deductions for March, April, May and June of 1985 as they became increasingly deficient. Such deficiencies continued to mount and no payments—either of deficiency or current deductions were made in the months of June, July, November or December 1985 (a complete schedule of deductions and remittances has been provided above).

— It had become the practice of the Head Office Staff at St. John's to either not make out the “payroll deduction cheques", or not to mail them, during periods when funds were not available, either from operating sources, bank sources, or even from Mr. Noel himself.

— At the end of October 1985, the bank "cut off" credit for the company.

— The "cut off” of credit by the bank interfered with that payment arrangement—but it had been attempted and set up.

— Mr. White did try to find buyers for the plant when it was in financial difficulty.

— He did everything he could do to save the facility and to ensure that Revenue Canada was paid, even without knowing he might be personally liable.

— In addition, some allowance should be made for the fact that Mr. Noel had made a serious attempt to bring up to date deficient remittances, only to be thwarted by the bank's action in cutting off credit in October 1985.

For the respondent, the main features of the evidence were:

— Mr. White was quite aware of business operations generally, not totally without knowledge of such affairs.

— If he did not know the details of payroll requirements, it was because he did not enquire

(a) the foreman compiled the time sheets;

(b) the office girl at Greenspond calculated the gross pay and deductions for each employee, then telephoned the office girl at St. John's for a transfer to a local bank for the total net payroll;

(c) the office girl at Greenspond prepared the cheques;

(d) Mr. White signed the payroll cheques;

(e) the remittances, along with the other company bills, were paid out of the company operating account which was located at St. John’s.

— He was aware that Greenspond operated by a line of credit, or cash infusions from Mr. Noel.

— He was well aware that Greenspond could not possibly be making a profit— it was losing money at a great rate.

— There was a fairly free flow of information —including general financial information —between Mr. Noel and Mr. White, particularly on anything about which Mr. White made enquiries.

— There was nothing to indicate that Mr. White's powers or responsibilities were curtailed in any way other than by his own volition.

— Even if the argument was made on behalf of Mr. White, that he was only some form of nominal director, or passive director, rather than an active director, it would not have application since there is no indication in the evidence such a role was either assigned to him, or adopted by him as a director.

Analysis

It is quite clear from the above that there is little dispute between the parties regarding the facts of the case—but a substantial difference in the interpretation to be put on the facts and the application of the Act to this situation.

First, I would note that counsel for both parties made direct and exhaustive reference and comments regarding the body of case law which is building up on the general subject of "directors' liability”, out of this Court. I will refrain from reviewing it in detail except to repeat that which I noted in Clark v. M.N.R., [1990] 1 C.T.C. 2212; 90 D.T.C. 1094 at 2217 (D.T.C. 1097):

I have carefully reviewed Moored, [1] supra, and I am unable to find in it anything which conflicts with the provisions of section 227 of the Act as I read that section. Further I do not read any of Cybulski [2] , Merson [3] , or Fancy [4] , supra, in such a way that would satisfy me they should serve to overturn the major points made in Moore, supra. The appeal of Mr. Moore was obviously decided with direct relationship to the line of cases which had preceded it, some of which were referenced already, and with which I could find little fault in deciding Moore, supra.

The determination of the appropriate approach to applying section 227 of the Act in such matters is obviously an evolving situation, and clear direction may soon be provided by the higher courts. I do acknowledge that the case of Robitaille v. The Queen, [1990] 1 C.T.C. 121; 90 D.T.C. 6059 may serve to provide some degree of guidance, and is useful in determining a viewpoint, particularly the comments from pages 125-26 (D.T.C. 6062-63):

The argument is based on the common law principle that no distinction is to be made between directors whether they are active or purely nominal directors. Although that burden would, in the vast majority of cases, fall upon any director seeking to escape liability under section 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 exists, 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). The fact that the Bank, to the knowledge of and with the consent of the defendant, from October 1982, effectively assumed sole control over all disbursements of the corporation, constitutes a very important circumstance.

The exercise of freedom of choice on the part of the director is essential in order to establish personal liability.

The term “diligence”, which is now codified, provides a higher objective standard than that imposed by the common law on directors generally. Although the test is to a large extent an objective one, the question remains, however, what a reasonably prudent person would do in the circumstances in which a director finds himself. These circumstances include subjective elements such as, degree of education, business knowledge and general ability of the director.

It is not entirely clear to me that in all situations, the mere fact that the bank— to protect its own vital interests—may assume control of the deployment of funds—whether from operating or additional bank advances—relieves a director from his responsibilities. The fact that the company from its inception was under-capitalized, and always short of funds, even with the bank credit and that of Mr. Noel, does not provide a basis for avoiding the application of subsection 227.1(3) of the Act to its directors. In my view, the extension of the absolving provisions of subsection 227.1(3) of the Act to the directors of undercapitalized corporations could create a distortion adversely affecting the directors of adequately financed and cautiously managed operations.

With regard to the "freedom of choice” comment in Robitaille, supra, while again relevant in some situations, I have not been persuaded that it has application in all situations merely as a result of financial difficulty and I quote from page 2196 (D.T.C. 1540) of Moore, supra:

He can say that he had very limited, if any, financial flexibility (he would probably say responsibility or authority) for the period before the receiver-manager took over, and certainly it was curtailed after that point. He can say that he would have paid the deductions if the money had been available—in essence if the bank had allowed him more credit. And that is the crux of the problem. The funds so deducted from employees' wages are held in trust on condition that they be remitted to Revenue Canada by the 15th of the following month. To use these trust funds at all even after deduction from the payroll and before remittance day, is a highly questionable procedure. So too is the practice of even keeping these trust funds intermingled with the regular corporate funds, taking a risk. But when the remittance date—the 15th of the month following the deductions—has been reached, the obligation must be met, or those who have the responsibility of making certain it is met may be held accountable.

And from Clark, supra, at pages 2220-21 (D.T.C. 1100-101):

It is difficult to see how a director by relinquishing his authority over the operations of a company, or having it removed or curtailed by a bank, thereby relieves himself of the liability already imposed on him under section 227 of the Act, unless specific measures are taken to put the bank in the shoes of the director. It is certainly late for even that effort, when the deadline for remittance has passed.

I do not see that the interjection of outside financial control of the operations has any beneficial impact on a director's liability, it is a risk of business accepted by any corporation or individual relying on outside support.

The direct involvement of Revenue Canada in the arrangement with the bank in Robitaille, supra, may have had a bearing on the critical findings by the learned judge that in Robitaille, supra, the threshold of "due diligence” had been met as noted on page 126 (D.T.C. 6063):

I find that, except to the extent that any wife might benefit from the financial success of her husband, the plaintiff had not one iota of interest in the operations of Placage St-Laurent Ltée. nor did she, at any relevant time, have any knowledge of the situation regarding the non-payment of payroll deductions. Even had she known of the situation, she could not have done anything about it. The defendant on the other hand, from the outset, was fully aware of the situation and, as stated previously, agreed with the bank to allow the condition to continue and further non-payments to occur in the hope of keeping the company operating. I do not wish to infer that the actions of the defendant were blame-worthy since it would have been to the advantage of everybody if the business could finally have been saved. The Federal Government itself, independently of the tax situation, in view of the substantial grants made to the company, had a real interest in ensuring its financial survival.

In this appeal, while there was an arrangement worked out between Mr. Noel and Revenue Canada, clearly the arrangement was not agreed to by the bank, since it ended quickly with the “cut off" of credit. Accordingly, I do not find from Robitaille, supra, much comfort for this appellant from that aspect.

As noted earlier, I have relied in previous judgments on the seminal case of Fraser, H. Estate (Trustee of) v. M.N.R., [1987] 1 C.T.C. 2311; 87 D.T.C. 250, and I would quote from there certain comments of the learned judge at page 2314 (D.T.C. 251-52):

Finally, he argued that because Mr. Fraser had no knowledge of the financial affairs of Kemac he was not in a position to give any instructions regarding the payment of creditors. He was in a position only to make enquiries, he had done just that and, in doing so, had fulfilled his duties as director and brought himself within the ambit of subsection 227.1(3).

Section 227.1 effectively imposes a duty on directors to ensure that the corporation performs the obligations listed in subsection (1). It does so by making them vicariously liable for any failure of the corporation to perform and by creating a defence for those who exercise the requisite degree of care, diligence and skill to prevent the failure. It is not necessary to a decision in this appeal to attempt to set down in a general way what must be done to meet the standard of care required by subsection (3). The central fact in this case is that Mr. Fraser did absolutely nothing to prevent a failure.

Although his expertise lay in the field of manufacturing operations I cannot believe that he did not possess the skill and ability necessary to formulate policies required to ensure that Kemac was at least discharging its obligations under subsection 227(5). This is not a case in which a director is forced to rely on other directors or officers or subordinate employees because those others possess skills which he does not. Mr. Fraser did not make an unsuccessful attempt to prevent default. He simply did not try.

Mr. Fraser was unaware of the requirements of sections 153 and 227 of the Income Tax Act and that is why he did nothing. However, subsection 227.1(1) of the Act imposes liability on ”. . . the directors of the corporation . . .” and not just on those directors of the corporation who are aware of the requirements of the Act.

Internal arrangements are a circumstance to be taken into consideration in an appropriate case. Subsection (3), however, does not assist those whose only excuse is that others had a better opportunity to prevent failure than they did.

It is quite clear from the above that Judge Bonner anticipated that a "standard of care" reflecting the so-called "due diligence” test might require review and fixation in other appeals, and that “internal arrangements are a circumstance to be taken into consideration in an appropriate case”. It appears to me that a substantial portion of that which has arisen in the appeals determined since Fraser, supra, has been the result of the effort of the courts to look at these aspects of the matter. Clearly the prospect of “third party" liability (in these cases the personal liability of a director for a corporation obligation) is not one which rests easily with the parties to any such dispute, nor with the courts. It is laudable that every effort is going forward by all concerned to find a suitable and perhaps even equitable level of responsibility. For me, however, I see little which minimizes the fundamentals of Fraser, supra.

— The central fact in this case is that Mr. Fraser did nothing to prevent the failure.

— Mr. Fraser did not make an unsuccessful attempt to prevent the default. He simply did not try.

— The Act imposes liability on "the directors of the corporation . . .”.

— Section (3) however does not assist those whose only excuse is that others had a better opportunity to prevent the failure than they did.

[Emphasis added.]

They represent the impediments inherent in the wording of the "relief" subsection as well as I can determine. Subsection 227.1(3) reads:

A director is not liable fora 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.

[Emphasis added.]

As I read that subsection, it would seem to me that the direct responsibility of a director—any director—is to prevent the failure (to deduct or remit), not to attempt to rectify or remedy the failure at a point in time subsequent to the failure itself. Further, in my view, a director may be considered to possess the attributes of "care, diligence and skill” that would be found in a “reasonably prudent person”. No one should be expected to act in a fashion which would be at a level higher than that of which he is capable. But perhaps the Court is entitled to ask—would not a “reasonably prudent person” have made enquiries at a very early point in time to determine the personal parameters and responsibilities of the position of director—particularly those which might be imposed by third party obligations? The Act seems to presume that anyone occupying the position of director would be a "reasonably prudent person". It does not refer simply to a "person", nor to a "prudent person", nor to a “reasonable person", but to a "reasonably prudent person". I make no effort beyond that point to refine or define the impact of that description on the requirements of the "due diligence” test. I leave that to those more learned than I am to pursue, other than my earlier reliance on Fraser, supra. I can only conclude that the standard of “care, diligence and skill” to be demonstrated under subsection 227.1(3) of the Act to be “not liable” is of a relatively high order, and not accomplished by the simple protestation of the appellant director that he was unaware that he should respond to or that he was unable to do so in that corporate situation. In addition, I have earlier noted (Clark, supra) that the word "exercised" to me represents some form of demonstrable positive action—and I have not been persuaded otherwise by the representations in this appeal. I would also refer to a view brought forward in this appeal, which would import to the phrase "in comparable circumstances", references to a general lack of sophistication, knowledge, experience or training of the appellant director himself as some form of excuse or reason for not fulfilling the conditions required under subsection 227.1(3) of the Act. I do not understand that perspective. The word "circumstances" in my opinion, refers to the operational and administrative situation in the corporation in which the director who has responsibility finds himself, not to the personal attributes or characteristics which he brings (or does not bring) to the corporate duties. A reasonably prudent person, therefore would be capable of exercising care, diligence and skill in the corporate business. The nature of the directors' particular functional responsibilities in the corporation, if completely disconnected from the realm of administrative and financial operations, might provide some relief to a director—if such disconnection was the result of something other than his own volition—but I have seen little indication or evidence that this would be anything other than a very exceptional situation, not merely some form of internal division of day-to-day authority.

It is quite clear from this appeal that Mr. White exercised “care, diligence and skill” in the performance of his direct duties in the operational field of the plant. I have no reason to assume that he could not have done if not equally well, at least acceptably well, in the area of responsibility associated with assuring himself regarding the status of employee deduction remittances. Obviously, I see no merit in the more liberal viewpoint tentatively put forward by counsel for the respondent (above) that the Court might consider three classifications of "director"—nominal, passive and active. The situation, as I read it, leaves no room for such interpretation, even though the Minister’s compassion and consideration in suggesting it might well be appreciated by appellants.

The efforts of both Mr. White and Mr. Noel to bring this dream to fruition, together with its objective of local employment and economic stimulation are noteworthy and highly commendable. But the first priority, not the last priority, should have remained the proper remittances of the employees' funds held in trust in the coffers of the company. In effect, during the period relevant to this appeal, these funds were used for the other operational requirements of the company, as an alternative to the infusion of additional required capital either from Mr. Noel or from the bank. I am fully aware that such additional capital contributions might not have been possible in the circumstances, but that does not provide authority without censure, for the directors of the company to continue deductions and reallocate these deductions for more immediate or pressing purposes—and that is what was done. Such conduct does not give viable conviction or assent to this practice of the misdirection of the unremitted deductions to other uses.

The position of Mr. White in this appeal—aged, retired, not in good health, and living on limited financial resources, gives no comfort to me in reaching this decision. But I am not persuaded that any of these factors can enter legitimately into a determination of an appeal under subsection 227.1(3) of the Act. I do not believe this to be an unrealistic or overly-strict interpretation of the subsection, but rather to be in concert with the direction and guidance provided in dominant case law dealing with interpretation of statutes, the leading recent one of which indicating some latitude is Stubart Investments Ltd. v. The Queen, [1984] C.T.C. 294; 84 D.T.C. 6305 at 316 (D.T.C. 6323):

Gradually, the role of the tax statute in the community changed, as we have seen, and the application of strict construction to it receded. Courts today apply to this statute the plain meaning rule, but in a substantive sense so that if a taxpayer is within the spirit of the charge, he may be held liable.

Perhaps the facility of amendment to the Income Tax Act is one of the sources of the problem since the practice does not invite the courts to intervene when the legislature can readily do so.

From our own Court, the Associate Chief Judge while commenting on the possible flexibility available to the courts in such interpretation, cautioned as follows at page 2928 (D.T.C. 1818) of Susan Bracken v. M.N.R., [1984] C.T.C. 2922; 84 D.T.C. 1813:

To conclude that section 11 of the Interpretation Act is the approach to be followed in construing the Income Tax Act is not to say that the fundamental rules of interpretation are to be thrown to the wind and replaced by interpretive contor- tionism designed to arrive at a subjective or quasi-subjective notion regarding the object or purpose of provisions of the Income Tax Act and regulations made thereunder.

In my opinion, sad as it may seem to be, the liability of Mr. White as determined by the respondent must be upheld. The appeal is dismissed.

Appeal dismissed.