Hartnell v. R., [1997] 2 CTC 2005

Teskey T.CJ.:

The Appellant (a director of Posi-Line Installation Ltd. (“Posi-Line”)) appeals from an assessment of $71,782.25, pursuant to subsection 227.1(1) of the Income Tax Act (the “Acf ’). The defalcations were during the 1991 calendar year.

Issues

(1) Was the Appellant a director of Posi-Line at the pertinent time,

and if so

(2) Did the Appellant exercise the required due diligence to attempt to prevent the defalcations to escape liability pursuant to subsection 227.1(3) of the Act?

Facts

The Appellant left high school on completion of grade 10 and went to a trade school for four years, where he became a journeyman welder.

The Appellant, throughout his whole working life, was always a paid employee on a hourly basis, as a welder, except for a brief period prior to 1985, where he provided welding for a transport company as an independent contractor. He started to work for Posi-Line in 1985 as an hourly paid welder. In 1987, although he was still paid by the hour, he became a crew supervisor with other welders working under him.

In 1988, when he advised Donald Eddy (“Eddy”), the then so le owner and director of Posi-Line, that he had a better job offer, as an inducement to stay with Posi-Line, he was given a 24 percent interest in the Company and made a director as well as secretary. This was all formalized on November 15, 1988 in the offices of Posi-Line’s solicitors. On that date, the number of directors were increased from one to three. The two additional directors were the appellant and Madeline Gardiner (“Gardiner”), Eddy’s wife. At the same time, Eddy transfered 24 percent of his shares of Posi-Line to each the Appellant and Gardiner. The end result being that Eddy owned 52 shares, his wife, Gardiner, owned 24 shares and the Appellant owned 24 shares.

His job with Posi-Line and his terms of employment stayed the same. He accepted the directorship in writing, which consent did not indicate when the consent ceased. (Tab 3, Exhibit A-l)

The Appellant’s job took him away from Kamloops for long periods of time, extending up to eight months. The only times he would be in Kamloops would be between jobs and for a duration never longer than two weeks.

On August 31, 1989, the Appellant, along with his two co-directors declared a total dividend of $157,000 of which he would receive $37,640. The dividend was to be payable on or before November 30, 1989. He claims that the directors’ resolution declaring the dividend was the last document he ever signed. (Exhibit A-2)

He claims that he never received his $37,640, nor did he ever do anything in his capacity as secretary of the Company, and never attended any director’s meeting or shareholders’ meeting after August of 1989. He did receive from the Company’s chartered accountant the financial statement for Posi-Line for the fiscal year ending August 31, 1989, dated November 23, 1989.

By early 1991, he became concerned that the husband and wife team were milking the company. At lot of money appeared to be being spent on a farm owned by them. In June of 1991, he quit. By November of 1991, he had negotiated a settlement, and he obtained ownership to the half-ton truck that he had been driving, which was worth approximately $15,000. No documentation was produced regarding the settlement with Posi-Line and/or Eddy and Gardiner.

The Appellant admitted that he knew that source deductions were not set aside at the time the employees were paid. Posi-Line apparently relied upon the final payments on the various contracts to use that money to pay the source deductions.

I do not accept as factual that the Appellant believed his directorship had ceased by November 30, 1989 for the following reasons; he knew or ought to have known that no annual meeting of shareholders was called to accept the financial statement for the fiscal year ending August 31, 1989. He did not receive any written notice of an annual meeting.

As the Appellant was a 24 percent equity shareholder of Posi-Line up to the fall of 1991, it was up to him to prove that an annual meeting of Posi- Line took place sometime after November 23, 1989 and before 1991. He has failed to do so.

On November 30, 1989, the Appellant had been a 24 percent equity shareholder of Posi-Line for 121/2 months as well as being a director and the secretary thereof. There is no evidence whether Posi-Line shareholders and directors met to review and approve the December 31, 1988 financial Statement.

If the shareholders and directors did not approve the December 31, 1988 statements, then the Appellant would be aware of this. He could not simply assume the annual meeting was held to approve the August 31, 1989 financial statement. At that time, Posi-Line owed him his $37,640 in a declared dividend and another $10,587 in shareholder loans. I cannot believe that the Appellant just sat back and did nothing with this type of money being owed to him by Posi-Line.

The Appellant claims he only attended one meeting with Marvin Stone, Posi-Line’s certified general accountant.

For Stone Laurie & Company to prepare a financial statement for a fiscal year end of August 31, 1989 and noting that it was a change, I would assume that they would have required a resolution of the board of directors, dated sometime prior to August 31, 1989, changing the year end, or they would have in their review engagement report to the shareholders dated November 23, 1989, have brought up the necessity of proper corporate procedures to be carried out to effectively change the corporate fiscal year end.

Note 8 of Posi-Line’s financial statement, dated August 31, 1989, confirms that the fiscal year end had been changed, the previous fiscal year end of Posi-Line being December 31, 1988. Note 7 also confirms that the new fiscal year ended on August 31, 1989. Note 6 confirms that Posi-Line owed the Appellant by way of shareholder loans as of August 31, 1989 an amount of $10,587.

Although the testimony of the Appellant was not seriously challenged by the Respondent, in cross-examination, parts of his testimony are just not acceptable without some valid explanations by the Appellant, which was not given. The problem is from missing facts that was up to the Appellant to explain or prove.

Analysis

Issue 1

Was the Appellant a director in 1991?

Several provisions of the Company Act of British Columbia (the “Company Act”) has to be reviewed to make this determination. Section 136 specifies the requirement that the consent given by the Appellant is only effective until the next following annual election or appointment of directors, as it did not state that it was effective until revoked or until a specific date or time.

This provision reads:

136. (l)No election or appointment of a person as a director is valid unless

(a) he consented to act as a director in writing before his election or appointment; or

(b) if elected or appointed at a meeting, he was present and did not refuse at the meeting to act as a director.

(2) A consent in writing given under subsection (l)(a) is only effective until the next following annual election or appointment of directors unless the consent states it is effective until

(a) revoked; or

(b) a date or time stated in it.

Section 154 specifies that a director ceases to hold office when his term expires in accordance with the articles of the company. However, since the articles are not in evidence, this section is of no importance.

Section 163 specifies that an annual general meeting shall be held at least once in every calendar year and not more than 13 months after the date of the last general meeting.

This provision reads:

163. (1)A company shall hold an annual general meeting not more than 15 months after

(a) the date of incorporation,

(b) the date of amalgamation under section 274, or

(c) the effective date of a certificate of continuation under section 36(4), and afterward an annual general meeting of the company shall be held at least once in every calendar year and not more than 13 months after the date that the last annual general meeting was held, or was deemed under section 164 to have been held, wichever is later.

(2) Notwithstanding subsection (1), the registrar may extend, for a period not exceeding 6 months, the time in which a company is required to hold an annual general meeting.

The exception to the provision in section 163 as stated in section 164, provides for a consent in writing. This provision reads:

164. Notwithstanding section 163, where all the members entitled to attend

and vote at the annual general meeting of a company that is not a reporting company consent in writing to all the business required to be transacted at the meeting, the meeting shall be deemed to have been held on the date specified in the consent and it is not necessary for the company to hold that annual general meeting.

Again however, there is no evidence whatsoever on this point.

The Company Act also provides for alternative statutory corporate articles. Since there is no evidence of the corporate articles of Posi-Line, I cannot infer that the statutory articles were in fact used. This was something the Appellant could easily have proven at trial by producing the actual articles of incorporation.

The Appellant submitted that in the case of Perri v. Minister of National Revenue, [1995] 2 C.T.C. 196, (sub nom. KR. v. Wellburn) 95 D.T.C. 5417 (F.C.T.D.), it was held that the authority of directors to act was suspended by the appointment of a receiver-manager. Such appointment did not terminate the director’s office but did suspend the director’s liability under section 227.1 of the Income Tax Act (the “Act”).

This submission is obviously wrong. Mackay J. specifically held that the date the receiver was appointed did “not" start the two-year limitation period to commence an action against corporate directors under subsection 227.1(4) of the Act.

MacDonald, J.A. of the Federal Court of Appeal in Kalef v. R. [1996] 2 C.T.C. 1, (sub nom. R. v. Kalef) 96 D.T.C. 6132, expressly agreed with the position taken by Mackay J. in Perri (supra). He stated at page 5 (D.T.C. 6135):

I agree with the reasoning of MacKay, J. While it may be open to Parliament to expressly deviate from the principles of corporate law for the purposes of the Income Tax Act, I do not think such an intention should be imputed. Given the silence of the Income Tax Act I think the guidance of the applicable corporate legislation, in this case the Ontario Business Corporations Act, should be taken. A director cannot and should not obtain the benefits of incorporation under the Ontario Business Corporations Act without accepting the responsibilities as well. At all pertinent times Mr. Kalef was a director of Bynamics. He did not cease to be a director by virtue of the appointment of the Trustee in Bankruptcy. He did not meet any of the requirements for ceasing to be a director established by the Ontario Business Corporations Act. The time limit found in subsection 227.1(4) of the Income Tax Act does not apply to bar the reassessments.

The Appellant also argues that the shareholders of Posi-Line, by statute, should have had an annual meeting on or before the 15th day of December 1989, this again is patently wrong. There is nothing in the exhibits before the Court indicating that what took place on November 15, 1988 was an annual shareholders meeting. If an annual shareholders meeting was held, or waived pursuant to section 164 of the Company Act, it would have to have been held sometime in 1989 after the December 31, 1988 financial statement had been prepared (presumably around the First of April 1989). We know that the Appellant still believed himself to be a director on August 31, 1989, when he signed the dividend resolution and presumably, this would be after the annual meeting approving the December 31, 1988 financial statement and changing the fiscal year end. Therefore, the requirement for an annual general meeting would be sometime in 1990.

I reject the Appellant’s argument that it was reasonable for him to assume that he no longer had any power or potential liabilities of a director after, when Posi-Line should, by statute, ought to have had their annual meeting.

The Appellant also submitted the alternative argument that Posi-Line’s failure to hold an annual meeting should not, in fairness, act to hold the Appellant as a hostage director past the time when his directorship would normally have terminated automatically. This is also rejected. The Appellant, besides being a director, was the secretary and a 24 percent equity shareholder. He could easily have (in writing) resigned his directorship or also as secretary or as shareholder called an annual general meeting.

Since the Appellant has not proven that an annual meeting of shareholders was ever held after August 31, 1989, he, in law, was still a director of Posi-Line at the time of the defalcations in 1991.

Issue 2

Due diligence and/or puppet director

Herein, the Appellant cannot successfully argue due diligence. The evidence is quite clear he did nothing to prevent the defalcation. Furthermore, he knew prior to 1991 that Posi-Line was not setting aside or withholding the statutory deductions.

The only possible argument the Appellant can put forth is that he was a puppet or nominal director within the ambit of the following line of cases:

Robitaille v. R., (sub nom. Robitaille v. Canada), [1990] 1 C.T.C. 121, 90

D.T.C. 6059

Cloutier v. Minister of National Revenue, [1993] 2 C.T.C. 2038, 93 D.T.C. 544

and

Sanford v. R. [1996] 1 C.T.C. 2016

On the facts before me I believe the applicable law that should be applied herein is represented by the decision in Stuart v. Minister of National Revenue, [1995] 2 C.T.C. 2458 (D), 95 D.T.C. 537 and Black v. R., (sub nom. Black v. Canada), [1993] 2 C.T.C. 2825, 93 D.T.C. 1212.

Christie A.C.J.T.C.C., in Stuart (supra), at page D.T.C. 539 stated the following:

It strikes me that if a corporation fails to deduct and remit an amount as required by the Act and Regulations a director of the corporation is liable to pay that amount and any interest and penalties related thereto unless he establishes that in relation to preventing the failure his conduct was that of a reasonably prudent person in the circumstances. To voluntarily abdicate the responsibilities of the office of director is not of itself conduct of that kind. Intervention by some relevant factor can, however, bring an individual within the scope of subsection 227.1(3). These are some examples relating to deductions at source: a bona fide belief by an appellant based on reasonable grounds that he ceased to be a director prior to the failure alleged to give rise to liability under subsection 227.1(1) or if an appellant is effectively barred from exercising influence over the management of the company by the persons in de facto control of its affairs. Both of these factors were present in Cybulski v. M.N.R., 88 DTC 1531 (T.C.C.). In Robitaille v. The Queen, 90 DTC 6059 (F.C.T.D.) a bank was in total control of the company when the failure to deduct and remit occurred. Somewhat analogous circumstances existed in Fancy and another v. M.N.R., 88 DTC 1641 (T.C.C.). In Fitzgerald et al. v. M.N.R., 92 DTC 1019 (T.C.C.) Mogan T.C.J. said at page 1021:

I would not hold as a general role that a passive or inactive director is free from liability under subsection 227.1(1) of the Income Tax Act. For example, a person who consents to being a director of a corporation in order to accommodate a friend or client and then fails to participate as a director in the affairs of the corporation is still very much at risk under subsection 227.1(1). The passive or inactive director is not, per se, free from liability under subsection 227.1(1). But when the passive or inactive director has become a director in the context of a family business operated by a corporation which is dominated by an uncompromising patriarch, the domestic responsibility for maintaining harmony within the family becomes interwoven with the legal responsibility to third parties and, in these circumstances, I think that it is not reasonable to impose the same standard of care, diligence and skill on the passive 'family director’ as on the person who is truly free to become a director and does so outside a family context.

The appellant relies on Pidskalny v. M.N.R., 91 DTC 1046 (T.C.C.), and he cites the headnote. In that case the appellant was held not to be liable under subsection 227.1(1). The headnote reads in part as follows: “At all material times, the taxpayer’s directorship of R. Ltd. had been purely titular. He was wholly uninvolved with the company and had no knowledge of the rights, responsibilities and obligations of a directorship. He was therefore totally free of any personal liability for the unremitted source deductions in issue.” I cannot accept this as a correct statement of the law and it is noted that in Black v. The Queen, 93 DTC 1212, (T.C.C.) Bonner T.C.J. considered Pidskalny. He said this at page 1215:

The decision of this Court in Pidskalny appears to suggest that subsection 227.1(3) protects a director who failed to try to prevent a failure to remit because he had no knowledge of the rights, responsibilities and obligations of a directorship and was uninvolved with the management of the company. If that were the ratio of the decision it would be very difficult to reconcile with the language of section 227.1. Nothing in that language suggests the existence of a legislative intention to offer relief to a director who fails to act because he is ignorant of and indifferent to his responsibilities and those of his company. It is illogical for example to suggest that a person who drives his vehicle in heavy traffic with his eyes firmly shut can not be negligent because he is unaware of the existence of a duty to those he is about to injure. It is equally illogical to suggest that a director who is ignorant of his responsibilities and who fails to attempt to identify and fulfil them can meet the 227.1(3) standard. However a careful reading of the reasons in Pidskalny especially at page 1049 indicates that the outcome rests on an application of the decision of the Federal Court, Trial Division in Robitaille to a finding that Mr. Pidskalny was unable to do anything to prevent the failure.

Herein, you can summarize the Appellant’s action as ‘"he did nothing”. He could have and should have;

1. made enquiries of the corporate lawyers as to the obligations, rights and duties of directors;

2. made enquiries of Posi-Line’s accountants;

3. taken an active interest in the company’s affairs;

4. enforced his rights;

5. resign as a director;

6. call an annual meeting of shareholders.

Even if the Appellant could successfully argue that he could not alter Posi-Line’s policy regarding statutory deductions, a simple resignation as a director anytime in 1990 would have relieved him of this obligation.

The appeal is dismissed, with costs to the Respondent.

Appeal Dismissed.