Citation: 2009 TCC 247
Date: 20090504
Docket: 2003-25(GST)G
BETWEEN:
RONALD STAFFORD,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Bowie J.
[1] Mr. Stafford appeals from an assessment under section
323 of the Excise Tax Act
(the Act) for the unpaid liability of Stafford’s Investments Limited
(“SIL” or the “company”) for harmonized sales tax (HST). The company was
assessed on May 19, 1999 for net tax, interest and penalties as follows:
|
Net tax
|
$236,344.09
|
|
Net interest
|
7,372.79
|
|
Penalties
|
9,651.31
|
|
|
|
|
Total
|
$253,368.19
|
A
certificate under section 316 of the Act in the amount of $303,356.67
was filed in the Federal Court, and execution was issued thereon, all on
February 5, 2001. It is not disputed that the writ was returned nulla bona
on or about May 14, 2001. On May 15, 2001, the appellant was assessed under
subsection 323(1) of the Act in the total amount of $314,175.17. The
single ground of appeal invoked by the appellant is the due diligence defense
found in subsection 323(3).
[2] The following are the
relevant parts of section 323:
323(1) If a corporation fails to remit an amount
of net tax as required under subsection 228(2) or (2.3) or to pay an amount as
required under section 230.1 that was paid to, or was applied to the liability
of, the corporation as a net tax refund, the directors of the corporation at
the time the corporation was required to remit or pay, as the case may be, the
amount are jointly and severally, or solidarily, liable, together with the
corporation, to pay the amount and any interest on, or penalties relating to,
the amount.
323(2) A
director of a corporation 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 under section 316 and execution for that amount has been
returned unsatisfied in whole or in part;
(b) the corporation has commenced
liquidation or dissolution proceedings or has been dissolved and a claim for
the amount of the corporation’s liability referred to in subsection (1) has
been proved within six months after the earlier of the date of commencement of
the proceedings and the date of dissolution; or
(c) the corporation has made an
assignment or a bankruptcy order has been made against it under the Bankruptcy
and Insolvency Act and a claim for the amount of the corporation’s
liability referred to in subsection (1) has been proved within six months after
the date of the assignment or bankruptcy order.
323(3) A
director of a corporation is not liable for a failure under subsection (1)
where the director exercised the degree of care, diligence and skill to prevent
the failure that a reasonably prudent person would have exercised in comparable
circumstances.
323(4) The Minister may assess any person for
any amount payable by the person under this section and, where the Minister
sends a notice of assessment, sections 296 to 311 apply, with such
modifications as the circumstances require.
Facts
[3] Ronald Stafford does
not have a great deal of formal education, but in spite of that he enjoyed a
successful career in business. Not academically inclined, he left Fredericton High
School after only two weeks in grade
nine and took a job at the Apple Exchange. He soon left there to take a job in
the produce department of a Dominion Stores supermarket. Over the next 30 years,
he progressed in the Dominion Stores organization through the position of
produce manager to assistant store manager in Saint John, and finally store
manager in Fredericton. His progress through the managerial ranks was due to
his ability to deal with people, rather than with numbers or with letters. As
he put it in his evidence, he was able to do the manager’s job successfully
because he had a head cashier and a bookkeeper to look after the financial side
of the business while he looked after the people side.
[4] In the early 1970s,
the appellant was hired by a Mr. Randall to work as a produce specialist for
his company, Atlantic Wholesalers. By 1978, he had become a partner in the
company, and was paying for his 25% interest in the partnership from his share
of the profits. For the next seven years Mr. Stafford ran the Sussex store,
and when Mr. Randall retired in 1985 Mr. Stafford bought his 75% interest in
the business, at the same time taking in another partner to whom he sold his
own original 25% interest. The new partner looked after the financial and
office side of the business; the appellant continued to look after the people
side of the business.
[5] In 1989 the appellant
retired from the Atlantic Wholesalers business. A new partner was brought in
and Mr. Stafford sold his interest for approximately $1 million. He then,
on advice, created SIL as an investment vehicle to manage the proceeds of the
sale of his share of the business and to finance his retirement. He and his
wife were the directors. Between 1989 and 1997 the company invested in various
enterprises and passive investments.
[6] It is at this point
that Mr. Stafford’s younger brother, Terrance Stafford, enters the picture.
Terry is four years younger than the appellant, and they had a fairly close
relationship for most of their lives. Terry had worked at a number of jobs, but
had not been particularly successful in any of them. He had some experience as
a bookkeeper, and from 1995 to 1997 was the comptroller for Maritime Tobacco
Ltd. (“MTL”), a small manufacturer of cigarettes. In the spring of 1997 he
approached his brother with a request for a favour.
[7] Terry Stafford had an
opportunity, he said, to enter the tobacco business as a wholesaler for MTL,
but in order to do so he had to have a corporate vehicle with an established
record in the province and the ability to post a $100,000 bond. This was far
beyond Terry’s resources, and he asked the appellant if he would let him use
SIL for the purpose. The appellant and his wife considered this proposal and
decided to accede to it. SIL would have a tobacco division which would operate
as a wholesaler for MTL, and Terry would run it as general manager. A separate
bank account was opened for the tobacco division’s operation.
[8] The appellant
testified that, beginning in May 1997, he and Terry had a breakfast meeting
once every two or three weeks to discuss the business and review financial
matters. At these meetings, the appellant invariably asked his brother about
the financial state of the business, and in particular whether the accounts
payable, the New Brunswick tobacco tax and the HST remittances were paid up‑to‑date,
and whether there was money in the operating bank account. These meetings took
place regularly through 1997 and 1998, with the same questions being asked and
Terry answering on each occasion that the payments were up‑to‑date
and the bank balance was satisfactory.
[9] The appellant’s accountant
prepared financial statements at the September 30, 1997 yearend. The
tobacco division showed a small loss, in the order of $3,500 at that time. The
appellant said that he was not at all alarmed by this as he understood that it
was not unusual for a business to sustain losses during a start‑up
period. By the 1998 year-end there was a small profit. On January 4, 1999, the
appellant learned that he had been deceived by his brother. That day he was
visited by two auditors from the New Brunswick Department of Finance. They
presented to him their audit of the company that established arrears of tobacco
tax payable of $517,332.93. Upon receiving this news and realizing that his
brother had been untruthful, Mr. Stafford immediately took over personally the
management of the tobacco division. He discovered that there were substantial
accounts receivable, and by collecting them and liquidating some securities he
was able to pay the arrears of tobacco tax by March 1999.
[10] At this point, the
appellant had resolved that he did not want to be in the tobacco business, and
that he would either close the tobacco division or sell it. There was a
potential buyer who showed interest in it, but before Mr. Stafford had a chance
to negotiate a price the next disaster befell him in the form of the HST audit.
The assessment resulting from that audit is dated May 19, 1999, and it is for a
total of $253,368.19 for tax, penalty and interest. As a result of this
revelation, Mr. Stafford was left with little alternative but to sell the
company, which he did on June 2, 1999. In this he had the advice and counsel of
his accountant and his lawyer, upon whom he relied entirely in financial and
legal matters.
[11] The sale of SIL was
structured for Mr. Stafford by his lawyer. The purchaser was 1354987 Ontario
Inc., a corporation whose shares were owned by a Mr. Kokorudz. Prior to the
closing on June 2, the company declared a dividend in kind consisting of four
mortgages whose balances owing at that time totaled $221,349. This dividend was
specifically contemplated and authorized by the said agreement in paragraph 1.01
which reads:
The Purchaser acknowledges and
consents to the Corporation declaring a dividend in kind payable to the Vendor
prior to the acquisition of the common and preferred shares of the Corporation
by the Purchaser hereunder and the payment of such dividend by the transfer and
assignment by the Corporation to the Vendor of the following debts owing by the
Corporation and all related security held by the Corporation in support
thereof, namely:
|
Debts
|
Amount Owing
|
|
(a) Nathan Gordon Nagle
Carolyn Anne Nagle
|
$29,118.89
|
|
(b) Donald Horsman
Jeannene Horsman
|
24,704.30
|
|
(c) William E. Smith
Janet M. Smith
|
80,126.33
|
|
(d) H & P Sands Holdings Ltd.
|
87,400.00
|
|
Total
|
$231,349.52
|
The Purchaser shall cause the Corporation to take
such steps and execute and deliver all further documentation as may be
reasonably required in order to transfer and assign such debts and related
security to the Vendor.
[12] Paragraph 4.01 of
the agreement made specific provision that the purchaser would cause the
corporation to pay the outstanding HST assessment after the closing.
The
Purchaser shall cause the Corporation and the Corporation shall pay when due
the amount of HST assessed as owing by the Corporation in the approximate
amount of $254,000 as a result of a recent audit conducted by Revenue Canada
and the Purchaser and the Corporation shall jointly and severally indemnify and
save harmless the Vendor from any liability with respect to same and also with
respect to any other debts, liabilities and obligations of the Corporation. The
indemnities herein shall survive the closing of this transaction.
On
the closing date the outstanding liability for HST amounted to $109,623.00. On
that date the balance in the company’s bank account for the tobacco business
had a balance of $186,126.94. On the advice of his lawyer, Mr. Stafford signed
the closing documents at his lawyer’s office in Saint John, and then went to Sussex and transferred
signing authority for the bank account to the purchaser. The HST assessment was
under appeal at that time, and the purchaser was to pay the assessment from the
bank account transferred and also pursue that appeal. In fact the purchaser did
neither of these things. The HST assessment went unpaid and the appeal was
abandoned. The result was the section 323 assessment now under appeal.
[13] Soon after, Terry
Stafford was charged with fraud in connection with his activities at MTL, and
as the result of a plea bargain was convicted and sentenced to 10 months house
arrest. He was candid in his evidence that as comptroller of MTL he had been
engaged, along with the president of the company, in issuing false invoices and
keeping false books of account. When he left that firm and started the tobacco
division of SIL he engaged in similar criminal activity there. He testified
that both the tobacco tax audit and the HST audit revealed the large unpaid
balances that they did only because he had deliberately issued false invoices
in the name of the company, and had caused the company to pay MTL invoices for
tobacco product that it had never received. He did not reveal any of these
fraudulent activities to his brother until after the HST audit had been
completed and presented to the appellant.
Analysis
[14] In Soper v. Canada, the Federal Court of Appeal
reviewed certain principles that govern the determination that is to be made
under subsection 323(3) of the Act. That decision has since been
reaffirmed by the Federal Court of Appeal in Canada v. McKinnon and again in Hartrell v.
The Queen.
Directors are not held to the standard of trustees. Mr. Stafford, of course, is
an inside director, but even as such he is not an insurer. The appropriate
standard of care was described by Robertson J.A. at paragraph 22 of Soper
as that “… expected from a person of his or her knowledge and experience.”
Mr. Stafford has many years of business experience, but I accept without
reservation his evidence that he had little understanding of financial
documents. His success in business came from his ability to deal with customers
rather than from financial acumen. As a manager at Dominion Stores, and later
as a partner in Atlantic Wholesalers, he had relied on bookkeepers and accountants
to handle the financial end of the business. After his retirement he was
engaged in businesses in a small way through SIL, but there too he relied on
others to look after the financial aspect of the business.
[15] The Federal Court of
Appeal also recognized in Soper that, in the absence of grounds for
suspicion, a director is not in breach of his duty of care under subsection
323(3) simply because he delegates to company officials the responsibility to
ensure that HST is collected and remitted. The appellant knew that his brother
Terry had experience in the tobacco business from his years at MTL, and he had
specific experience there in the financial side of the business. He would
certainly have known that as comptroller, Terry was responsible for the company
finances, and he had no reason to suspect that he had not carried out his
duties there in an exemplary manner. It was not until after the default at SIL
had been revealed by the audit that Terry confessed to his fraudulent
activities, and by that time the damage had been done, not only with respect to
the tobacco tax but also HST.
[16] Delegation, of
course, needs to be accompanied by appropriate oversight, and the question that
this case must ultimately turn on is whether the appellant’s oversight of the
tobacco division of the company was adequate. The appellant had no experience
in or knowledge of the tobacco business. In fact, he had never aspired to be in
the tobacco business. The tobacco division was begun as a favour to his brother
who, apparently, had an opportunity that he could only seize with the
appellant’s help. The appellant apparently understood his responsibilities; I
accept completely his evidence concerning the breakfast meetings that he and
Terry had every two or three weeks. That he held the meetings regularly, and
that he asked the questions that he did, satisfies me that he fully intended to
fulfill those responsibilities to the best of his ability. Considering that he
was the only shareholder of SIL, it could hardly be in doubt that he was
concerned to ensure that the tobacco division was successful, and that it would
not create liabilities that would detract from the success of the company’s
other operations and investments. The important question is whether those
meetings were sufficient to discharge the duty, and that in turn raises the
question what other steps could the appellant have taken that he failed to
take.
[17] Family relationships
have been considered in a number of cases in this court dealing with the
liability of directors under the Income Tax Act and the Excise Tax
Act, but in the final analysis, the extent to which a director is justified
in relying upon an employee of the company, relative or not, is a question of
fact that must be decided in the particular circumstances of each case. The
appellant testified that he and his brother had had a close relationship. There
was nothing in the evidence to suggest that previous experience should have
made him reluctant to trust his brother, as general manager of the tobacco
division, both to conduct the company’s business honestly and also to give him
honest answers to his questions about the company’s finances at their breakfast
meetings.
[18] Mr. Woon suggests
that the appellant, if he had been diligent, would have looked at the books and
at the bank statements, he would have made inquiries of Ms. Dunn, the
bookkeeper, and he would have confirmed with the tax authorities the accuracy
of Terry’s assurances to him that the remittances were kept up-to-date. In the
circumstances, however, none of these things would have revealed the problem to
him, because Terry was falsifying the accounts. Quite apart from the
appellant’s inability to read and understand financial statements and other
financial documents, none of these measures would have made any difference,
because the books and records did not reflect the truth. Only a thorough
forensic audit would have revealed the problem. I do not accept that subsection
323(3) of the Act requires that a director who has delegated managerial
functions to his brother is obliged, in the absence of suspicious
circumstances, to commission periodic forensic audits of the undertaking. In my
view, there is nothing imprudent about a person accepting his brother’s word as
true, in normal circumstances.
[19] Two of the Minister’s
assumptions pleaded in support of the assessment require comment. They appear
in the Reply to the Notice of Appeal as subparagraphs 13 (v) and (w).
(v) on June 1, 1999, the Appellant caused the Corporation to
pay dividends of $221,349.52 to himself instead of paying the GST owed by the
Corporation;
(w) the appellant failed to cause the Corporation to pay the GST
owed by the Corporation before he sold the Corporation on June 1, 1999, for
$100,000.00;
These
assumptions suggest that in the Minister’s mind the appellant was intent upon
liquidating the value in the company for his own benefit while leaving the tax
bill outstanding. Nothing could be further from the true facts of this case.
Having trusted his brother and been betrayed, Mr. Stafford acted honourably
throughout what was for him a disastrous series of events. When the liability
to the province of New Brunswick for unpaid tobacco tax was revealed
he sold investments intended to finance his retirement to pay the tax, penalties
and interest. When the HST liability became known a few months later, he sold
his company in order to ensure that it was paid. The sale was structured to
leave more than enough money in the company’s bank account to pay the HST after
the closing, as the purchaser agreed to cause it to do, while leaving the
appellant with only the mortgages that comprised the dividend referred to in
the Minister’s assumptions, and the consideration of $100,000.00 for the sale.
I have no reason to disbelieve the appellant’s evidence that he acted as he did
in the transaction on the advice of his lawyer, although it is not easy to
understand why any lawyer would give that advice. If the company had paid the
HST immediately before the closing, or if the purchaser had complied with
article 4.01 of the agreement, then there would have been no assessment of Mr.
Stafford. Unfortunately, he delivered the bank balance to the purchaser with
the shares, relying on the purchaser to fulfill its obligation. Instead, the
purchaser acted dishonestly. It cannot be said, though, that Mr. Stafford
was indifferent whether the HST was paid, or that he was imprudent to act, as
he did, upon the advice of a lawyer.
[20] Despite Mr. Woon’s
very able submissions in support of the assessment, my
conclusion is that Mr. Stafford has satisfied the due diligence
provision in subsection 323(3) of the Act, and that the assessment
must therefore be vacated. The appellant is entitled to his costs.
Signed at Ottawa, Canada, this 4th day of May, 2009.
“E.A. Bowie”
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