Citation: 2007TCC227
Date: 20070523
Docket: 2006-2250(GST)I
BETWEEN:
RICHARD HEAD,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Angers J.
[1] This is an appeal
with respect to an assessment under Part IX of the Excise Tax Act
(the "Act") for the periods from July 1 to
July 31, 2003, August 1 to August 31, 2003, and December 1
to December 31, 2003; the notice of assessment bears the number 24686
and is dated November 23, 2003. The appellant was assessed amounts of
$73,558.88 in taxes, $2,024.64 in interest and $4,985.98 in penalties in
respect of unremitted net tax owed by Mainstream Homes Inc.
("Mainstream"), of which the appellant was a director during all
relevant periods.
[2] Mainstream was
incorporated on April 7, 1999, for the purposes of a housing development to be
completed in four phases. Apart from the appellant, Mainstream’s only other
director at all material times was David O'Reilly.
[3] Mainstream
constructed approximately 86 homes over a three-year period.
David O'Reilley had responsibility for Mainstream’s financial dealings
while the appellant assumed responsibility for the operations side of the
business. All construction materials needed were purchased through a company
identified as Albert Hichman: ("Hichman"), which company also
provided capital to Mainstream over the years. Hichman was eventually acquired
by Chester Dawe Limited ("CDL").
[4] In July 2003, many
houses were under construction and Mainstream suffered a cash shortfall such
that its obligations exceeded its capability to pay. Up to then, Mainstream had
had no arrears in its Harmonized Sales Tax ("HST") remittances. In
August, Mainstream's financial difficulties continued and David O'Reilly
began negotiations with CDL to resolve the situation. The July, August and
September 2003, HST returns were filed, but Mainstream failed to remit the net
tax to the Minister of National Revenue (the "Minister").
[5] On September 2,
2003, CDL and Mainstream signed a Memorandum of Understanding (MOU) whereby CDL
was to acquire title to the remaining property held by Mainstream and another
corporation owned by the appellant and O'Reilly, subject to the encumbrances registered
against it. CDL also undertook to assume Mainstream’s HST liability for August
and September 2003, which amount was to be added to other amounts Mainstream owed
CDL. O'Reilly testified that the HST clause was added to the MOU at his request,
for he understood his liability as a director to pay the tax.
[6] CDL was managing
the construction site as of the date of the MOU, but it did not pay the HST.
O'Reilly became aware in October 2003 that CDL had not paid the tax. He wrote to
the Canada Customs and Revenue Agency (CCRA, as it was then) to file the HST
returns and advise it of the MOU and of CDL's failure to pay the HST. O'Reilly
also advised the CCRA of the upcoming transfer of the land to CDL and of the
possible exercise of a power of sale by a secured creditor, and invited the CCRA
to take steps to protect and secure its claim.
[7] Some land was
eventually sold by power of sale on January 2, 2004. In the meantime, O'Reilly had
declared personal bankruptcy on November 10, 2003. On January 19, 2004,
O'Reilly drafted a letter to the CCRA on behalf of Mainstream but it was the
appellant who signed it because of O'Reilly's bankruptcy. The letter disclosed
a failure by Mainstream to report the sale of two lots in December 2002
and requested that the CCRA add the unremitted tax for these two lots to its
lien on lands that were to be sold by power of sale the following day. The
facts do not show whether the CCRA actually did so.
[8] The appellant is a
draftsman. His expertise is in construction, which is why he testified that
O'Reilly was needed to take care of the business side of the project. He had met
O'Reilly through mutual friends and they both became involved in the project.
O'Reilly was responsible for the administration side of the business, including
finances. The appellant understood that HST was payable on their sales and stated
that it was O'Reilly's responsibility to remit it on behalf of Mainstream.
[9] On July 3, 2003,
the appellant was seriously injured, breaking a leg in seven places. As he was
allergic to pain medication, his recovery lasted eight months and was painful.
It also prevented him from being on the construction site. According to the
appellant, steps were taken to have the outstanding HST debt paid. He referred
in this regard to the MOU with CDL and to the subsequent letters suggesting
avenues for the CCRA to collect the debt. The appellant did not play any role
in negotiating with CDL or in the negotiation of the eventual MOU in which CDL
undertook to pay Mainstream's debt and particularly the HST.
[10] The appellant was
made aware of the outstanding HST debt by O'Reilly near the end of August or in
early September 2003. He never signed any HST forms except those that were sent
in January of 2004. He signed these for the same reason he signed the letter of
January 19, 2004, to the CCRA. Other letters sent to the CCRA and signed
by him were drafted by O'Reilly. The appellant testified that, even though
he spent his time on the job sites, he kept checking with O'Reilly on a monthly
basis and was assured that the bills were all paid. He acknowledged that he
never checked the books but said that, even if he had done so, he would not
have been able to make anything of them. The appellant, although he had signing
authority, never signed a cheque for Mainstream or the other corporation that
owned land and was a party to the MOU.
[11] The appellant testified
that at all material times it was always his understanding that CDL and the
previous owner were what he termed the finances of the project and that, as the
MOU was a legal document, CDL would honour it and the outstanding HST amount
would be paid. He also began to gain from the MOU an understanding of
director's liability with respect to unpaid remittances.
[12] The assessment was
made under section 323 of the Act, which makes directors of a
corporation jointly and severally liable with the corporation for unremitted
tax in case of failure by the corporation to remit the net tax owing. If a
director can meet the test set out in subsection 323(3) of the Act,
he or she may escape that liability. Subsection 323(3) reads as follows :
(3) Diligence – 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.
[13] As for the
limitations contained in subsection 323(2), they are not in issue in this
appeal, nor is there any dispute as to the amount involved.
[14] The test is
therefore one of fact and the question is: "What would a reasonable person
have done in those circumstances at that time to prevent the failure of the
corporation to remit the tax?" The leading case and the one most quoted in
this kind of litigation is Soper v. R., [1997] 3 C.T.C. 242
(F.C.A.), in which Robertson J.A. summarizes the standard of care at
paragraphs 29 and 30 of his reasons:
29 This is a
convenient place to summarize my findings in respect of
subsection 227.1(3) of the Income Tax Act. The standard of care
laid down in subsection 227.1(3) of the Act is inherently flexible. Rather than
treating directors as a homogeneous group of professionals whose conduct is
governed by a single, unchanging standard, that provision embraces a subjective
element which takes into account the personal knowledge and background of the
director, as well as his or her corporate circumstances in the form of, inter
alia, the company's organization, resources, customs and conduct. Thus, for
example, more is expected of individuals with superior qualifications (e.g.
experienced business‑persons).
30 The standard of care
set out in subsection 227.1(3) of the Act is, therefore, not purely
objective. Nor is it purely subjective. It is not enough for a director to say
he or she did his or her best, for that is an invocation of the purely
subjective standard. Equally clear is that honesty is not enough. However, the
standard is not a professional one. Nor is it the negligence law standard that
governs these cases. Rather, the Act contains both objective elements −
embodied in the reasonable person language − and subjective elements
− inherent in individual considerations like "skill" and the
idea of "comparable circumstances". Accordingly, the standard can be
properly described as "objective subjective".
[15] He goes on to add
the following at paragraphs 33 and 39:
33 At the outset, I wish to emphasize that in
adopting this analytical approach I am not suggesting that liability is
dependent simply upon whether a person is classified as an inside as opposed to
an outside director. Rather, that characterization is simply the starting point
of my analysis. At the same time, however, it is difficult to deny that inside
directors, meaning those involved in the day‑to‑day management of
the company and who influence the conduct of its business affairs, will have
the most difficulty in establishing the due diligence defence. For such
individuals, it will be a challenge to argue convincingly that, despite their
daily role in corporate management, they lacked business acumen to the extent
that that factor should overtake the assumption that they did know, or ought to
have known, of both remittance requirements and any problem in this regard. In short,
inside directors will face a significant hurdle when arguing that the
subjective element of the standard of care should predominate over its
objective aspect.
39 In order to satisfy the due diligence
requirement laid down in subsection 227.1(3) a director may, as the
Department of National Revenue has noted, take "positive action" by
setting up controls to account for remittances, by asking for regular reports
from the company's financial officers on the ongoing use of such controls, and
by obtaining confirmation at regular intervals that withholding and remittance
has taken place as required by the Act: see Information Circular 89-2, supra
at para. 7.
[16] Mainstream’s
financial difficulties arose in the third year of the land development project
and at a time when most of its profits were yet to be realized, which is
usually the case in these types of projects. Up to that point, Mainstream had relied
on, and was backed financially by, its supplier of construction materials. It
was accordingly able to meet its other financial obligations, and, in
particular, was able to make its remittances of net tax under the Act in
a timely fashion. A change in the ownership of its supplier and poor sales in
2003 prevented Mainstream from remitting its net tax for the periods of July
and August 2003.
[17] The director
responsible for the administrative and financial aspects of Mainstream's
operations, namely, O'Reilly, undertook negotiations with CDL, which had bought
the supplier, to resolve this financial crisis and also to address the issue of
the unpaid tax or HST liability. CDL undertook to pay the HST owed by
Mainstream but never did so. On the other hand, it took over Mainstream’s
operations in the hope of reducing its advances to Mainstream.
[18] We know from the
evidence that the appellant's responsibilities with Mainstream had nothing to
do with that company’s day-to-day business and financial operations. By virtue
of his background and experience as a draftsman he was put in charge of the
construction aspect of Mainstream’s activities. As regards the business side, he
relied on O'Reilly and left that aspect to him. Not only was he out of commission
in early July because of an accident, but he was only made aware that the HST
had not been remitted at the end of August and in early September 2003. At that
time, it was almost too late, as CDL had taken over, and Mainstream's only hope
came from CDL's undertaking to pay the HST on its behalf.
[19] The appellant had no
reason to suspect that the HST remittances had not been made for the period in
issue, as not only had they been made regularly from the start of the project,
but that aspect of Mainstream’s operations was in O'Reilly's hands, as it was
his responsibility to pay the bills and look after the business aspect of the
project. The appellant testified that he checked on a monthly basis with
O'Reilly to make sure that all the bills were paid. His injury, however, kept
him away from the action, but when he found out about the unpaid HST at the end
of August he agreed to sign the MOU in the hope that it would settle the matter
of Mainstream's liability with respect to the HST debt.
[20] Given that his
background and qualifications are in the construction field and that his
involvement in Mainstream had nothing to do with the financial and business
aspects of its operations, I find that the appellant did all that could be
expected of him in the circumstances and conclude that he has made out the
defence of due diligence. The appeal is allowed.
Signed at Ottawa, Canada, this 23rd
day of May 2007.
“François Angers”
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