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Citation: 2003TCC563
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Date: 20030902
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Docket: 2000-3139(GST)G
2000-3140(GST)G
2000-3141(IT)G
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BETWEEN:
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LARRY MACHULA,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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____________________________________________________________________
REASONS FOR JUDGMENT
Beaubier, J.
[1] These appeals pursuant to the
General Procedure were heard together at Saskatoon, Saskatchewan
on common evidence on August 6, 2003. The Appellant was the only
witness. An outline of each corporation involved in these
director's liability assessments will be set out followed by
chronological descriptions of the facts in evidence. As the facts
will establish, the Appellant was an inside director of all three
of these corporations.
[2] Respecting 2000-3139(GST)G:
1. Corporate name - 568969
Saskatchewan Ltd., ("969").
2. Incorporated February 3, 1984 in
Saskatchewan.
3. A personal service type corporation
which supplied Mr. Machula's services to other
businesses.
4. Mr. Machula was 969's sole
shareholder, director and signing officer.
[3] Respecting 2000-3140(GST)G:
1. Corporate name - 600987
Saskatchewan Ltd. ("987").
2. Incorporated July 6, 1992 in
Saskatchewan.
3. Took over a bankrupt condominium
from Standard Trust which was under construction at 611
University Drive, located at Broadway Avenue and University Drive
in Saskatoon. In a joint venture with the previous owner or
contractor, Farouk Shah, the condominium was finished in 9 months
at around the end of 1993 and the lowest three floors were leased
to an immigrant investment corporation, First Choice Capital Fund
(III) Ltd. ("FCC III") of which had been founded by the
Appellant and others. FCC III owned the "Saskatoon Fitness
Corner" equipment and premises on the main floor.
4. 987 had two shareholders owning 50%
each and two directors, the Appellant, Larry Machula, and James
O'Brien. The evidence is that James O'Brien was in
British Columbia at all material times and Larry Machula was in
Saskatoon, Saskatchewan, from where all of the corporations in
question were operated. Larry Machula was a bank-signing officer
of 987 in Saskatoon as an alternate with Diane Kindrachuk
(Exhibit R-2) dated January 7, 1995).
[4] Respecting 2000-3141 (IT)G:
1. Corporation name - 601161
Saskatchewan Ltd. ("161").
2. Incorporated July 27, 1992 in
Saskatchewan.
3. Operated Saskatoon Fitness Corner
and leased the premises and equipment from FCC III.
4. The two 50 - 50 shareholders and
directors were Larry Machula in Saskatoon and James O'Brien
in British Columbia, all as described in subparagraph [3]4. Larry
Machula was a signing officer of 161. (See Exhibit R-2).
[5] Mr. Machula has a B.A. and a
B.Comm. He graduated from university in about 1975 and went to
work for the Royal Bank of Canada. He then became a real estate
developer. After that he entered into the business of forming and
making public offerings of tax shelter syndicates. In 1988 he
established First Canadian Capital Fund Ltd. respecting a
Vancouver real estate project which he marketed in Hong Kong. In
Hong Kong he encountered inquiries about immigration into Canada.
As a consequence he developed and was a director of three
immigrant investor corporations, First Choice Capital Fund Ltd.,
First Choice Capital Fund II Ltd., and FCC III (referred to
collectively as the "Funds"). They were marketed to
immigrants from the Middle East, Southeast Asia and Europe. In
Saskatchewan these required an investment of at least $150,000 in
a business for 3 to 5 years before there could be any redemption.
The three corporations raised $47,000,000. Mr. Machula testified
that the Asian investors wanted a redemption of 75% in the
three-year period and began a lawsuit to bring this about. These
actions were begun in the Saskatchewan Court of Queen's Bench
in January, 1995 and judgments were issued by Laing J. on the
basis of "oppression" which removed directors of the
Fund corporations, including the Appellant, on April 19, 1995 and
March 22, 1996.
[6] 2000-3139(GST)G - 969, the
Appellant's personal service corporation, is assessed for tax
of $27,832, and penalties and interest, for the period 92-06-30
to 94-12-31. The Appellant has appealed a later dated assessment
of $27,814.11 and interest and penalties respecting the unpaid
969 assessment. 969's income was management fees. Two of
these sets of fees were large:
1. $352,700 from 987 for the GST
quarter period ending September 30, 1993, for which period 969
paid $2,100 in GST.
2. $44,900 in its 1994 taxation year
which ended on September 30, 1994, for which GST quarter it paid
$2,100 in GST.
It did not claim input tax credits for either quarter. The
Appellant was the person who signed the GST cheques for 969.
Given his business experience, education and knowledge, the fact
that 969's income was his income and that he was the only
individual with any investment in, or benefit from 969's
operations, he had to have known that cheques for $2,100 did not
represent 7% of the fees received by 969 at each of these
times.
[7] Respecting 969, Mr. Machula's
answer is that, for 969, he had set up an accounting system with
qualified staff, good computer equipment and accounting
programmes and 969 had a reputable chartered accounting firm
filing tax returns and that he relied on them. On the evidence,
all of that is true. However, 969's ordinary quarterly GST
cheque was $2,100 with three exceptions recorded in each of 1993,
4 and 5, each of which was a payment of over $23,000.
Particularly in 969's case, in which Mr. Machula was the sole
cheque signer and recipient of benefits, and where these large
sums of GST were as a result of direct income, it is clear that
Mr. Machula failed to exercise the degree of care, diligence and
skill to prevent the failure to pay. Because these two failings
are clearly representative of the Appellant's mind set and
actions respecting 969, the appeal in 2000-3139(GST)G is
dismissed.
[8] 2000-3140(GST) G - 987 was an
operating construction corporation. The fiscal year end was
October 31. The assumptions state that it did not remit
$13,536.33 GST during the period March 31, 1993 to December 31,
1994 and claimed input tax credits of $36,927.19 to which it was
not entitled during the same period. The assumptions also state
that part of the unpaid GST related to a portion of the GST
charges for the Appellant's residence (7% of $ 697,135.55)
which was built and owned by 987. These assumptions were not
refuted. 987's quarterly GST reports and payments for 1992 -
1995 were wide ranging and substantial; in one quarter they were
$146,043.40 and in another they were -$136,899.00.
[9] Respondent's counsel directed
the Court to the following quotation from the reasons of the
Federal Court of Appeal in Ann Drover v. The Queen 98 DTC
6378 at 6380 and 6381:
[8] The present case adds a further dimension to the
principles set out in Soper. The obligation imposed on
directors is not limited to that of exercising the requisite
standard of care in ensuring that GST as calculated was remitted.
There is also an obligation to exercise the same standard with
respect to ensuring that GST is properly calculated. To interpret
s.321(1) of the Excise Tax Act, (or for that matter
s.227.1(1) of the Income Tax Act) in a contrary manner
would undermine the purpose of that section. Carelessness in
calculation is as unacceptable as carelessness in remittance. The
obligation to properly calculate GST flows from ss.228(1) of the
Excise Tax Act which reads as follows:
Every person who is required to file a return under this
Division shall in the return calculate the net tax of the person
for the reporting period for which the return is required to be
filed
[9] Utilizing the language adopted in Soper , the issue
in the present case may be recast as follows: Did the taxpayer
exercise the required standard of care as to ensure that
Conestoga did not fail in its obligation to properly calculate
and remit GST to the Receiver General? Having regard to the
surrounding circumstances and the taxpayer's business
experience and acumen should she have been aware that there was a
problem with respect to the proper calculation of GST?
Correlatively, if the taxpayer knew or ought to have known that
there was a problem with respect to its proper calculation, did
she exercise the requisite standard of care in ensuring that the
problem was resolved. Though the taxpayer was an "inside
director" (involved in the day to day operation of the
business) it is evident that other persons, including an
accountant, were responsible for calculating and remitting all
taxes. I should add that no evidence was drawn to this
Court's attention in support of the understanding that the
taxpayer was actually aware of a problem with respect to the
proper calculation of GST.
[10] The taxpayer seeks to persuade us that having regard to
the requisite standard of care and the facts of this case, the
tenets of the due diligence defence have been met. The Minister
asserts that as this particular issue was not raised by her
before the Tax Court, it is too late to raise it on the
application for judicial review. In other words, since the
taxpayer failed to raise the due diligence defence in the context
of the $18,296 in dispute, thereafter she is precluded from
raising it in this Court: on this point see generally Athey v.
Leonati (1997), 203 N.R. 36 (S.C.C.) at 58, paras.50 &
51.
[11] I have two difficulties with the Minister's position.
First, I doubt that the taxpayer would have been as quick to
reach an agreement with respect to the other two amounts if she
had known that the right to raise the due diligence defence would
be inadvertently eliminated. Second, the argument ignores the
fact that the Tax Court Judge committed a reviewable error of
law. At the same time, I have difficulty in accepting that it is
the proper role of this Court on a judicial review application to
arrive at a finding of mixed fact and law when the Tax Court
Judge was not asked to address what the parties would later
identify as the pivotal issue. This difficulty is heightened by
the realization that the taxpayer's plea of due diligence
rests on transcript evidence. In my opinion, this application is
more appropriately disposed of by referring the matter back to
the Tax Court for a determination with respect to the $18,296
remaining in dispute.
[12] For the above reasons, the application for judicial
review should be allowed and the judgment of the Tax Court dated
April 3, 1997 set aside. The matter should be remitted to the Tax
Court Judge for a determination in a manner consistent with these
reasons and those found in Soper. The Tax Court Judge
shall retain the discretion to determine whether the parties are
entitled to adduce further evidence on the sole issue in
dispute.
[10] Appellant's counsel countered with
the following excerpt by Bowman A.C.J. from Lau and Lau v. The
Queen 2002 DTC 2212 at 2214.
[23] There have been a number of cases in this court and in
the Federal Court of Appeal involving directors' liabilities
for unremitted tax under the Income Tax Act and the
Excise Tax Act. I set them out in Fremlin v. R.,
(2002) G.S.T.C. 65 at paragraph 32 and they need not be repeated
here. They demonstrate an evolution in the law with respect to
the derivative liabilities of directors for unremitted tax. Some
of the earlier cases in this court imposed in my view an unduly
stringent obligation on directors. Section 323 of the Excise
Tax Act and section 227.1 of the Income Tax Act do not
demand the impossible. They do not require perfection. Directors
are not insurers for the fisc. All that is needed is that the
director "exercise the degree of care, diligence and skill
that a reasonably prudent person would have exercised in
comparable circumstances."
[24] One might ask the question "What did the director
fail to do that ought reasonably to have been done?" The
answer is, in this case, nothing. Once Patrick was satisfied that
Agatha's mastery of the system was adequate and that she
could rely on KPMG for any assistance she needed with respect to
the GST filing and remittances I think it would be unreasonable
to require him to go further and check her work, particularly
when neither he nor Agatha were given any indication that
anything was wrong.
[25] This conclusion is sufficient to dispose of the appeals.
However a number of other arguments were advanced and out of
respect to counsel I shall mention them briefly.
[11] Mr. Machula testified that the total
number of individuals employed in his various corporate
operations at one time amounted to 800. He is believed. In
addition to fund raising and other enterprises, the corporations
acquired and renovated the Saskatchewan Hotel in Regina,
Saskatchewan, and 611 University Drive in Saskatoon. His counsel
calculated that the amounts involved in 987's assessment
amounted to 1.7% of 987's GST and 5.3% of 987's input tax
credits claimed in 1992 - 1995 inclusive. 987's accounting
was done centrally with other corporations in which Mr. Machula
was involved. The accounting system had up to date software,
computers, two supervisory staff including a very experienced
woman, Diane Kindrachuk, and three or four other accounting
staff. Mr. Machula was, himself, unable to enter the computer
system. Rather, he relied on monthly printed financial reports
for 987 and the other corporate entities in which he was
involved. There was no indication that anything was wrong.
Moreover, these discrepancies or failures were discovered during
an audit which occurred after the periods in question. The
assumptions suggest an innuendo that the assessment relates
directly to the Appellant's residence, but there is no
evidence of that.
[12] In these circumstances, there is no
evidence that the Appellant knew or ought to have known that
there was a problem respecting the calculation of 987's GST
or ITCs for the period in question. The accounting system,
equipment and staff used by 987, and its reporting system,
together with 987's chartered accounting firm's actions
constitute, in the Court's view, the exercise by the
Appellant of the degree of care, diligence and skill to prevent a
failure that a reasonably prudent person would have exercised in
comparable circumstances. This appeal by the Appellant is allowed
and the assessment is remitted to the Minister for
reconsideration and reassessment accordingly.
[13] 2000-3141(IT)G - 161, is an assessment
which Mr. Machula appealed relating to an assessment upon 161 for
the period 01/01/96 to 12/31/96 for unremitted source deductions
under the Income Tax Act, Employment Insurance Act,
Canada Pension Plan and Income Tax Act -
Saskatchewan. The tax is $26,746.12 and associated interest
and penalties. 161 was the operator of "Saskatoon Fitness
Corner" at 611 University Drive in Saskatoon.
[14] Mr. Machula was subjected to an Order
of the Saskatchewan Court of Queen's Bench which effectively
removed him as a director and officer of many of the corporations
in which he was involved, including 987, on April 19, 1995
(Exhibit A-1). This was confirmed on March 22, 1996 (Exhibit
A-2). He was actively involved in the foregoing litigation. All
of this is recounted to indicate that Mr. Machula's other
business activities during 1996 were reduced from what they had
been in earlier years. In addition, Exhibit R-2 is a letter dated
January 7, 1995 from the operating Manager of Saskatoon Fitness
Corner to Mr. Machula which describes its outstanding GST
account with Revenue Canada in December 1994 as a result of which
Saskatoon Fitness Corner's bank account was attached on
"this day" by Revenue Canada, as a result, a number of
employees' pay cheques were returned NSF in December 23,
1995. The only bank signing officers of 161 were
Diane Kindrachuk and Larry Machula.
[15] Given the Appellant's education,
business experience, the ongoing business activities of 161 and
the other business occurrences in which Mr. Machula was involved
by 1996, the Court finds that the events described in Exhibit R-2
and Exhibit R-2 itself constitute evidence, in the words of
Robertson J. in Soper v. The Queen (F.C.A.) 97 DTC 5407 at
5419 of extremely serious financial problems which should have
alerted Mr. Machula to a possible problem with remittances. There
is no evidence that these problems were of a temporary nature or
that Mr. Machula changed his practises or took any steps
after January 7, 1996 or made any inquiries to correct
the situation except to speak to those who were already in
charge, namely Diane Kindrachuk and Simon Lillyman. He testified
that he accepted their reassurances.
[16] The facts described in paragraph [15]
are evidence that on January 7, 1995 Mr. Machula became aware
that 161 could not meet its ordinary monthly payroll expenses or
its periodic GST liabilities as they came due. These were not
extraordinary expenses. In such circumstances, a mere
conversation with those in charge does not satisfy the duty cast
upon the Appellant. Either 161's income had to be increased
or its expenses had to be reduced to meet 161's normal day to
day disbursements. In the Court's view physical intervention
and evidence of active corrective measures and follow up by the
Appellant director are called for where Revenue Canada takes
garnishee action or employees' pay cheques are NSF. After
January 7, 1995, he was on notice to prevent the failure which
occurred.
[17] But Mr. Machula failed to exercise the
degree of care, diligence and skill to prevent the failure in
question that a reasonably prudent person would have exercised in
comparable circumstances. The appeal respecting the assessment
relating to 116, file 2000-3141(IT)G is dismissed.
[18] The total amounts in question
respecting the appeal allowed and those dismissed are
approximately the same. For this reason, no costs are
awarded.
Signed at Saskatoon, Saskatchewan, this 2nd day of September
2003.
Beaubier, J.
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