Date: 20010516
Docket: 98-9316-GST-I
BETWEEN:
NICOLA DILORENZO,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
McArthur J.T.C.C.
[1]
This appeal involves the liability of the Appellant as a director
of 819636 Ontario Inc. (the Corporation) for unremitted goods and
services tax for the periods April 1, 1993 to June 30, 1993 and
January 1, 1994 to March 31, 1994 in the amount of $66,442
including interest and penalties. Presentation of the evidence at
trial took three days in April and June 2000 and closing
submissions were not heard until January 2001, having awaited the
Federal Court of Appeal decision in Worrell v. The Queen,
[2000] F.C.J. No. 1730.
[2]
The issues are whether the Appellant had an obligation to remit
goods and services tax under subsection 321(1) of the Excise
Tax Act and if so, did the Appellant exercise the degree of
care, diligence and skill to prevent the failure of the
Corporation to remit GST that a reasonably prudent person would
have exercised in comparable circumstances pursuant to subsection
323(3) of the Act.
Facts
[3] I
will first deal with the facts, which I accept, as presented by
the Appellant and his witnesses. The Appellant immigrated to
Canada from Italy at the age of 16 in 1957 when he commenced
working in the construction industry in the Toronto area. He has
little formal education but quickly rose in the industry. In the
1960s, with his brothers, he managed 3,700 men. He repeated
throughout his evidence that he never got involved in paperwork
but hired accountants, lawyers and office workers while he did
the outside work.
[4]
The Appellant and a friend, Charles O'Hara (O'Hara)
planned the construction of a senior citizen home in Ajax,
Ontario through the Corporation of which both were directors. I
will refer to it as the Project. He and O'Hara had several
other projects at various stages which are not the subject of
this appeal. The Appellant was the outside man and O'Hara was
the administrator. The Appellant's responsibilities were to
overlook the trades, deal with the architects and assure the
construction progressed properly. The Corporation hired
Philip Weinstein (Weinstein), a chartered accountant, to
administer the total financial area. The witnesses, O'Hara
and Weinstein, confirmed that the Appellant's
responsibilities were out in the field and not in the office.
[5]
Financing was arranged through Royal Life Insurance Company for
which Zurich Indemnity Company was the surety or guarantor.
Pursuant to its contractual rights on April 26, 1991, Zurich
appointed monitors to take over the Project's finances and
take control of the Corporation's bank accounts. The monitors
received all of the advances to the Corporation and retained
control throughout the assessed period to the exclusion of the
Appellant, O'Hara and Weinstein. It was obvious the Project
was undercapitalized and Zurich was concerned with the loan it
had guaranteed and wanted control of the flow of funds. The
Appellant had no control over the Corporation's banking. The
monitors did not pay the remittances in question although they
were on occasion, asked to do so by Weinstein. He would present
cheques made payable to the Receiver General to the monitors for
signature and remittance but these cheques were ignored.[1] The monitors received
approximately $7.5 million in advances from the Project which
clearly had a GST component yet they did not remit the GST
amounts to the Receiver General. From July 1992, no cheques
issued by the Corporation were signed by the Appellant, nor did
he have authority to do so. Both the Appellant and O'Hara
transferred their ownership in the Corporation to Zurich. All of
the monies went into the monitor's account. The monitor
consisted of three or four individuals appointed by Zurich.
[6]
The Corporation passed a banking resolution in June 1992
approving Zurich's appointment of a monitor to be the only
signing authority with respect to all banking. During the
relevant periods, Weinstein continued to do the accounting for
the Project and made the requests to Ajax Municipal Housing
Corporation for progress advances or draws. He calculated the
amount of the draws including the requisite amount for GST. The
draw proceeds would go into the bank account over which Zurich,
through the monitor, had complete control. The last deposit from
the Project to the Corporation's account was in
September 1993. All draws went into the one Bank of Montreal
account. These draws included GST. The security agreement
provided that all taxes were to be paid by the monitors but this
provision was ignored by them. It would appear that Zurich paid
those debtors who were a threat to shutting down the Project and
the cash flow. The Appellant and O'Hara abandoned the
Corporation's construction contract with Ajax Municipal
Housing Corporation in September 1993 before its completion. The
first indication the Appellant received that GST had not been
paid was in 1996. For the period after December 1993, the
Appellant was off the Project having abandoned it.
[7]
The Respondent's counsel introduced facts under his theme of
"responsibility" that casts a shadow over the
simplicity of the foregoing. I accept the following further
facts. In addition to extensive cross-examination of the
Appellant, O'Hara and Weinstein, the Respondent called on one
of the monitors to testify.
[8]
The Appellant and O'Hara had four companies referred to as
the Dilhara Group which Group intended to build four
projects. The Ajax senior citizen project was projected to cost
$10 million of which $700,000 was for GST. Weinstein agreed
that the Corporation was to receive $10 million from the Project.
The Corporation subcontracted the construction for $7 million.
Had the Corporation not carried the debt loan of its three
related Corporations, there would have been no need for the
monitors and there would have been sufficient funds to pay
GST.
[9]
One of the four corporations, 698375 Ontario Limited, may have
been in default of unremitted GST in January 1991 but not on the
Project in question. The evidence in this regard lacked
clarity and certainty and I give it no weight.
[10] Roderick
Dougherty, one of the monitors, gave evidence on the
Respondent's behalf. During the relevant period, he was an
employee of an insurance brokerage company that had arranged
financial guarantees and bonding for the Dilhara Group. He was
also the president of Surety Monitors Limited which assumed a
monitoring role on behalf of Zurich for these projects. He did
not recall being asked by the Appellant or anyone else to pay
GST.
[11] The
Appellant was not prevented from reviewing the Corporation's
records. The Corporation may have had some control over a very
small amount of Project funds. There were isolated incidents when
the Appellant was able to interfere with some monies going to the
monitor. In October 1993, the Appellant was able to direct the
amount of $8,183 to be paid for the benefit of Weinstein. The
Respondent submits that $300,000 relating to the land and soft
costs was not properly accounted for. The accounting in this
regard was not clear and I give this evidence very little
weight.
[12] The
Appellant was a director and secretary-treasurer of the
Corporation; he guaranteed the financial transactions of the
Dilhara Group; was involved in the construction; attended
some site and draw meetings; signed statutory declarations
stating that the Corporation was current on its liabilities; and
directed money from the Project to pay some minor
receivables.
Position of the Appellant
[13] In his
Notice of Appeal, the Appellant sets out the following defences:
(i) he had no control over the funds received by the monitors of
Zurich as a result of the sales of the non-profit units; (ii) he
was not a trustee of the funds under the circumstances; (iii) he
directed the monitor to remit the tax, however, could not secure
such remittance; (iv) the trust funds sought by the Minister were
in the hands of Zurich and the Appellant had no signing authority
over the Corporation's account during the relevant periods of
assessment; and (v) the Appellant was not a de facto
director of the company at the relevant time periods and the
Minister did not properly exercise its proper and fair discretion
when this matter was determined.
[14] The
Appellant's counsel stated that the appeal was
two-pronged: (i) it is our position that the obligation
under subsection 323(1) did not arise because there was no
control whatsoever over the funds that generated the liability;
and (ii) the Appellant did everything he possibly could, or
could not have been accused of not having exercised due diligence
based on his background and his position in the Corporation and
the information he had provided to him and the way that the
monies moved throughout these projects.
Position of the Respondent
[15] The
Respondent stated that the first project of the
Dilhara Group "seems to have been behind between
$300,000 in GST remittance". The evidence that the Appellant
was unaware of a GST problem until 1996 is undermined by this.
The Appellant wilfully blinded himself to the financial and
administrative side of the Corporation. The Appellant cannot make
his own shortcoming into his defence. He was the
secretary-treasurer of his own company. He signed most of
the key documents. When it suited him, he interfered with
payables by directing that monies from Ajax Municipal Housing
Corporation be paid to his friend Weinstein.
[16] The
Appellant set up the situation for the Zurich/monitors take-over
by entering into a highly risky arrangement. The Respondent's
premise is first, responsibility and second, the Corporation and
the Appellant acquiesced in the monitor's misuse of the GST
funds. They were the ones who were telling the monitors how to
misuse the money. The monitors are not on trial. If the
Corporation acquiesced and instructed the monitors how to act,
how can it possibly be said that monitors acted to prevent the
Corporation from paying GST as and when it was due?
Analysis
[17] I am
assisted by the decision of the Federal Court of Appeal in
Soper v. The Queen, 97 DTC 5407. The starting point is to
classify the Appellant as an inside or outside director. I have
no difficulty in finding that the Appellant was an inside
director. In Soper, Robertson J.A. stated that inside
directors are those involved in the day-to-day management of the
Corporation. The Appellant was such a person. He was involved in
the day-to-day construction. While the construction work was
subcontracted and not actually carried on by the Corporation, the
Appellant supervised the construction process to be assured that
the contract was being fulfilled. I find the Appellant was not
passive. He hired Weinstein, a chartered accountant, on a
full-time basis and relied on the expertise of O'Hara.
[18] I cannot
accept the Appellant's position that there is no need for a
due diligence analysis because the Appellant lacked control and,
therefore, subsection 321(1) was never triggered. Evans J.
in Worrell found the contrary. The fact that the money
lender has control is not sufficient to relieve a director from
demonstrating due diligence under the legislation. I find that
the Appellant was a director and an inside director as described
in Soper and the fact that the monitor took control does
not relieve the Appellant from demonstrating due diligence.
[19] At
paragraphs 51, 56 and 61 in Worrell, Evans J. stated:
... However, despite some broad statements by Addy J.,[2] in my opinion this
case cannot be regarded as authority for the general proposition
that once a bank exercises control over the cheques written by a
company, the directors are not vicariously liable for source
deductions not remitted to Revenue Canada.
With all respect to those who have taken a different view, in
my opinion it is inappropriate to import into subsection 227.1(1)
a requirement that it is only engaged if the directors have de
facto control over the financial operation of the company,
particularly the payment of its bills.
Therefore, in my respectful view, the decision of McArthur
J.T.C.C. that the directors of Abel were not liable for the
unremitted source deductions and GST cannot be supported on the
ground that subsection 227.1(1) was not triggered because the
bank's insistence that it approve any cheques written by the
company deprived the taxpayers of control of the company's
finances.
Due Diligence
[20] This
brings me to the Appellant's second argument that he is not
liable pursuant to subsection 323(3) of the Act which
reads:
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.
While the Appellant gave up control of the finances to Zurich,
he remained a director of the Corporation and continued to
supervise the Project. This puts him within the situation in
Worrell.
[21] In
summary, the Respondent's four points are: (i) the Appellant
was a fairly sophisticated business person; (ii) his company was
undercapitalized; (iii) the monitors never interfered with
the payments of receivables to Revenue Canada; and (iv) the whole
issue of control is completely irrelevant. The Corporation
demonstrated a pattern of indifference and neglect which
undermines the availability of the due diligence defence,
especially when that neglect contributed to the failure to
remit.
[22] All draws
from the Ajax Project went into a bank account over which the
Appellant had no control - only the monitors had signing
authority. The advances were inclusive of GST yet the GST was not
paid. The monitors paid the amounts necessary to keep the
construction producing advances and paid its own fees. Now the
Appellant is being called upon to pay Revenue Canada the GST
which was collected but not remitted. I believe a strong argument
can be made to the effect that the GST component over which the
monitors had control is trust money that cannot be paid to anyone
other than Revenue Canada.[3] Be that as it may, the monitor had no legal obligation
to remit the GST collected. A monitor, Mr. Doughtery, stated no
one told them to remit the GST to Revenue Canada, yet the
agreement under which they were working stipulated that the
monitor was to pay taxes. I agree that the monitor is not the
subject of the assessment and I should not be side-tracked
into blaming the monitor. The question is whether the Appellant
acted reasonably to assure that GST collected was remitted as
envisaged in subsection 323(3). There is no evidence that the
Appellant was made aware that there was a GST problem. What
proactive steps were undertaken by the Appellant to take him out
of the totally passive mode? The Appellant's answer was
"I'm not a paper man, I relied absolutely on my
chartered accountant, Mr. Weinstein".
[23] Is this
due diligence? I believe it is. What more could have been done?
He had hired a highly experience chartered accountant and he had
no control over the bank account into which the draws were
deposited. In December 1993 when the building was substantially
completed, the Appellant and O'Hara notified the Ajax
Municipal Housing Corporation that they could no longer honour
their contract. There is an assessment for the period from
January 1994 to March 1994 when the Appellant no longer was
involved in the completion of the Project.
[24] There is
insufficient evidence that the Corporation was in GST remittance
arrears prior to the take-over of the draws by the
monitors. There is no evidence that the Appellant was aware of
any such arrears. A distinguishing factor with this case from
Worrell and many others is that in Worrell, the
directors knew of the default to remit. The Appellant did not. In
order to obtain financing, he entered into an agreement wherein
the finances were taken out of his Corporation's control.
[25] In
Worrell, Rothestein J.A. in his brief concurring reasons
at page 6605 stated:
... I wish to emphasize that whether the due diligence
defence will be successful is fact-driven in each case, i.e.
always comparing what the directors did to prevent the failure
with what a reasonably prudent person would have done in
comparable circumstances. I agree with Evans J.A. that the due
diligence defence is established on the facts of this case.
...
Evans J.A. had stated at paragraph 77 of his reasons (at page
6604):
Given the limitations placed upon them by the bank's de
facto control of the company's finances, I am satisfied
that, on the facts of this case, the directors exercised the
degree of care, diligence and skill to prevent failures to remit
that would have been shown by a reasonably prudent person in
comparable circumstances. ...
[26] In
conclusion, I find that the Appellant did exercise the degree of
care, diligence and skill to prevent failures to remit that would
have been shown by a reasonably prudent person in comparable
circumstances. The appeal is allowed.
Signed at Ottawa, Canada, this 16th day of May, 2001.
"C.H. McArthur"
J.T.C.C.
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