Western v. The Queen, docket 96-436-IT-G

Date: 19990315

Docket: 96-436-IT-G; 96-437-IT-G

BETWEEN:

ROGER P. WESTERN, RICHARD ROGER WESTERN,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for judgment

Rip, J.T.C.C.

[1] Roger P. Western and Richard Western appeal income tax assessments issued against them by the Minister of National Revenue ("Minister") under section 227.1 of the Income Tax Act ("Act") on the basis that each of them was a director of King Cash Register Systems Ltd. ("King") at the time that the corporation failed to deduct, withhold or remit amounts of tax with respect to salaries, wages or other remuneration paid to its employees in 1988, 1989 and 1990 as required by subsection 153(1) of the Act. Each of the appellants state that he exercised the degree of care, diligence and skill to prevent the failures of King to remit tax that a reasonably prudent person would have exercised in comparable circumstances and therefore, in accordance with subsection 227.1(3) each is not liable for the failures of King to remit the tax.

[2] The appeals of the appellants were heard on common evidence. However not all the facts each of the appellants relies on in his claim that he exercised due diligence in accordance with subsection 227.1(3) are similar.

[3] Roger Western is the father of Richard Western. At time of trial he was 66 years old. Roger Western commenced working in 1951 for National Cash Register ("NCR") where he was employed for twenty years. He worked as a production manager, equipment analyst and finally in sales. He left NCR in 1974 to sell life insurance but returned to NCR two years later. After two and a half years at NCR he started a business with Richard called Direct Cash Register Sales Ltd. After four or five years a former colleague in Vancouver asked him to represent his product in Ontario and for this purpose King was incorporated in 1981.

[4] When Direct Cash Register Sales Ltd. was in operation, Richard Western was president of the corporation and was in charge of its administration. Roger Western was responsible for selling product. He had no experience in administrative matters. All banking and accounting matters were the responsibility of Richard. The appellants followed a similar practice with King. Roger Western was in charge of sales, marketing and dealing with customers. If there was a problem with a customer's account Roger Western would communicate with the customer to clear up any conflict, this was the extent of his administrative functions. Richard Western was in charge of all administrative matters. His father was not interested in, nor was he experienced in, administration or bookkeeping. Richard Western was in charge of withholding source deductions and making remittances to Revenue Canada. While a bookkeeper would have calculated the amounts of the source deductions under Richard Western's supervision, Richard Western would ensure that the payments were made.

[5] The appellants obtained a line of credit from the Toronto Dominion Bank for King's operations. The line of credit was secured by guaranteed investment certificates owned by the Westerns and which the Westerns had purchased personally with funds borrowed from the bank. The security for the personal loans was the home of each appellant. Roger Western declared "all I own" was used as collateral to the bank.

[6] While King had a difficult year in 1983, it recovered and was successful in 1985 and 1986. After 1986 there were problems, Richard Western recalled. Changes in technology were bringing down prices of cash registers and competition was increasing. The bulk of the company's income was now from the service and maintenance side of the business. Sales were diminishing.

[7] Richard Western recalled that in the past the company's profits and losses fluctuated with each quarter. The quarters before Christmas and during the summer months were weak but the spring and fall quarters were profitable. Starting in the fall of 1989 there was a slow down that continued into December and into 1990. Usually, after Christmas, there was an increase in business but not in 1990. There was talk in the media of a recession and to many potential customers the acquisition of a cash register was discretionary. At first Richard Western thought the poor sales in January 1990 were nothing to get overly excited about but they continued into February and March. Business "just wasn't there".

[8] Richard Western stated that he first realized that there might be a major problem sometime in the fall of 1989. By February of 1990 he realized the continuing downturn in sales was something different from the traditional downturns. For example, he stated that in late March or early April he had a list of ten prospective customers for product but the company was not able to sell product to any one of them. Then he "really knew a major problem existed". He said that the company could have weathered one or two bad months but did not have the financial wherewithal to endure three, four or five bad months. King terminated business in April 1990.

[9] King remitted regular source deductions in September, October, November and December 1989. Revenue Canada had audited the company during the summer of 1989 and discovered that the company was in arrears in the amount of approximately $17,000. King and Revenue Canada agreed to a repayment schedule whereby King would pay $2,300 immediately, then forward to Revenue Canada three monthly cheques in the amount of $5,000 each. The first two $5,000 cheques cleared the bank but the third cheque, payable in December 1989, did not. From January to April 1990 King remitted no source deductions to Revenue Canada.

[10] By the beginning of 1990, Richard Western estimated, King had utilized approximately 98 percent of its line of credit with the bank and had no additional cash on hand. He complained that the bank was becoming "more difficult since other businesses, not only that of King, were having problems". In 1990 the company's cash flow was primarily from services rendered to its customers.

[11] Richard Western conceded that 1989 was not the first time the company had been audited or that the company was in arrears for payment of source deductions or that the company had to enter into arrangements for payment of arrears with Revenue Canada. But, he stated, in the past the company was able to live up to the arrangements because a bad quarter was usually followed by a good quarter and there was money available to make payments. But after December 15, 1989 no remissions were made to Revenue Canada "because we did not have the money". After King had failed to make various remissions Richard Western instructed the company's accountant to write Revenue Canada in an attempt to come to some kind of accommodation.

[12] Richard Western stated that in the fourteen to fifteen years that he had been in business he had never seen such a bad business situation. He discussed the matter with his father who understood that "we were under pressure". He and his father tried to "push equipment sales" without any appreciable success. He tried to reduce expenses but it was necessary to keep three service employees who were producing cash for the company. "Without the technicians, you close the door". So, he explained, he struggled and paid the technicians throughout January, February, March and April but did not make any remissions to Revenue Canada. In some cases the technicians were paid only one half or one third of their regular salaries. By August 30, 1990 he was "tapped-out" and had to stop the company's operations. People would not work for nothing. Various suppliers, such as Bell Canada, were threatening to withdraw service or product and King required a source of money to pay the suppliers, if not Revenue Canada. Customers who paid immediately had been given a discount.

[13] Richard Western declared that there was no "real decision" not to pay Revenue Canada. He was "more or less thinking of how to survive and deal with all the suppliers". In other words, as he presented the situation, a payment to Revenue Canada meant a supplier would not be paid and without supplies the company would not survive. He wanted to keep the company going; he hoped that if he could turn the corner he would be able to deal with and pay Revenue Canada. He was constantly thinking how he could get through the adverse conditions the company was facing and honour the company's obligations.

[14] On the last day of King's business the company's bookkeeper came to King's office with various income tax forms, including forms for wages (T4). The bookkeeper assumed all the cheques, including those payable to the Receiver General, had cleared the bank, but this was not the case.

[15] In cross-examination counsel for the respondent produced King's bank statements for the period February 28 to April 10, 1990. Richard Western acknowledged that these were typical bank statements, although the cash flow was declining. The statements reflect all payments made to employees within the five-week period. Of the ninety-eight cheques cleared during this period, twenty-two cheques were made payable to employees and the balance made payable to creditors. Cheques aggregating $73,000 cleared the account over the five week period. Cheques were drawn payable to employees as wages. But no cheque was paid to Revenue Canada. Richard Western explained that payments were made to suppliers so the company could sell product. He said if he did not "stretch things out" by paying minimum amounts to creditors the company would have terminated at the end of December 1989.

[16] Richard Western also explained that in some months King had not remitted in full the amount of source deductions. This was due to the fact that certain employees were paid a commission above their salary and King did not withhold source deductions from payments of commission.

[17] Richard Western stated at all times his objective was to pay "Revenue Canada as fast as I could and satisfy creditors with as little money as possible". When he paid arrears to Revenue Canada in the fall of 1989 he was unable to pay creditors. After December 1989 he paid creditors but not Revenue Canada because "things did not improve as expected".

[18] Roger Western was aware during the last year of King's operations that the company was in financial difficulty. He said that during the eighteen months before the company closed at the end of April 1990 he and his son felt the stress of a company struggling for survival. He allowed his son to handle the administration and try to put the company on a firm financial basis while he tried to save the business by promoting sales. Roger Western was not involved nor concerned with the company's requirement to make timely remittances to Revenue Canada. He said that he was only "now" learning what the situation was.

[19] Roger Western has a high school education. He also attended night school to study continuing education courses at the University of Toronto, where he received certificates in economics and accounting, and Ryerson College, where he obtained an electronics certificate.

[20] Roger Western agreed with his son that the business began to deteriorate seriously after December 1989. Roger Western was "totally focused on sales". He never discussed the failures of the company to remit with his son Richard. He was unable to answer whose decision it was to pay employees without remitting source deductions to Revenue Canada.

[21] Roger Western conceded in cross-examination that he did not do anything to prevent failure of King to remit source deductions to Revenue Canada. He relied on his son and was "desperately trying to get sales going".

[22] The amount of source deductions not remitted to Revenue Canada was in the amount of $12,660.03. Richard Western stated that the company never had the money to remit. In his view he and his father did everything possible to collect and remit the source deductions. Some of the examples of the due diligence exercised by the appellants, according to them, were that they reduced the company's operating expenses, remitted current source deductions due in the months of September to December 1989 and tried to generate cash into the company. In short, what they attempted to do, was to continue the company in operation with the hope that it would turn a corner and be successful. The appellants both acknowledge that they did nothing to prevent the actual failures of the company to remit.

[23] Appellant's counsel argued that King was a small family run business operated by the two appellants. Roger Western had a modest formal education; his real education was his education in life. He was involved in the cash register business and devoted all of his life to the industry. When he started in business with his son it was natural for him to do what he knew best, that is, sales. It was also natural for him to let his son do what he knew best, that is administration. That his son was responsible for the administration of the business was not an abandonment of Roger Western's functions as a director. He met the standard refused by subsection 227.1(3) by leaving a function to a person in whom he had confidence. He did what he thought he could do best, to sell. It was reasonable for a father to put his faith in his son and a person in comparable circumstances to Roger Western would have done exactly the same thing.

[24] Richard Western did not cause King to remit source deductions to Revenue Canada since this was perhaps the only way King could continue in business. Richard Western hoped that in a relatively short run he could turn the business around and pay Revenue Canada. He was attempting to remedy the failures of the company to remit and to avoid further failures. He was exercising a degree of care, diligence and skill to prevent failures.

[25] Respondent's counsel agreed that this was a small family run business. The directors, father and son, were in close contact. Each knew of the company's financial difficulties. While Roger Western may not have known of the company's failure to remit source deductions he did know that the company had a financial problem. He thus had an obligation to determine if the company was meeting its statutory obligations under the Act. He did not query his son with respect to anything the company was doing or not doing and as such he failed in his statutory duty. Appellants' counsel referred to Stuart v. The Queen, 95 DTC 537, at 538-539, a decision of Christie, A.C.J.T.C.C., as he then was. In Stuart the taxpayer was entirely passive in his capacity as an officer and a director of the corporation, never asserting himself in that capacity, and never making inquiries about the responsibilities of directors. A significant question, therefore, was whether an individual who consents to being appointed as director of a corporation can escape liability under section 227.1 of the Act by, for all practical purposes, ignoring its existence thereafter. Christie, A.C.J.T.C.C., agreed with Bonner, J.T.C.C., in Black v. The Queen, 93 DTC 1212, that there is nothing in the language of section 227.1 to suggest 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. Roger Western simply ignored his obligations, duties and responsibilities as director.

[26] Counsel also referred to Soper v. The Queen, 97 DTC 5407, F.C.A., at 5418 in where Robertson, J.A. stated that a director has:

... the positive duty to act ... [when he or she] ... obtains information, or becomes aware of facts, which might lead one to conclude that there is, or could reasonably be, a potential problem with remittances. Put differently, it is indeed incumbent upon an outside director to take positive steps if he or she knew, or ought to have known, that the corporation could be experiencing a remittance problem. The typical situation in which a director is, or ought to have been, apprised of the possibility of such a problem is where the company is having financial difficulties...

[27] On the basis of these cases, Roger Western is liable under the provisions of the Act. He was not an outside director. He was involved in the company's business. He knew the company was floundering and did not take steps that a responsible outside director, let alone an inside director, would have taken.

[28] As far as Richard Western is concerned, he did absolutely nothing to prevent the failure of King to make remissions. Indeed, he was the actor who caused the company not to make remissions. It was his decision that the company not make remissions. If a director causes a company to continue in operation knowing full well that the company cannot, or will not, make remissions of source deductions to Revenue Canada in the hope that the company will turn around and be successful he or she is not, in my view, exercising any degree of care, diligence and skill to prevent the failure that reasonable prudent person would have exercised in comparable circumstances within the meaning of subsection 227.1(3).

[29] In their Notices of Appeal the appellants alleged that the Minister erred in calculating the outstanding balance owed by King to Revenue Canada. During the course of his cross-examination, Richard Western was shown several documents describing how Revenue Canada calculated the balance outstanding and the reasons. Mr. Western eventually conceded that Revenue Canada's calculations are correct.

[30] The appeals are therefore dismissed. The respondent is entitled to one set of costs.

Signed at Ottawa, Canada this 16th day of March 1999.

"Gerald J. Rip"

J.T.C.C.