Bohn v. The Queen, docket 97-1008-GST-I (Informal Procedure)

Date: 20000428

Dockets: 97-1008-GST-I; 97-1010-GST-I

BETWEEN:

EDWARD BOHN, PATRICIA BOHN,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent,

Reasons for Judgment

Mogan J.T.C.C.

[1] The appeals of Edward Bohn (Court file 97-1008(GST)I) and Patricia Bohn (Court file 97-1010(GST)I) were heard together on common evidence. The Appellants are husband and wife. For convenience, I shall refer to the husband as "Edward" and to the wife as "Patricia" because each could be called an "Appellant". They are assessed under section 323 of the Excise Tax Act (the "GST legislation") in their capacity as directors of Brandwest Distributors Inc. ("Brandwest"). They claim that the assessments should be vacated because they have satisfied the due diligence test in subsection 323(3). Both Appellants have elected the informal procedure.

[2] The Appellants are enterprising people with limited formal education. Edward was born in 1938 and left school after Grade 9. Patricia was born in 1939 and left school after Grade 12. For 13 years, through the 1970s and early 1980s, the Appellants operated a furniture store in British Columbia. Around 1985, they purchased a small strip mall in Regina with five commercial tenants located at Lewvan Drive and Pasqua Street. The mall is actually owned and operated by Bonaventure Enterprises Ltd. ("Bonaventure"), a corporation owned by the Appellants. Another corporation owned by the Appellants is Brandee's Corner Store Inc. ("Brandee's") which operates two community convenience stores with postal outlets in Regina. One of Brandee's convenience stores is a tenant in the mall owned by Bonaventure. The Appellants incorporated Brandee's and opened their first convenience store around 1986. In 1993, 1994 and 1995, the time most relevant to these appeals, Bonaventure and Brandee's were profitable companies providing a good living to the Appellants.

[3] In the winter of 1992-1993, one of the suppliers to the Brandee's convenience stores told Edward about a business (Border Wholesale) which was for sale in Estevan, Saskatchewan. Border Wholesale purchased and sold grocery items, confection items, tobacco, paper products and other items ordinarily sold in small stores and convenience stores. Edward thought that his acquisition of Border Wholesale would be a good fit with Brandee's because Border Wholesale could become the principal supplier to Brandee's. Also, Edward had a good friend who was out of work and Edward thought that he could hire his friend to manage the Border Wholesale business in Estavan. Edward decided to purchase the business of Border Wholesale and incorporated Brandwest to acquire and operate the new wholesale business. The purchase was completed in the early weeks of 1993. Brandwest operated the new wholesale business; and Edward's friend in Estevan was hired by Brandwest to manage the business.

[4] Edward had a chance to look at the books and records of the wholesale business before the purchase in early 1993 but those records were not produced in evidence and Edward could not recall what he and Patricia paid for the business through Brandwest. The vendor of the business had operated a hotel in Estevan and the hotel had been a good customer of the business. Edward concluded that the Brandwest business was too local as a wholesale supplier and, if Brandwest were to acquire two or three trucks, Edward expected that Brandwest could supply 90% of the needs of small stores and convenience stores in southern Saskatchewan. Accordingly, Brandwest leased three trucks; hired three new employees as drivers; and started a policy of sending the trucks out each day to see if the wholesale business of Brandwest could be expanded.

[5] As the Brandwest business expanded, Edward spent more of his time on Brandwest and less time on Brandee's convenience stores. He said that he "worked like a slave". (Transcript page 47). Almost every day, he would drive from Regina to Estevan (220 kilometres) and return. In 1994, he put more than 60,000 kilometres on his van. Much of what he did was physical. In the morning, he would pick up supplies and load his van and a covered trailer which he pulled; take the merchandise to Estevan; unload it and store it. He would work the Estevan warehouse for the rest of the day and check the accounts receivable. At the end of the day, because Brandwest was the principal supplier to the Brandee's convenience stores in Regina, he would load the van and trailer with goods needed by Brandee's and return to Regina.

[6] Exhibit A-1 is a set of unaudited financial statements for the 12-month period ending December 31, 1994 with comparable amounts for 1993. According to those financial statements, sales in 1993 were $2,810,000 and sales in 1994 were $4,834,000. Cost of sales increased similarly from $2,614,000 to $4,596,000. Needless to say, Edward and Patricia were well aware of the expanding business of Brandwest because they were paying the bills and recording the sales. At the end of 1993, Brandwest showed accounts receivable of $424,000 and so there was a shortage of cash as the early months of 1994 passed.

[7] Brandwest had a GST registration number and was required to file GST returns quarterly. In subparagraph 15(g) of the Respondent's Reply to the Notice of Appeal, there is a table with certain information with respect to Brandwest's GST returns and the accuracy of that table was confirmed by Edward and Patricia. For convenience, I will reproduce that table and summarize the Appellants' testimony with respect to the date, amounts owing and methods of payment.

Period End Date	Return Due Date	Date Filed	Net Tax Due
93/04/30	93/05/31	93/07/07	$0.00
93/07/31	93/08/31	93/09/01	4,560.42
93/10/93	93/11/30	94/03/22	27,532.76
94/01/31	94/02/28	94/07/08	21,212.79
94/04/30	94/05/31	94/07/08	29,226.47
94/07/31	94/08/31	94/09/07	28,263.49
94/10/31	94/11/30	94/12/06	27,424.44*
95/01/31	95/02/28	95/08/23	34,392.34
95/04/30	95/05/31	95/08/23	3,500.61
Total			$176,113.32*

* amended by oral testimony

[8] Patricia was the bookkeeper for Brandwest, Brandee's and Bonaventure and so she provided most of the oral testimony pertaining to the above table. The GST return which was due on November 30, 1993 for the period ending October 31, 1993 was not filed until March 22, 1994. Patricia said that she delayed filing that return because Brandwest had a cash flow problem and she was trying to pay the net tax due when she filed the return. Brandwest did in fact pay the amount of $27,532.76 on March 22, 1994 when the return was filed. The GST return for the next period ending January 31, 1994 was not filed until July 8, 1994 and the net tax of $21,212.79 due on February 28, 1994 was paid in five instalments of approximately $5,400 each between July 8 and August 12, 1994.

[9] The GST return for the period ending April 30, 1994 was filed with the prior period return on July 8, 1994 and the net tax due of $29,226.47 was paid in part by applying an overpayment from a prior period and in part by applying a refund payable to a related corporation. The GST return for the period ending July 31, 1994 was filed on September 7, 1994 (only 7 days late) and the net tax due of $28,263.49 was paid in five instalments of $5,725 between September 26 and October 21, 1994. According to the above table and Patricia's evidence, the GST payments were up-to-date as at October 21, 1994 for all periods prior to August 1, 1994.

[10] It is a fact that Brandwest became insolvent and went out of business in February or March 1995 owing GST in the net amount of $38,101.98 for the period from August 1, 1994 to April 30, 1995 (the "relevant period"). In 1996, notices of assessment were issued to Brandwest and to Edward and Patricia as directors of Brandwest. Each assessment was in the aggregate amount of $44,490.06 computed as follows:

Net tax for relevant period $38,101.98

Accrued interest 3,412.87

Accrued penalty 2,975.21

$44,490.06

[11] The GST return for the period ending October 31, 1994 was filed on December 6, 1994 (only 6 days late) and, in order to pay the net tax due of $27,424.44, Brandwest delivered to Revenue Canada seven cheques each in the amount of $3,428.06 dated between December 6, 1994 and January 27, 1995. One of those cheques dated on or about January 19, 1995 was returned to Revenue Canada marked NSF for reasons explained below. The table in paragraph 7 above and the pattern of payments adopted by Brandwest from and after July 1994 prove to my satisfaction an attempt in good faith to keep current the remittances of GST after Brandwest was no longer able to remit the full amount owing with each quarterly GST return. Edward and Patricia both testified at the hearing of these appeals. I was favourably impressed with their candour and honesty and found them to be totally credible witnesses.

[12] In January 1995, Edward conducted an inventory count at the Brandwest warehouse in Estevan. According to the Brandwest financial statements (Exhibit A-1), the inventory at December 31, 1993 was $456,000 in a year when gross sales were $2,810,000. In the following year (1994), gross sales were $4,834,000. Accordingly, one could expect the inventory at December 31, 1994 to be correspondingly higher, perhaps in the range of $650,000. When the inventory count was completed, it was valued (lower of cost or market) at $327,000; and Brandwest recorded a loss of $181,000 for the year ending December 31, 1994. Brandwest was in fact, if not in law, insolvent.

[13] Edward and Patricia were shocked at the inventory shortfall. They knew that Brandwest had a cash flow problem as evidenced by the remittance of GST with post-dated cheques; but they had no idea that the inventory was so depleted and that Brandwest would record such a significant loss for 1994. Edward actually thought that Brandwest was doing well prior to the inventory count. Here is a passage from his examination-in-chief:

A. I really did. I thought we were doing well, I really did.

Q. Did you change that opinion?

A. Well I know when we did the inventory in January of 1995 – I believe that is when it was. I was absolutely shocked. I couldn't believe it. When the figures came in I phoned the inventory company and I said, You've made a mistake. I couldn't believe it because I had been so close to the company, and the difference between what we thought and what was reality was just unbelievable.

Q. Can you particularize that? What did you think?

A. I thought we were okay. I thought we were making money, at worse breaking even. And I even forget the amount of the shortage, but it was so huge that we were maxed out. We couldn't have baled out the company at that point if our life depended on it, there was just no way, you know.

Q. You say you can't recall the exact amount. Can you approximate what your inventory shortage was?

A. It was in excess, I believe, of $100,000. I have always used that figure, but it was something close to that. I really don't know.

Q. So as a result of that inventory shortage, that changed your opinion of the financial health of the company?

A. Well there is no way you could operate, it was done. You have to pay your suppliers, you have got liabilities, and if you don't have the funds, you are done. I was finished. I was very distraught, quite frankly.

Transcript pages 54-55

[14] When Edward and Patricia realized the desperate situation at Brandwest, they immediately sought legal advice from George Nystrom, a Regina lawyer. With Mr. Nystrom's help, they put together a rough statement (Exhibit A-2) showing Brandwest's assets and liabilities and a proposal to pay all creditors starting with Sherwood Credit Union which was fully secured for all sums owing by Brandwest. Sherwood Credit Union ("SCU") was in effect the bank for Brandwest. On January 24, 1995, Edward and Patricia and Mr. Nystrom met with senior officers of SCU when the desperate financial circumstances of Brandwest were described including the proposal to pay all creditors starting with SCU. Edward and Patricia thought that the meeting had gone well and that Brandwest would have time for an orderly winding down. Later in the day, however, by letter dated January 24, 1995 (Exhibit A-3), SCU made formal demand for payment of indebtedness in the aggregate amount of $195,494.

[15] In the Brandwest statement of net worth and proposal to pay creditors (Exhibit A-2), the realizable value of assets and list of creditors was summarized as follows:

Assets

Accounts Receivable $375,000

Inventory $100,000

Warehouse Equipment 20,000

$495,000

Liabilities

SCU $210,000

Saskatchewan Revenue 201,000

Revenue Canada

GST 20,000

Source deductions 1,500

Employees 6,500

Vendor of business 142,200

Utilities 4,500

Truck leases 20,000

Suppliers 190,000

$795,000

[16] It was the intention of Edward and Patricia to pay the creditors in the order that they appear in the above list. SCU was fully secured and would naturally claim the first proceeds of disposition. Brandwest did not realize as much from the sale of assets as was expected in the proposal (Exhibit A-2) and so Revenue Canada, the third creditor on the list, did not get paid. That is the reason for the two assessments against Edward and Patricia as the only directors of Brandwest. According to Note 12 to the financial statements (Exhibit A-1) Brandwest had ceased operations as of February 20, 1995. That Note is consistent with the oral testimony of Edward and Patricia who stated that the business was wound down very quickly after the meeting with SCU on January 24.

[17] The relevant statutory provisions of the GST legislation are in section 323:

323(1) Where a corporation fails to remit an amount of net tax as required under subsection 228(2) or (2.3), the directors of the corporation at the time the corporation was required to remit the amount are jointly and severally liable, together with the corporation, to pay that amount and any interest thereon or penalties relating thereto.

...

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.

The above words in section 323 are almost identical to the words in section 227.1 of the Income Tax Act which imposes a similar vicarious liability on directors. Accordingly, cases decided under section 227.1 of the Income Tax Act are important to consider when deciding appeals under section 323 of the GST legislation. One of the leading cases under section 227.1 of the Income Tax Act is Soper v. The Queen, 97 DTC 5407. In Soper, Robertson J.A. drew a distinction between inside and outside directors at page 5417:

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.

[18] There is no doubt that Edward and Patricia were inside directors because they were the only directors of Brandwest and were involved in the day-to-day management of the company. With respect to the subjective and objective standard of care, Robertson J.A. stated at page 5416:

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".

[19] For the reasons set out below, I have decided to allow the appeals of Edward and Patricia. Although they were inside directors, their liability is not absolute. In paragraph 10 above, there is a table which shows that the actual amount of tax assessed to each Appellant is $38,101.98. According to the evidence before me, almost all of that tax ($38,101.98) resulted from transactions in the two quarterly periods ending January 31, 1995 and April 30, 1995. In my opinion, that is the most important fact. In particular, I distinguish these appeals from other cases (mainly under the Income Tax Act) in which directors have continued to operate an unstable business for many weeks or months by using payroll source deductions to finance the business.

[20] In the circumstances of these appeals, Edward and Patricia honestly thought that the Brandwest business was doing well (but with a cash flow problem) until they received the result of the inventory count in late January 1995. Once they knew of the inventory shortfall, they did everything that a reasonable person could do. They sought legal advice; they prepared a proposal (Exhibit A-2) which recognized the corporate insolvency; and they met with their banker (SCU) and secured creditor to make full disclosure of the desperate Brandwest situation. When they received the demand from SCU (Exhibit A-3), they decided to close down the Brandwest operation and sell all assets.

[21] Considering the objective standard of care, Edward and Patricia did what any two reasonable persons would do. When the cash flow problem arose in the first six months of 1994, they remitted GST with post-dated cheques which were all honoured until the last 10 days of January 1995 when SCU took steps to protect its interest as a secured creditor. All of the GST owing for the quarter ending October 31, 1994 was paid by post-dated cheques in December 1994 and January 1995 except for the one or two cheques which were returned NSF in the last 10 days of January. The GST return for the quarter ending January 31, 1995 was not due to be filed until February 28, 1995. By that date, the Brandwest business had been closed down.

[22] Considering the subjective standard of care, Edward and Patricia had limited formal education but they were operating two profitable corporations (Bonaventure and Brandee's) when they acquired what became the Brandwest business. Also, they had operated a furniture store in British Columbia for 13 years and had never experienced a business insolvency until Brandwest failed. I think that Edward did not pay enough attention to detail because he could not recall what he had paid for the Brandwest business. Also, he may have put too much trust in human nature because he rented three trucks and hired three new employees to drive out each day with a load of small goods which could be easily sold for cash. He concluded too late (after the inventory shortfall) that Brandwest was a victim of significant thefts. All of this is hindsight and it does not diminish the honesty of the Appellants or their good faith attempts to remit GST as the Brandwest business rolled along.

[23] Subsection 323(3) states that a director "is not liable for a failure under subsection (1) where ... ". The "failure" under subsection (1) is a failure to remit GST. There was, for all practical purposes, no failure to remit GST until February 28, 1995 when the quarterly return for January 31, 1995 was required to be filed. Long before February 28, 1995, the secured creditor (SCU) had made a formal demand on Brandwest to pay $195,494; had seized all of Brandwest's accounts and funds; and had effectively closed down the Brandwest business. In those circumstances, there was nothing that the directors of Brandwest could do on February 28, 1995.

[24] There is unequivocal evidence that neither Edward nor Patricia received any remuneration or financial benefit (no wages, salary, goods or dividends) from Brandwest at any time in its brief two years of operation. When Brandwest became insolvent, Edward and Patricia each lost approximately $190,000 which had been invested in the company. On February 22, 1995, Edward and Patricia borrowed $158,000 from Edward's sister and her husband (Exhibit A-7) but those funds by-passed SCU and were paid to Saskatchewan Revenue with respect to a bond for tobacco tax. Saskatchewan Revenue was, in effect, a secured creditor; and the Brandwest business was closed down by February 22, 1995. The appeals are allowed, with costs.

Signed at Ottawa, Canada, this 28th day of April, 2000.

"M.A Mogan"

J.T.C.C.

After delivering the above Reasons for Judgment, counsel for both parties communicated with the Registrar of the Court stating that they were in agreement that the Appellants could not be awarded costs in these appeals. Accordingly, the above Reasons are amended to allow the appeals without costs.

Signed at Ottawa, Canada, this 31st day of May, 2000.

"M.A Mogan"

J.T.C.C.