REASONS
FOR JUDGMENT
C. Miller J.
[1]
Kenneth Hall and Arlene Hall (the “Appellants”) were assessed on September 12, 2011 as
directors of Petco Holdings Inc. (the “Company”)
pursuant to section 227.1 of the Income Tax Act (the “Act”). The Appellants object to the
assessments on three grounds:
i.
the Minister of National Revenue (the “Minister”) has been unable to prove that the amounts
assessed accurately reflect the amounts actually owed by the Company for
employee source deductions;
ii.
the Appellants ceased to be directors prior to
September 12, 2009; and
iii.
the Appellants exercised due diligence in
attempting to prevent the Company’s failure to remit source deductions.
[2]
Hall was the only witness for the Appellants. He
testified that he was the decision-maker when it came to deciding what the
Company should pay and what it could defer. Mrs. Hall looked to him for
direction in that regard. She had no authority to make payments if Mr. Hall, as
he put it, went down a different path.
[3]
The Company was in the alarm system business and
had been for many years prior to the 2004 to 2005 taxation years, the years in
which the Company failed to remit the source deductions at issue. In the late
1990’s, the Company built a new building, which ultimately caused greater
expense than anticipated. Mr. Hall left me with the impression this was the
beginning of the Company’s financial woes. By 2004, Mr. Hall acknowledged that
the Company was not making the payments it should have been making, but in fact
paid whoever would allow for the continued operation of the Company. The Halls
were well aware in 2004 and 2005 of the Company’s financial problems specifically
relating to source deduction remittances. This arose due to the Company’s cash
flow difficulties. The Halls maxed out the mortgage on their residence to put
money into the business. They cut their own salaries significantly, ultimately
taking home less than their employees. They pushed their suppliers to the limit
to the point that no credit was left with them.
[4]
Mr. Hall acknowledged that he decided to pay
employees before he paid the Canada Revenue Agency (“CRA”).
He suggested his dilemma was whether he should pay the CRA recognizing the
directors’ liability, should he pay the employees, again recognizing potential
directors’ liability and the harm the workers would suffer if he did not, or
should he pay the Worker’s Compensation Board again recognizing directors’
liability, or should he make loan payments recognizing the Halls could possibly
lose their home if he did not. He opted against paying the CRA on a timely
basis, though the Company did make significant payments of $165,000 from
September 2004 to April 2007 to North Central Bailiffs Ltd., the bailiff
attempting to collect on writs issued pursuant to Federal Court certificates. I
will discuss this in greater detail shortly.
[5]
Throughout 2004 and 2005, Mr. Hall was in
regular communication with the CRA. The CRA actually would freeze the Company’s
account and upon receiving a form of release from the Halls would unfreeze the
account. One of the terms of the form of release that the CRA required the
Halls, as directors, to sign was:
I personally
undertake not to use or rely on the fact of the agreement as an argument or
grounds for defence in proceedings resulting from the application of the
provisions of section 227.1 of the Income Tax Act.
[6]
The Halls provided this type of agreement to the
CRA in January 2003 and again in February 2004. In the interim, the Company’s
debt to the CRA for source deductions had increased not decreased. I find that
the ongoing dialogue between Mr. Hall and the CRA was after default of payment,
dealing with terms of repayment, not how to prevent future default. Whatever
the arrangement with the CRA it was clearly not working.
[7]
Corporate assessments were issued on March 15, 2005
as follows:
[8]
Returning to the payments of $165,000 made by
the Company to the bailiffs, it is not as clear as it might be where those
payments went. Mr. Hall does not know. The two CRA collections officers who
testified presumed such amounts were received and attributed to a GST debt the
Company had accumulated. One collections officer, Mr. Devauld, swore in an
affidavit that no amounts were received by the CRA from the bailiffs with
respect to the Company’s payroll account between January 1, 2004 and December
31, 2008, yet goes on to state that during that time the Company’s payroll
account was credited with the following payments:
(a)
on August 1, 2007, $16,689.87 was transferred
from the GST account of Petco Holdings;
(b)
on August 1, 2007, $2,654.60 was received
pursuant to a Requirement to Pay issued to Vernon Business Service;
(c)
on August 31, 2007, $14,000 was transferred from
the GST account of Petco Holdings;
(d)
on November 26, 2007, $2,180.00 was transferred
from the GST account of Petco Holdings Inc.; and
(e)
on March 31, 2008, $9,072.00 was received
pursuant to a Requirement to Pay;
(f)
on July 29, 2008, $1,188.59 was received
pursuant to a Requirement to Pay;
(g)
on August 8,2008, $1,158.94 was received
pursuant to a Requirement to Pay;
(h)
on August 12, 2008, $1,317.03 was received
pursuant to a Requirement to Pay;
(i)
on September 18, 2008, $1,991.45 was transferred
from the GST account of Petco Holdings;
(j)
on September 24, 2008, $1,693.49 was received
pursuant to a Requirement to Pay;
(k)
on December 9, 2008, $1,004.92 was paid by Petco
Holdings to the Canada Revenue Agency.
This totals
approximately $53,000. It is noteworthy that the first payment represents funds
transferred from the Company’s GST account, over $32,000 in total being
transferred from the GST account.
[9]
Mr. Devauld’s affidavit also states:
6. The Director’s liability assessments in these matters, in
the amount of $107,064.31, are based upon Writ ITA-13652-05, issued on
December 29, 2005, and includes the following amounts:
(a) amounts assessed to Petco Holdings Inc. for the period of
January 1 to December 31, 2004, including:
i. federal tax of $31,669.86;
ii. provincial tax of $12,034.40;
iii. Canada Pension Plan contributions of
$11,275.82;
iv. Employment Insurance premiums of $4,373.25;
v. penalties totalling $5,480.34; and
vi. interest totalling $1,943.14;
(b) amounts assessed to Petco Holdings Inc. for the periods
of January, February, July, August and September 2005, including:
i. federal tax of $1,911.13;
ii. provincial tax of $726.22;
iii. Canada Pension Plan contributions of
$1,743.32;
iv. Employment Insurance premiums of $960.93;
v. penalties totalling $484.16; and
vi. interest totalling $21.00; and
(c) additional interest of $34,440.74 accrued between
November 30, 2005 and September 12, 2011.
[10]
What is not clear to me is what payroll account
was credited with $53,000 if not the amounts owing in 2004 and 2005.
[11]
The Federal Court of Canada issued a certificate
and writ with respect to the Act file 13652-05 on December 29, 2005 and
February 22, 2006, respectively, in the amount of $72,623.57. The writ has a
note from the bailiff dated September 15, 2008 indicating “no further exigible goods”. There were, according to
the collections officers, other certificates and writs which one officer
suggested made it difficult to track all the payments received, whether or not
through the bailiff, as to which account of the Company they were attributed. There
was an earlier writ ITA-7393-06 dated June 21, 2001 for $44,668 and a writ
ITA-4870-04 for outstanding payroll amount of $123,886 dated March 30, 2004. In
an affidavit from Mr. Chris Johansen, a technical advisor in
collections with the CRA, he states:
9. the payroll account payments made by or on behalf of the
Appellant during 2007 and 2008 totaled $47,294.88 paid, as per Schedule A, but
I cannot determine which Writ they were applied against.
10. On June 5, 2012 a CRA write-down of the Petco Holdings
Inc. payroll was processed:
ACCOUNT BALANCE: $332,401.85
WRITE DOWN AMOUNT: $225,337.54
BALANCE COLLECTIBLE: $107,064.31
YEAR(S): 2001/2002/2003/2004/2005/2006/2007/2008
Mr. Hall was clearly
frustrated by the fuzziness surrounding this accountability.
[12]
After a seizure of assets in May 2007 the
business was effectively closed. It appears it was a year, however, before the
bailiff submitted remaining proceeds to the CRA and returned the writ
unsatisfied.
[13]
In June 2009, the Halls were advised by their
lawyer that the Company would be dissolved within a month. A notice of
commencement of dissolution from the British Columbia Corporate Registry on
June 2, 2009 indicates the Company is in the throes of dissolution.
Specifically, the notice states:
If, within one
month after the date of this notice, the company fails to file all outstanding
annual reports, a notice may be published on the Queen’s Printer Web site www.qplegaleze.ca.
This notice will state that, at any time after the expiration of one month
after the date of publication of the notice, the company will be dissolved,
unless cause is shown to the contrary or a copy of an entered court order to the
contrary is filed.
…
If you fail to
file the annual reports or to request a delay in dissolution, and your company
is dissolved under section 422, section 347 of the Act states the liability of
every director, officer, liquidator and shareholder of a company that is
dissolved continues and may be enforced as if the company has not been
dissolved.
[14]
The Company was not, however, struck until
September 14, 2009. The personal assessment against the Halls, as directors,
was brought on September 12, 2011.
Analysis
[15]
Are the Halls liable as directors pursuant to
section 227.1 of the Act parts of which read:
227.1(1) Where a corporation has failed to deduct or
withhold an amount as required by subsection 135(3) or 135.1(7) or section 153
or 215, has failed to remit such an amount or has failed to pay an amount of
tax for a taxation year as required under Part VII or VIII, the directors of
the corporation at the time the corporation was required to deduct, withhold,
remit or pay the amount are jointly and severally, or solidarily, liable,
together with the corporation, to pay that amount and any interest or penalties
relating to it.
(2) A
director is not liable under subsection 227.1(1), unless
(a) a certificate for the amount of the corporation’s
liability referred to in that subsection has been registered in the Federal
Court under section 223 and execution for that amount has been returned
unsatisfied in whole or in part;
(b) the corporation has commenced liquidation or dissolution
proceedings or has been dissolved and a claim for the amount of the
corporation’s liability referred to in that subsection has been proved within
six months after the earlier of the date of commencement of the proceedings and
the date of dissolution; or
(c) the corporation has made an assignment or a bankruptcy
order has been made against it under the Bankruptcy and Insolvency Act and a
claim for the amount of the corporation’s liability referred to in that
subsection has been proved within six months after the date of the assignment
or bankruptcy order.
(3) A director is not liable for a failure under
subsection 227.1(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.
(4) No action or proceedings to recover any amount payable by
a director of a corporation under subsection 227.1(1) shall be commenced more
than two years after the director last ceased to be a director of that
corporation.
[16]
I will deal first with Mr. Hall’s concern that
the Federal Court of Canada’s certificate of December 29, 2005 is incorrect.
His basis for this assertion is that he has never been provided with a detailed
accounting as to what payments were applied to which writs, both GST and income
tax. Indeed, he claims to have no information that the monies paid to Northern
Central Bailiffs Ltd. ($165,000) were ever even received by the CRA. Mr. Hall
is claiming that there is a possibility monies may have or should have been
applied to the income tax withholding deficiency, significantly decreasing the
outstanding amount of $72,623. Notwithstanding some lack of clarity from the
CRA, there is no doubt considerable amounts were owed by Petco, considerable
amounts were collected, yet considerable amounts remained unpaid. While Mr.
Hall raises the possibility of funds collected by the bailiff should have gone
to reduce the payroll amount for which he is now personally liable, I have no
convincing evidence upon which to conclude the account has not properly been
credited by the CRA. The Minister’s assumptions as to the amount owing under
writ ITA-13652-05 have not been demolished.
[17]
Mr. Hall’s second argument is that he and Mrs.
Hall resigned prior to September 14, 2009, the formal date of dissolution of
the Company in British Columbia. Mr. Hall argues that he and Mrs. Hall
should not be held to be directors during the period from July to September
2009 simply because the British Columbia Corporation Registry
administration did not move as expediently as anticipated it should have. Mr.
Hall implicitly asked the following – does a directorship end only on the
formal date of dissolution? Does the Company’s existence depend on a
registration that is in the throes of dissolution? Can the end of the one-month
period referred to in the notice be considered the end of the directorships?
[18]
While these were all thoughtful concerns
presented by Mr. Hall, the British Columbia Corporate Act in section 422
is explicit that the date of dissolution is the “date
and time recorded in the corporate register as the date and time of dissolution”.
That date was September 14, 2009. There is no basis for me to find otherwise. The
personal assessments were brought on a timely basis.
[19]
I turn now to the due diligence defence found in
subsection 227.1(3) of the Act.
[20]
Considerable case law has arisen in connection
with the due diligence defence. There used to be a subjective/objective
approach to determining the reasonableness of a director’s due diligence
efforts. More recently the law has evolved to simply an objective standard that
was explained in the Federal Court of Appeal decision of Buckingham v The
Queen
as follows:
37. Consequently, I conclude that the standard of care, skill
and diligence required under subsection 227.1(3) of the Income Tax Act and
subsection 323(3) of the Excise Tax Act is an objective standard as set out by
the Supreme Court of Canada in Peoples Department Stores.
…
52. Parliament did not require that directors be subject to an
absolute liability for the remittances of their corporations. Consequently,
Parliament has accepted that a corporation may, in certain circumstances, fail
to effect remittances without its directors incurring liability. What is
required is that the directors establish that they were specifically concerned
with the tax remittances and that they exercised their duty of care, diligence
and skill with a view to preventing a failure by the corporation to remit the
concerned amounts.
…
56. A director of a corporation cannot justify a defence under
the terms of subsection 227.1(3) of the Income Tax Act where he condones the
continued operation of the corporation by diverting employee source deductions
to other purposes. The entire scheme of section 227.1 of the Income Tax Act,
read as a whole, is precisely designed to avoid such situations. In this case,
though the respondent had a reasonable (but erroneous) expectation that the
sale of the online course development division could result in a large payment
which could be used to satisfy creditors, he consciously transferred part of
the risks associated with this transaction to the Crown by continuing
operations knowing that employee source deductions would not be remitted. This
is precisely the mischief which subsection 227.1 of the Income Tax Act seeks to
avoid.
57. Once the trial judge found as a matter of fact that the
respondent’s efforts after February 2003 were no longer directed towards the
avoidance of failures to remit, no successful defence under either subsection
227.1(3) of the Income Tax Act or subsection 323(3) of the Excise Tax Act could
be sustained.
[21]
Mr. Hall argued he should not be saddled with
this new more stringent test but that the objective/subjective test prior to Buckingham
is what should govern his case, given that was the law in 2004 and 2005. I do
not accept this proposition. Common law tests evolve. In any event, I do not
believe reliance on an earlier enunciation of the test would assist Mr. Hall.
[22]
Have the Halls, as directors, simply condoned
the continued operation of the Company by diverting source deductions to other
purposes? I find they have. Where it is clear, as here, that it is the director
himself, in Mr. Hall’s case, who made the decision to pay other creditors
rather than remit the source deduction funds to the CRA, it is difficult to see
exactly what steps such a director could have taken to meet the due diligence
standard. This is not a situation of a director playing only the role of
director, but the director is also the manager – the decision-maker. There are
several examples of what the non-manager/director might do when cash flow is a
problem and remittances are at issue:
-
instruct management to actively seek funding;
-
instruct management to establish separate
accounts;
-
instruct management to trim expenses;
-
instruct management to lay-off employees;
-
obtain financial advice or assistance;
-
fire the financial officer or CEO;
-
devise a new business plan;
-
approach the CRA before default.
These all
presuppose that the directors have some ability to act, unlike in a situation
such as in the case of Worrell v Canada
where it was found the bank had control over such decisions.
[23]
What can the director, who is also charged as
manager with deciding who to pay when cash flow is a problem, do? This is more
problematic. I do not intend to revert to any active versus passive director
distinction as far as the test or standard to be met. The objective standard of
how the reasonable director exercises his or her duty of care, diligence and
skill is the same. But, it is simply an uncomfortable reality for the managing
director that options are more limited: for example, it is unrealistic to
expect such a director to fire himself.
[24]
Mr. Hall did seek other financing through
personal loans and did cut back wages to himself and Mrs. Hall, but ultimately
still opted to pay others to keep the business afloat. Also, those actions were
instituted with a view to repay already failed remittances. So, obviously,
these efforts did not prevent the failure. Are they sufficient to have met the
duty of care, diligence and skill? What would the reasonable director have done
differently? With the greatest respect to Mr. Hall, who struck me as an
individual of integrity, who cooperated fully and helpfully after the defaults
to see the CRA paid, and whose world has since collapsed around him, the
reasonable director would have considered shutting the door and stopping the
bleeding, or hiring new management. This is in hindsight easy to say and,
perhaps getting to my earlier point, easier for the non-managing director to
do.
[25]
Justice Boyle in the case of Deakin v The
Queen
dealt with a similar situation and his comments are noteworthy in that regard:
22. Based upon the facts of this case, nothing was done to
prevent the failures to remit. The Deakins made informed and considered
decisions to use the source deductions and GST in part to pay its suppliers and
employees and only remitted a portion to CRA. The many earnest efforts of the
Deakins to address the arrears cannot help in this case to establish a due
diligence defence. For this reason, the appeals must be dismissed except to the
extent of the concession made by the Crown at trial in respect of the dividend
received from the bankrupt estate of Deatech in the amount of $23,316.99 which
reduced the income tax source deduction arrears.
23. Given the specific wording of the subsections and the
Federal Court of Appeal’s comments in Buckingham, it appears somewhat difficult
to imagine circumstances in which an informed and active owner-manager and
director of a corporation will not be liable for unremitted employee source
deductions and unremitted GST amounts. As mentioned above, the scope of the
Worrell exception post-Buckingham remains to be developed in other cases than
the Deakins’.
24. Source deductions and GST remittances are required by law
to be made by a business corporation. These are not the corporation’s own
funds. The corporation has collected them from its employees and customers.
Those employees and customers are given credit for these amounts once withheld
and collected, even when not remitted. When owner-managers and directors decide
to use these funds to keep their business afloat and support their investments,
they are making all Canadian taxpayers invest involuntarily in a business and
investment in which they have no upside. In doing so, shareholders and
corporate decision-makers are investing or gambling with other people’s money.
Directors should be aware of that when they cause or permit this to happen. The
directors’ liability provisions of the legislation should be regarded by
business persons as somewhat similar to a form of personal guarantee by the
directors that can expose them to comparable liability for the amount involved.
It is they who are deciding to invest the funds in their own business, for
their own gain, not the government or people of Canada. They are doing so
contrary to clear law and it appears appropriate as a policy matter that
Parliament has legislated clearly that they will generally be responsible for
such decisions and the loss resulting from them. In essence, if a corporation
and its directors choose to unilaterally “borrow” from Canadian taxpayers and
the public purse, Canadians get the benefit of security akin to personal
guarantees of the directors.
[26]
While the Federal Court of Appeal has stated in Buckingham
that “Parliament did not require that directors be
subject to an absolute liability”, if a director is the very person who
ultimately makes the decision to not make remittances to the Government, in
favour of paying other creditors, it is difficult to perceive of an available
due diligence defence. Such a director is assuming a personal liability.
[27]
Does a director, such as Mrs. Hall, who
apparently followed Mr. Hall’s instructions escape liability? It is for Mrs.
Hall to prove that she acted reasonably to prevent the failure. She knew the
Company was in financial straits and, effectively, let Mr. Hall take the lead.
This is not sufficient to escape liability.
[28]
The Appeals are dismissed.
Signed at Ottawa, Canada,
this 13th day of October 2015.
“Campbell J. Miller”
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