Date: 200103026
Docket: A-154-00
Neutral citation: 2001 FCA 84
CORAM: NOËL J.A.
EVANS J.A.
SHARLOW J.A.
BETWEEN:
GORDON E. SMITH
Applicant
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
SHARLOW J.A.
Gordon E. Smith has been assessed under subsection 227.1(1) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) and subsection 323(1) of the Excise Tax Act, R.S.C. 1985, c. E-15 for amounts owed by a corporation of which he was a director. He appealed the assessments to the Tax Court of Canada under the informal procedure on a number of grounds, including the due diligence defence. His appeal was dismissed on February 9, 2000 (reported as Smith v. Her Majesty the Queen, 2000 D.T.C. 1888, [2000] 2 C.T.C. 2494, 2000 G.T.C. 758, [2000] G.S.T.C. 12, 16 C.B.R. (4th) 289). Mr. Smith now seeks judicial review of the Tax Court decision.
Mr. Smith did not include a transcript of the Tax Court proceedings in the application record. He indicated that the transcript was "unavailable". It appears that he asked for a transcript and was told by a Tax Court official that the Tax Court did not have one. As a self-represented litigant who is not a lawyer, Mr. Smith apparently was unaware that if the proceedings had been recorded, as they apparently were in this case, he could have ordered a transcript himself and taken steps to have the transcript included in the application record. Instead, Mr. Smith included in his application record an affidavit in which he made certain assertions about the oral evidence given at trial.
Counsel for the Crown did not cross-examine Mr. Smith on his affidavit. Nor did she produce a transcript of the proceedings or include in the respondent's record an affidavit that contradicted Mr. Smith's version of the facts. In these circumstances, I am inclined to accept Mr. Smith's assertions about the oral evidence that was before the Tax Court Judge. I also note that many of the statements in Mr. Smith's affidavit are legal arguments that should have been in the memorandum of argument rather than the affidavit, and I have treated them accordingly.
I turn now to the merits of this application. The assessments challenged by Mr. Smith were issued under subsection 227.1(1) of the Income Tax Act and subsection 323(1) of the Excise Tax Act, which read as follows:
| Income Tax Act
R.S.C. 1985 c. 1 (5th Supp.)
227.1(1) Where a corporation has failed to deduct or withhold an amount as required by subsection 135(3) 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 liable, together with the corporation, to pay that amount and any interest or penalties relating thereto.
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Loi de l'impôt sur le revenue
L.R.C. 1985 ch. 1 (5e suppl.)
227.1(1) Lorsqu'une société a omis de déduire ou de retenir une somme, tel que prévu au paragraphe 135(3) ou à l'article 153 ou 215, ou a omis de remettre cette somme ou a omis de payer un montant d'impôt en vertu de la partie VII ou VIII pour une année d'imposition, les administrateurs de la société, au moment où celle-ci était tenue de déduire, de retenir, de verser ou de payer la somme, sont solidairement responsables, avec la société, du paiement de cette somme, y compris les intérêts et les pénalités s'y rapportant.
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| Excise Tax Act
R.S.C. 1985, c. E-15
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.
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Loi sur la taxe d'accise
L.R.C. 1985, ch. E-15
323(1) Les administrateurs de la personne morale au moment où elle était tenue de verser une taxe nette comme l'exigent les paragraphes 228(2) ou (2.3), sont, en cas de défaut par la personne morale, solidairement tenus, avec cette dernière, de payer cette taxe ainsi que les intérêts et pénalités y afférents.
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Mr. Smith has raised a number of issues, but it is necessary to consider only one. That is whether he met the due diligence test in subsection 227.1(3) of the Income Tax Act and subsection 323(3) of the Excise Tax Act. Those provisions read as follows:
| Income Tax Act
R.S.C. 1985 c. 1 (5th Supp.)
227.1(3) A director 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.
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Loi de l'impôt sur le revenue
L.R.C. 1985 ch. 1 (5e suppl.)
227.1(3) Un administrateur n'est pas responsable de l'omission visé e au paragraphe (1) lorsqu'il a agi avec le degré de soin, de diligence et d'habileté pour prévenir le manquement qu'une personne raisonnablement prudente aurait exercé dans des circonstances comparables.
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| Excise Tax Act
R.S.C. 1985, c. E-15
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.
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Loi sur la taxe d'accise
L.R.C. 1985, ch. E-15
323(3) L'administrateur n'encourt pas de responsabilité s'il a agi avec autant de soin, de diligence et de compétence pour prévenir le manquement visé au paragraphe (1) que ne l'aurait fait une personne raisonnablement prudente dans les mêmes circonstances.
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The directors' liability provisions were enacted to strengthen the Crown's ability to enforce the statutory obligation imposed on certain taxpayers to remit taxes payable by other parties, such as tax withheld at source from wages paid to employees, and net GST collected from customers. Normally, the Crown's remedies against a corporation that fails to remit these third party taxes would be limited to the corporation's assets. That is a necessary incident of separate corporate personality. However, it was perceived that a corporation, particularly a corporation in financial difficulty, might prefer to default on its obligation to remit taxes, in order to satisfy creditors whose claims were more immediately pressing. It was apparently thought necessary to enact legislation that would deter corporations from making such a choice.
Consequently, subsection 227.1(1) of the Income Tax Act and subsection 323(1) of the Excise Tax Act were enacted to impose liability, subject to certain conditions, on the directors of a corporation that had failed to remit tax collected from others: Soper v. Canada, [1998] 1 F.C. 124, 215 N.R. 372, 149 D.L.R. (4th) 297, [1997] 3 C.T.C. 242, 97 D.T.C. 5407 (F.C.A.). This is based on the presumption that a decision by a corporation to default on its remittance obligations would originate with the directors: Kalef v. Canada (1996), 194 N.R. 39, 39 C.B.R. (3d) 1, [1996] 2 C.T.C. 1, 96 D.T.C. 6132 (F.C.A.).
The obligations of corporate directors under these provisions are subject to a number of statutory preconditions (subsection 227.1(2) of the Income Tax Act and subsection 323(2) of the Excise Tax Act) that are not in issue in this case. In addition, a director may have recourse to the statutory due diligence defence in subsection 227.1(3) of the Income Tax Act and subsection 323(2) of the Excise Tax Act.
The Soper decision, supra, established that the standard of care described in the statutory due diligence defence is substantially the same as the common law standard of care in Re City Equitable Fire Insurance Co., [1925] Ch. 407 (Eng. C.A.). It follows that what may reasonably be expected of a director for the purposes of subsection 227.1(1) of the Income Tax Act and subsection 323(1) of the Excise Tax Act depends upon the facts of the case, and has both an objective and a subjective aspect.
The subjective aspect of the standard of care applicable to a particular director will depend on the director's personal attributes, including knowledge and experience. Generally, a person who is experienced in business and financial matters is likely to be held to a higher standard than a person with no business acumen or experience whose presence on the board of directors reflects nothing more, for example, than a family connection. However, the due diligence defence probably will not assist a director who is oblivious to the statutory obligations of directors, or who ignores a problem that was apparent to the director or should have been apparent to a reasonably prudent person in comparable circumstances (Hanson v. Canada (2000) 260 N.R. 79, [2000] 4 C.T.C. 215, 2000 D.T.C. 6564 (F.C.A.)).
In assessing the objective reasonableness of the conduct of a director, the factors to be taken into account may include the size, nature and complexity of the business carried on by the corporation, and its customs and practices. The larger and more complex the business, the more reasonable it may be for directors to allocate responsibilities among themselves, or to leave certain matters to corporate staff and outside advisers, and to rely on them.
The inherent flexibility of the due diligence defence may result in a situation where a higher standard of care is imposed on some directors of a corporation than on others. For example, it may be appropriate to impose a higher standard on an "inside director" (for example, a director with a practice of hands-on management) than an "outside director" (such as a director who has only superficial knowledge of and involvement in the affairs of the corporation).
That is particularly so if it is established that the outside director reasonably relied on assurances from the inside directors that the corporation's tax remittance obligations were being met. See, for example, Cadrin v. Canada (1998), 240 N.R. 354, [1999] 3 C.T.C. 366, 99 D.T.C. 5079 (F.C.A.).
In certain circumstances, the fact that a corporation is in financial difficulty, and thus may be subject to a greater risk of default in tax remittances than other corporations, may be a factor that raises the standard of care. For example, a director who is aware of the corporation's financial difficulty and who deliberately decides to finance the corporation's operations with unremitted source deductions may be unable to rely on the due diligence defence (Ruffo v. Canada, 2000 D.T.C. 6317 (F.C.A.)). In every case, however, it is important to bear in mind that the standard is reasonableness, not perfection.
Against this statutory background, it is necessary to summarize the facts of this case and to consider how the Tax Court Judge applied the relevant principles.
Mr. Smith was a director of ECO Superwood (B.C.) Ltd. (ECO) from February of 1993 until at least October 31, 1995. It is not clear when he ceased to be a director, but nothing turns on that termination date.
The Crown asserts that between November 1, 1993 and October 31, 1995, ECO became liable for unremitted employee source deductions and unremitted net GST. On that basis, Mr. Smith was assessed under subsection 227.1(1) of the Income Tax Act and subsection 323(1) of the Excise Tax Act for a total of $27,385.12, consisting of unremitted employee source deductions of $7,036.15 for October, 1995, plus $6.00 interest, and unremitted net GST of $17,569.05 for the period November 1, 1993 to October 31, 1995, plus $1,434.14 interest and $1,339.78 in penalties.
In February of 1993, when Mr. Smith first became a director of ECO, he was a high school teacher with a Master of Arts degree. He retired from his teaching career in June of 1995. He had no business training and no business experience before the events that led to this appeal. Mr. Smith was a minority shareholder of ECO, having invested approximately $10,000. He made the investment because he felt that ECO had a good and useful product.
By 1993, ECO had faced some business difficulties that led to discord between the majority and minority shareholders. Mr. Smith was aware of that and was also aware that the
ECO was experiencing financial difficulties. He was elected to the board of directors in order to act as a liaison between the two groups and to try to restore harmony. In his role as director, he was not expected to participate in the day to day operations of ECO, nor was he expected to understand the details of its financial affairs.
At the outset, Mr. Smith sought legal advice about the legal duties of directors, and was generally aware of his obligation to exercise reasonable care and skill. He also learned about his obligations to ensure that ECO fulfilled its obligation to remit source deductions. At the first board meeting after his appointment, April 6, 1993, he proposed a motion that priority be given to the payment of Revenue Canada accounts. That motion was approved.
There is evidence that the directors were presented with reports at every meeting which led Mr. Smith to believe that the Revenue Canada remittances were not in default. The Crown appears to have accepted this, at least in so far as the obligations of ECO to pay net GST prior to June of 1995 were concerned. In summarizing the Crown's arguments, the Tax Court Judge says at paragraph 59:
The Appellant [Mr. Smith] knew from the start that there were difficulties existing in the Company and that it was behind in source deductions. He may not have known that the Company was behind in GST remittances until June of 1995.
For the period ending in June of 1995, Mr. Smith was not assessed for unremitted source deductions, but he was assessed for unremitted GST even though he had no knowledge of ECO's failure to remit GST.
The Tax Court Judge found that Mr. Smith was an "inside director" at the time of his election. As I read his reasons for decision, he based that conclusion on the following facts (paragraphs 123 and 124):
He [Mr. Smith] was an educated man possessing a Master of Arts Degree, although he was not in business and in spite of the fact that until the time he became associated with the Company he was unfamiliar with such business affairs. This is not a case where the Appellant was unaware of his position nor did he become a director reluctantly (even though he did indicate that he may have been pushed into it) and the actions that he took in allowing himself to be appointed as a director showed that he became so deliberately.
Before he became a director he inquired of the legal duties of a director from a lawyer. He checked the provisions regarding a director's responsibility in the statute. He admitted himself that when he became a director in February of 1993 he was aware of the financial difficulties facing the Company. When he attended the first meeting of the Board of Directors he asked about the duties and responsibilities of a director and was authorized to consult the Company's lawyer about it. He was aware of the fact that a director had at least "to act at all times with the care, diligence and skill expected of a competent person in the circumstances."
In my respectful view, the Tax Court Judge appears to have misdirected himself when he determined that Mr. Smith was an "inside director" at the time of his appointment because of his education, his willingness to act as a director, and his efforts to understand his obligations. Generally, for purposes of the due diligence defence, "inside directors" are those who are "involved in the day-to-day management of the company and who influence the conduct of its business affairs" (Soper, supra, paragraph 43). Those words simply do not describe the role of Mr. Smith when he first became a director. The facts that are relevant to the determination of whether a person is an "inside director" relate to the tasks that the person undertakes as a director and the degree of the person's involvement in the business of the corporation.
This error in the characterization of Mr. Smith's initial role as a director seems to have led the Tax Court Judge to err further by imposing a standard of care that was too high. Contrary to the conclusion of the Tax Court Judge, it seems to me that as an outside director, it was reasonable for Mr. Smith to do exactly what he did, which was to propose a motion to keep the Revenue Canada accounts current, and thereafter to rely on the inside directors and officers of the company to ensure that those instructions were followed.
The Tax Court Judge suggested that Mr. Smith should have done more. He should have sought more reports from corporate officials, asked more questions about actual balances and payments, or even had himself appointed as signing authority and monitored the payments himself. In my view, those are not steps that could reasonably have been expected of Mr. Smith, given his limited role as a director and the circumstances in which he took on that role. I conclude, therefore, that the due diligence defence is made out for the period up to and including June of 1995.
The situation changed in June of 1995, when Mr. Smith's role in the affairs of ECO changed from that of an outside director to that of an inside director. At that time, ECO was in serious financial decline and Mr. Smith attempted to assist in various attempts to keep it afloat and for that purpose became more active in the affairs of ECO. His more extensive involvement in the financial affairs of the corporation made him an inside director of ECO after June of 1995. He remained so at least until the end of October 1995 when the affairs of ECO were taken over by a receiver. He has not been assessed for any obligation that arose after that time.
It is clear from the evidence that by June of 1995 the corporation's financial resources were so depleted that there was little that could have been done to meet its remittance obligations. Despite the difficulties, however, Mr. Smith was not idle. In fact, the corporation's remittance obligations with respect to employee source deductions were met, except for the month of October. There also remained outstanding some unremitted GST for the period from June to October, 1995.
During that period Mr. Smith spent considerable effort in trying to ascertain the amount of the corporation's liabilities, and thought that he had done so, having relied on corporate officers and also on information that he received from Revenue Canada. As it turned out, that information was not accurate, but Mr. Smith cannot have been expected to know that. Given his limited experience in tax and business affairs, it was reasonable for him to accept that the information given to him was reliable.
He also learned that the corporation was about to receive a federal government research grant in an amount that, as best he could determine, would have been sufficient to cover the corporation's obligations. He went to great lengths to attempt to ensure that the grant would be applied against the corporation's obligations. That did not happen, but there is nothing in the record to suggest that Mr. Smith was to blame for that. If there were difficulties within the various government departments that made it difficult or impossible to accede to Mr. Smith's request for the grant to be used to pay the corporation's obligations, that is not apparent from the record.
The Tax Court Judge appears to have recognized the efforts made by Mr. Smith in and after June of 1995, but he noted, at paragraph 138:
The actions that he took did not have the effect of ensuring that Revenue Canada received any of the monies here.
and, at paragraph 142:
The Court is satisfied that the actions taken by the Appellant did nothing to prevent the failure.
It appears to me that these comments reveal another error in the Tax Court Judge's application of the due diligence defence. A director is required only to act reasonably in the circumstances. The fact that his efforts are unsuccessful does not establish that he has failed to act reasonably.
For these reasons, I would allow this application for judicial review with costs. The decision of the Tax Court Judge should be quashed and the matter referred back to the Tax Court with a direction that Mr. Smith's appeal be allowed and the assessments vacated.
Karen R. Sharlow
J.A.
"I agree
Marc Noël J.A."
"I agree
John M. Evans J.A."
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