Bronson Short v. Minister of National Revenue, [1991] 1 CTC 2464, 91 DTC 67

Rip. T.C.j.:—Bronson Short ( Short") appeals from an assessment by the Minister of National Revenue, the respondent, notice of which was dated January 10, 1989. The assessment was issued pursuant to the liability imposed by section 227.1 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63) (the "Act"). [1] The respondent alleges Short was a director of B & R Short Construction Limited ("company") in 1986 when the company, contrary to section 153 of the Act and other legislation, failed to remit to the Receiver General of Canada (” Receiver General") federal and Province of Newfoundland income taxes, Canada Pension Plan contributions and unemployment insurance premiums purportedly deducted and withheld from employees' wages and salaries; the amounts assessed total $52,589.49.

The appellant Short acknowledges he was a director of the company throughout 1986 and that the company failed to remit the source deductions as and when required. His wife was also a director at the relevant times. He says, however, he exercised the degree of care that a reasonably prudent person would have exercised in the circumstances and therefore in accordance with subsection 227.1(3) he should not be liable for the amounts not remitted by the company.

Short has a grade 11 education. He started working in construction at age 18 with his father, at first, and then worked on his own account. His training is primarily practical although he has taken a basic accounting course at the extension division of Memorial University.

The company carried on the business of a supplier of labour to contractors in Newfoundland and Labrador. It was, in effect, a subcontractor. Except for months during the mid-winter slowdown, the company had employees. Its annual sales volume was less than $500,000. Each year since its incorporation the company had remitted payments to the Receiver General on account of federal and provincial income tax, unemployment insurance premiums and Canada Pension Plan premiums. Occasionally the payments were late.

Short admitted the company's practice for many pay periods was to pay its employees their net pay. The difference between the gross pay and net pay represented amounts that were to be remitted to the Receiver General as source deductions. However, the company frequently did not have money on hand to pay the gross wages to its employees and it relied on accounts received from contracts after the wages were paid to remit the required amounts to the Receiver General.

The appellant said the company's troubles began with a subcontract he received in 1985 to build a fishermen's service centre in Punch Bowl, Labrador. The contractor was L.D. Fahey Construction Co. ("Fahey"). Fahey's contract was with the Federal Department of Public Works C Public Works"). Work commenced in 1985 and was to continue that year as long as weather permitted. The company was to receive progress payments from Fahey every 30 days. In late 1985, Short testified, progress payments fell behind schedule. In early December the company's employees left the work site for the winter and were to return in late May or early June when the shipping season opened. In the meantime Fahey stopped making progress payments but, according to Short, was promising to pay as soon as Public Works approved the payments.

In late spring 1986 Short learned Fahey was in“ desperate shape”. He got in touch with the bonding company but it was not prepared to complete the contract; the bonding company would not honour anything, Short testified, until the contract was completed and later, until the company completed its litigation with Fahey. In mid-May 1986 the company chartered an aircraft and Short and several men went to the Punch Bowl site to complete the contract. The job was completed about June 10, 1986. The Department of Public Works was not prepared to pay the company since it was not the principal contractor. The company never received its total price on this contract. Short informed the court the company is owed approximately $54,000.

The company's cash flow was "dried up”, said Short, by the end of June 1986. It was operating on a bank overdraft with the Bank of Montreal (“bank”) in the amount of approximately $35,000. The bank took control of the company's payables. The company had been meeting its payroll since April from its line of credit. The company undertook another job but its financial situation did not improve. When Fahey was placed in receivership the bank froze the company's accounts, cancelled its line of credit and in November or early December 1986 demanded payment in full over a number of days. Short revealed the bank seized $10,000 from his personal bank account as well as money on deposit in his children's accounts. Short stated he mortgaged his property to pay the bank and sustain his family.

The company failed to make remittances to the Receiver General for the months of May, June, July, September, October, November and December 1986. Within six weeks of the first default Short received a telephone call from Revenue Canada. By mid-summer 1986 the company's receivables were going directly to the bank. Short said he acknowledged his financial problems and tried to honour his debts while at the same time trying to carry on the business. “When it looked like I could survive” in the autumn of 1986, he recalled, he wrote post-dated cheques for arrears outstanding to the Receiver General but except for one or two cheques bearing early dates, the bank did not honour later cheques since by then it had called the loan.

The company ceased its operations in December 1986. Since then, according to Short, he has been in continuous contact with Revenue Canada. Apparently Public Works has not paid all the money called for under the Fahey contract and still refuses to pay any amount to the company notwithstanding the company completed its contract, Short testified. A lawsuit by the company against Fahey is still pending.

In cross-examination Short stated he was at the Punch Bowl site for two weeks when he went there in May 1986 and left because of a subcontract the company obtained for work at the Transportation Building at Deer Lake for the government of Newfoundland. The company had eight employees working at both sites by late May 1986. The Deer Lake subcontract was “ substantially, not 100 per cent" completed by the end of 1986; the company was unable to finish the job because or its financial plight. Progress payments under the Deer Lake contract were to be every 30 days; the final payment of about $30,000 would have been made about August 21.

Short was unable to advise the Court if, when the cheques to the Receiver General for May 1986 were prepared, the company had sufficient funds on hand to honour the cheques. He replied that the company had sufficient work on hand at the time from which it could reasonably expect to receive money by June 15 to honour the cheque. He always expected his receivables "to cover" his payables.

Another subcontract was obtained in May 1986 by the company with Colt Engineering and Construction Ltd. for the construction of housing units; the contractor was Sprachman's Building Lumber Ltd. The company was to complete its work by October or November 1986 and receive progress payments while the work was performed. The company was to receive the full contract price for its services 60 to 90 days after completion in October, subject to a ten per cent holdback. Here, too, the company substantially completed its contract, said Short; however, it was not fully completed due to the company's financial situation and the company did not receive the last progress payment or the holdback. The company employed eight people to perform this contract.

Short and his wife were paid a salary by the company. When the company’s cash flow was bad, said Short, neither he nor his wife was paid even though their salaries were recorded in the books of the company; the company's ledger book reflects payment to Mr. and Mrs. Short, including withholdings for source deductions; T4 forms were issued to each of Mr. and Mrs. Short.

The company's trade payables in 1986 were to suppliers for fuel and material as well as to an accounting service. Periodic partial payments on account were made from time to time to suppliers so as to continue in business. In June 1986 Short tried to arrange a settlement with the bank but failed. He did negotiate with the bank for the payment of amounts owed to the Receiver General through the company's operating loan; this was the reason the bank honoured the first post-dated cheques.

Eventually the bills and all of the company’s suppliers, save for one, were paid off by Short; only $4,200 is still to be paid. Had the bank not” pulled the plug", Short insisted, the company could have continued to operate. Short believed the company had sufficient receivables which, if paid to it, would have been sufficient to pay all its creditors, including the Receiver General.

Two officials of Revenue Canada also testified. Albert O'Brien (O’Brien") was a collection officer with the respondent for two months from August 21, 1986. When O'Brien spoke to Short on August 21 about the company's arrears of approximately $27,000 at the time, Short confirmed to him the company had "just received payment" from the Department of Public Works which would clear up the arrears and he would make payment of arrears at the end of August. Nothing was paid at the end of August. The cheques were not sent by Short, according to O’Brien, until October 1986. They comprised post-dated cheques, including a cheque in the amount of $6,800 for August arrears. The other cheques were four post-dated cheques for $8,000 each, to be applied to May, June and July arrears. It was the first cheque, he said, which was accepted by the bank.

Ray Peckford, the other employee of Revenue Canada, reviewed the remittances made by the company. In 1985, the company made four late remittances for July, August, November and December. No payment was received for March, April and September. An assessment in respect of non-payment by the company during 1985 was issued on December 4, 1985 and the assessment was paid at the beginning of 1986.

Subsections 227.1(1) and (3) of the Act provide:

(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.

(3) A director is not liable for a failure under subsection (1) where he exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.

Short's counsel says his client exercised the degree of care, diligence and skill to prevent the company from failing to remit the source deductions to the Receiver General. Counsel suggested that in the circumstances of the case no degree of care, diligence and skill could have prevented the company's failure to remit. The company was in financial difficulty from 1985 on and during the spring of 1986, when Short realized the company was in serious difficulty, he obtained small jobs for the company in attempts to turn it around.

The company, counsel submitted, was in financial difficulty and operating from a line of credit: it paid out what its banker permitted it to pay. At the end of November 1986 and company's banker called the loans and took measures to realize on the loans.

During 1986 the company was attempting to pay its creditors by obtaining work. The bank, counsel says, was“ helping to get the company on its feet" by extending a line of credit. Post-dated cheques were issued to pay off indebted- ness. The company could do nothing to prevent the failure because it had no money with which to pay.

The company operated by means of future progress payments from contracts being paid on time to permit the company to make timely remissions of source deductions to the Receiver General. Counsel stated the only reason the company could not remit the amount of source deductions was that it " didn't have money to pay" since it was operating on a bank loan.

According to his counsel, Short had only two alternatives. Short could have tried to overcome the company's difficulties by paying creditors or he could have closed the business with the result no creditor would get paid. A reasonably prudent person in comparable circumstances would have tried to overcome the company's difficulties and cause the corporation to continue in business, he argued.

While one sympathizes with the appellant's misfortune, it is quite clear that he did nothing to prevent the failure by the company. The company's practice was to pay its employees their net salaries and rely on future receipts to remit amounts that ought to have been deducted from wages. The company was playing with fire; there was always a reasonable probability that sooner or later anticipated revenue may not be received and no money would be available to remit. Short knew that the company was in violation of section 153 since the company's practice was not to deduct or withhold amounts as required. The company would simply pay net wages out of money available to it, hoping to have money available from its operation to remit when required. There was no system to operate within the company that was tried and tested and had been shown not likely to fail: Merson v. M.N.R., [1989] 1 C.T.C. 2074; 89 D.T.C. 22. When anticipated progress payments failed to be made the company had to rely on bank loans to pay its creditors. [2]

Short did make arrangements with the bank for the Receiver General to be paid as and when required, as well as arrears, out of the company's line of credit. But whether the Receiver General would continue to receive payments depended on the financial well-being of the company and willingness of the bank. The failure of the company to remit was not due to the bank cancelling its line of credit but was due to the company not having sufficient funds to pay gross wages to its employees from which it could deduct and withhold taxes and other statutory payments. I accept O'Brien's evidence that Short advised him that he was soon to receive $30,000 from the Department of Public Works and would pay his debt to the respondent. However, it appears he applied the $30,000 to paying suppliers to the detriment of the respondent. The facts in Fancy v. M.N.R., [1988] 2 C.T.C. 2256; 88 D.T.C. 1641 are not similar to the appeal at bar.

For Short to have complied with subsection 227.1(3) need not have entailed the cessation of the company's operations. However, as Taylor, T.C.J. stated in Clark (D.) v. M.N.R., [1990] 1 C.T.C. 2212; 90 D.T.C. 1094 at 2219 (D.T.C. 1099) ”. . . to continue an operation under circumstances which leaves little or no hope of making up that month's default, and runs the risk of additional liability, would . . . leave the director personally liable. . .". I appreciate Short wished to cause the company to honour debts and may have believed that to continue the company in business would assist this. But the fact is that each week the company continued to operate, its indebtedness to the Receiver General increased. There was no scintilla of evidence that the company's business during the summer and fall of 1986 was viable. To continue to operate such a business in the circumstances was not reasonable. The appellant's counsel raised two other issues: firstly, that since Revenue Canada assessed only Short and not Mrs. Short, the other director of the company, the respondent has discriminated against Short contrary to subsection 15(1) of the Canadian Charter of Rights and Freedoms (Charter") and secondly, that the Parliament of Canada does not have jurisdiction to pierce the corporate veil to collect tax from a director.

The discrimination complained of by the appellant is that only one director has been assessed for the company's failure to remit. Subsection 15(1) of the Charter reads:

Every individual is equal before and under the law and has the right to the equal protection and equal benefit of the law without discrimination and, in particular, without discrimination based on race, national or ethnic origin, colour, religion, sex, age or mental or physical disability.

There has been no discrimination against the appellant within the meaning of subsection 15(1). Section 227.1 of the Act does not distinguish between persons; any director is liable in the event a corporation fails to remit source deductions. That the taxing authority assesses the director from who it was most likely to collect is a business decision, not based on discrimination based on a person's race, ethnic origin, colour, sex, age or mental or physical ability. See Mcintyre, J.'s comments in Andrews v. Law Society of British Columbia, [1989] 1 S.C.R. 143; [1989] 2 W.W.R. 289 at 174 as well as Turpin v. The Queen and A.-G. of Canada, [1989] 1 S.C.R. 1296 and Reference re Workers’ Compensation Act, 1983 (Nfld.), ss. 32, 34, [1989] 2 S.C.R. 335; 44 D.L.R. (4th) 501 (S.C.C.).

With respect to the second issue, counsel for the appellant submits that subsection 227.1(1) pierces the corporate veil of a provincial corporation for the purpose of collecting a tax. A corporation at common law and statute law has limited liability; the purpose of limited liability of a corporation is to protect shareholders.

Appellant's counsel also argued that the Act infringes on the property and civil rights jurisdiction of the Province [3] since it assesses a director. He also questions the right of a federal statute to impose tax on a provincially- incorporated corporation.

As counsel for the respondent pointed out, it is the shareholders of a corporation whose liability to the corporation and its creditors is limited; section 227.1 does not attach liability to shareholders. Short has been assessed in his capacity of director. It is the directors who manage the business and affairs of the corporation [4] and as directors, individuals become liable for their actions. A section 227.1 assessment does not pierce the corporate veil.

The federal Parliament is granted power under subsection 91(3) of the Constitution Act, 1867 to raise money “by any mode or system of taxation”. This power extends to measures adopted for the collection of that tax: The Queen v. Inter-Provincial Commercial Discount Corp., [1966] C.T.C. 105; 66 D.T.C. 5107 at 109-110 (D.T.C. 5110-11). Pursuant to this power, Parliament clearly has the authority to tax provincially-incorporated companies; Bank of Toronto v. Lambe, (1887) 12 App. Cas. 575 and Caron v. The King, [1924] A.C. 999 (P.C.). A distinction exists in law between the incorporation of a company and the activities of the company. The province's jurisdiction under subsection 92(11) extends to the company's legal personality and to the regulation of its organization; the business of the company is regulated by whatever jurisdiction possesses the power under the Constitution to regulate that business.

The collection procedure embodied in section 227.1 is connected to the federal power to tax for the purpose of raising money and is a valid exercise of federal legislative power.

The appeal is dismissed.

Appeal dismissed.