Leonard J. Herbach v. Minister of National Revenue, [1990] 1 CTC 2508, 90 DTC 1354

Brulé T.C.J.:—This hearing involves an appeal from an assessment by the Minister dated August 8, 1988 in which is claimed the sum of $6,144.55 pertaining to the appellant's alleged liability under subsection 227.1(1) of the Income Tax Act (the Act).

Facts

The appellant and his wife were the only directors of Investech Management Ltd. (Investech). In 1986 Investech deducted or withheld from its employees the amount of $5,995.03 for income taxes, Canada Pension contributions and Unemployment Insurance premiums as required by subsection 153(1) of the Act, and other statutory provisions. The said funds were not received by the Receiver General and accordingly the assessment referred to above was issued.

Appellant's Position

The amounts involved, are mainly for the months of November and December 1985. In November of that year financial problems in Investech became quite apparent. In December of 1985 the appellant contributed another $10,000 to the company to look after debts. He did not pay some creditors but did forward a cheque to Revenue Canada prior to December 15 for the funds withheld in November. He did the same prior to January 15, 1986 for the funds withheld in December. These cheques were issued in the normal manner by the appellant. He did not know of the bank's refusal to honour the cheques to Revenue Canada and only learned in January of 1986 that Investech had been placed in receivership. The appellant maintained that he had always remitted on time including the amounts deducted immediately prior to the receivership. As a result of his actions the appellant is of the opinion that he should not be held liable under the provision of subsection 227.1(3) of the Act which reads as follows:

(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.

Minister's Position

Counsel stressed that the appellant should have done more to relieve himself of liability when serious difficulties arose in November of 1985. He should have taken proper steps to protect the funds deducted on behalf of employees in November and December.

The Court was referred to several judgments dealing with this section of the Act but more particularly to Lucette Robitaille v. Canada, [1990] 1 C.T.C. 121; 90 D.T.C. 6059, and Douglas B. Clark and Dorothy Claire Clark v. M.N.R., [1990] 1 C.T.C. 2212; 90 D.T.C. 1094.

In the Robitaille case, supra, the Court was told, guidance was provided in interpreting subsection 227.1(3) of the Act. Such included:

(1) at page 125 (D.T.C. 6062), ”. . . when dealing with 'the degree of care, diligence and skill’ to be exercised by 'a reasonably prudent person' in 'compa- rable circumstances’, each case must necessarily depend on its particular facts,"

(2) also at page 125 (D.T.C. 6062) ”. . . the 'circumstances' referred to in subsection (3) must be those which, either directly or indirectly, would have an effect on the actions or on the inaction of the person sought to be held liable under subsection (1)", and

(3) at page 126 (D.T.C. 6063) "The term ‘diligence’, which is now codified, provides a higher objective standard than that imposed by the common law on directors generally".

In the Clark case, supra, Taylor, T.C.J. said at page 2218 (D.T.C. 1098):

In my view, to relieve a director from the liability imposed under section 227 might well be the exception, rather than the rule.

Further at page 2222 (D.T.C. 1101) the learned judge said:

In my view in order for a corporate director to escape the impact of the provisions of section 227.1(1) of the Act, he must be able to demonstrate conduct with regard to his responsibilities which permits the narrow exclusion provided under section 227.1(3) of the Act.

Taylor, T.C.J. refers in the Clark case, supra, to the fact that neither director took any identifiable new action to ensure that deductions withheld would be remitted. He adds at page 1100 that ”. . . every reasonable effort must be made both by a corporation and its directors, while deductions are being withheld, that those amounts will be remitted and paid”.

In the present case it was submitted that the appellant did not do enough to come within subsection 227.1(3).

Analysis

It seems that the appellant had always remitted the withheld deductions in time and even attempted to do so in respect to the November and December amounts. While he realized there were financial problems there was no indication that the bank would stop payment on the Revenue Canada cheques. If there was any advance warning the liability could have been discharged with the additional $10,000 he put into the bank in December.

In the Robitaille case, supra, Addy, J. said at page 126 (D.T.C. 6063):

The exercise of freedom of choice on the part of the director is essential in order to establish personal liability.

In Otto Beutler v. M.N.R., [1988] 1 C.T.C. 2414; 88 D.T.C. 1286 the Court referred to Mr. Beutler's actions at page 2418 (D.T.C. 1289) as follows:

Under cross-examination Mr. Beutler said that he knew as a director that monthly remittances were necessary to be made. These were not made, he said, because of cash flow being tight. He knew the company was using "government" funds as a loan and that he and his associate made a decision not to pay Revenue Canada.

The Clark case, supra, pointed out that the directors of the corporation decided not to remit the amounts to the Receiver General for Canada, choosing instead to use the funds to operate the company.

These are examples of freedom of choice referred to by Addy, J. This is not what happened with the appellant in the present hearing. No choice was made. The same procedure as usual was followed and the appellant had no advance notice that the cheques forwarded to Revenue Canada would not be honoured, nor did he pay suppliers first. In fact the contrary existed according to the evidence.

Looking at the guidance factors suggested in Robitaille, supra, to come within subsection 227.1(3) I find that the appellant satisfies these to a sufficient degree to allow his appeal. Also in Clark, supra, the reference to relieving a director from liability under section 227 being the exception rather than the rule seems to fit the present appeal.

In Kenneth Merson v. M.N.R., [1989] 1 C.T.C. 2074; 89 D.T.C. 22 there is found the following passage at page 2085 (D.T.C. 29):

For a person to be in a position to prevent an act or an omission that person must know or reasonably should have known, having regard to all the circumstances, that the act or omission would occur.

From all the evidence the appellant in this case did not know or believe his cheques to Revenue Canada to satisfy the provisions of section 227 would be refused. Accordingly his situation falls within subsection 227.1(3) and this appeal is allowed and will be returned to the Minister for reconsideration and reassessment. The appellant is allowed his costs.

Appeal allowed.