Duchesne v. R., [1998] 1 CTC 2173

Archambault T.C.J.:

These are two appeals from assessments by the Minister of National Revenue (the “Minister”) dated November 23, 1992 pursuant to subsection 227.1(1) of the Income Tax Act (the “Act”). These appeals by Messrs. Duchesne and Larouche were heard on common evidence.

In his assessments, the Minister ruled that the appellants were liable for payment of the sum of $25,562.17 representing deductions at source (“DAS”) in respect of income tax, interest and a penalty owed by 2623- 8840 Québec Inc. (the “company”) for 1990. The appellants objected to the assessments, arguing as their only ground that they had exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.

Facts

The company has operated a sylvicultural business since 1989. Its two principal activities are reforestation and bush-clearing. To finance its first contract, the company took on two new shareholders, the two appellants, who invested $3,000 in its capital stock and guaranteed its line of credit. They thus joined Rémy and Clermont Tremblay, the company’s two founding shareholders and held its capital stock in equal parts. Rémy Tremblay handled the financial management and Clermont Tremblay supervised silvicultural operations. The four shareholders were also the four directors. Mr. Larouche acted as president, Mr. Duchesne as vice-president and Rémy Tremblay as secretary-treasurer.

Unlike Rémy and Clermont Tremblay, the appellants were not employees of the company. Each of the appellants operated his own business, Mr. Larouche a service station and convenience store and Mr. Duchesne a logging business that occupied him six days a week. As to Mr. Larouche, he had time to visit the company’s place of business, which was near his business, to examine the cheque stubs. The appellants admitted that they were aware of the business’s obligation to remit the DAS.

The DAS payments were made regularly, even though the company incurred a loss of $11,683 during its first year of operations. Before the end of that first fiscal year, on December 31, the appellants decided to offer their shares to new shareholders. It was Rémy Tremblay who had to find them. Negotiations were undertaken with the Centre d’aide aux entreprises des comtés de Jonquière et du Lac St-Jean Nord-Est Inc. (“CAE”), whose director was Claude Asselin.

On June 1, 1990, CAE purchased $13,674 worth of preferred shares of the company’s capital stock and lent the company $20,000. Under the finance contract, the company had to provide CAE with monthly financial statements and a list of accounts receivable and accounts payable. In addition to its right to act as an observer at meetings of voting shareholders, CAE was entitled to fees for its advice. This arrangement with CAE encouraged the appellants not only to maintain their interest in the company, but also to invest an additional of $10,000 each in it and to guarantee a $100,000 line of credit. It should be added that the appellants intervened in the finance contract with CAE.

New contracts were negotiated for the 1990 season. The first contract commenced around June 15, 1990. It was a reforestation contract for Rexfor. The company hired a large number of students for the contract. However, it encountered numerous production problems: the workers did not want to work regularly and the quality of the work suffered as a result. Furthermore, certain workers concealed trees rather than plant them. This obviously had repercussions for the payment of the amounts owed by Rexfor. In July, the directors met more often, every Sunday evening, to find a solution to these problems. Lastly, an action had to be brought against Rexfor to obtain payment.

A second contract, a bush-clearing contract for Abitibi-Price, commenced around late June 1990. Although the workers were not mainly students, disputes arose with this customer over the scope of the work performed. These production difficulties also caused cash flow problems for the company. Rémy Tremblay was unable to make all the DAS remittances that he was required to make. He decided to adopt a “trick” that an official of the Quebec Ministry of Revenue had apparently taught him: each month, he made “partial” remittances to the federal and provincial tax authorities. The following table provides particulars regarding those payments:

Rémy Tremblay had intended to pay the arrears upon receipt of accounts receivable. The arrears should normally have been fully paid before the end of the year. Rémy Tremblay sent CAE the in-house financial statements, which included the balance sheet and the list of accounts payable. Mr. As- selin was therefore able to observe that the amount of the DAS increased from month to month. He apparently expressed his displeasure to Rémy Tremblay. The latter, however, had to choose between the employees and the tax authorities. His total payroll represented about 85 per cent of his accounts payable.

Rémy Tremblay did not send the monthly in-house balance sheets to the appellants. He sent them only the income statements. The appellants were interested only in knowing whether the company was making profits or incurring losses. However, the accounting records were available to them for review, even though they did not exercise that right. Rémy Tremblay stated that he had never discussed the DAS problem with them. They had never asked him any question on the subject. Rémy Tremblay even stated that, in his 20-year career, no one had ever requested information from him on DAS arrears.

The appellants stated that they had relied totally on Rémy Tremblay, who was responsible for remitting the DAS, and on Mr. Asselin, a financial management expert. Mr. Larouche stated he had not noticed the lack of variation between the payment for May and that for June, even though he had signed most of the pay cheques and DAS remittances together with Rémy Tremblay. It should be added on his behalf that a number of those cheques could have been blank cheques signed in advance. As to Mr. Duchesne, he allegedly signed only one of the DAS remittance cheques.

Rémy Tremblay stated that the appellants had exercised no control over the accounts payable or accounts receivable. He nevertheless admitted at another point in his testimony that the appellants had discussed accounts receivable. Furthermore, Mr. Larouche stated that he had believed the students were not subject to DAS. He claimed he had learned that from Rémy Tremblay two or three years earlier.

In September 1990, the company was facing serious cash flow problems. However, the appellants stated that they did not learn that the company had DAS arrears until January or February 1991, when the annual balance sheet was filed. The company was unable to pay the Ministry the outstanding DAS balance and the latter proceeded against Rémy Tremblay, who filed for bankruptcy in 1994.

Analysis

Section 227.1 of the Act imposes a heavy obligation on the directors of a company where that company does not remit the DAS in respect of salaries paid to its employees. The purpose of this measure is to induce directors to take the necessary steps so that tax owed by employees which is deducted at source by an employer is remitted to the creditor, the government. These amounts do not belong to the employer.

This provision quite certainly does not create an obligation of warranty for the directors. Subsection 227.1(3) moreover provides a ground for exemption:

227. J(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.

Judge Bonner of this Court described this rule accurately in Cloutier v. Minister of National Revenue! when he stated:

The directors of a corporation are neither trustees for nor insurers of the Minister of National Revenue. They are required under section 227.1 to act with reasonable skill and prudence to ensure that the Minister is paid that which is owing to him.

In Stuart v. Minister of National Revenue? [2] however, Associate Chief Judge Christie of this Court recently recognized that a taxpayer may not be exempted from all liability if he abdicates his responsibilities as a director:

The significant question that arises is this: can an individual who consents to being appointed as director of a corporation escape liability under subsection 227.1 of the Act by, for all practical purposes, ignoring its existence thereafter? In my opinion the answer is no.

It strikes me that if a corporation fails to deduct and remit an amount as required by the Act and Regulations, a director of the corporation is liable to pay that amount and any interest and penalties related thereto unless he establishes that in relation to preventing the failure his conduct was that of a reasonably prudent person in the circumstances. To voluntarily abdicate the responsibilities of the office of director is not of itself conduct of that kind.

(my emphasis)

In that case, the Associate Chief Judge also approved Judge Bonner’s comment in Black v. R? [3] that a director who was indifferent to his responsibilities may not benefit from the exemption provided for in subsection 227.1(3) of the Act:

The decision of this court in Pidskalny appears to suggest that subsection 227.1(3) protects a director who failed to try to prevent a failure to remit because he had no knowledge of the rights, responsibilities and obligations of a directorship and was uninvolved with the management of the company. If that were the ratio of the decision it would be very difficult to reconcile with the language of section 227.1. Nothing in that language suggests the existence of a legislative intention to offer relief to a director who fails to act because he is ignorant of and indifferent to his responsibilities and those of his company.

(my emphasis)

The appellants in the instant case raised only the defence of reasonable diligence. The burden of proving that they exercised the degree of care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances in order to prevent the failure to comply with the Act was on their shoulders. To apply subsection 227.1(3) of the Act, one must examine the taxpayer’s conduct as a director of a company and the circumstances in which the company failed to remit the DAS. The case law recognizes that the courts must take into account the special circumstances of each person, including the degree of experience, education and skill. Judge Addy wrote as follows in Robitaille v. R. (1989), 90 D.T.C. 6059 (Fed. T.D.), at page 6063:

The term “diligence”, which is now codified, provides a higher objective standard than that imposed by the common law on directors generally. Although the test is to a large extent an objective one, the question remains, however, what a reasonably prudent person would do in the circumstances in which a director finds himself. These circumstances include subjective elements such as, degree of education, business knowledge and general ability of the director.

Each case thus necessarily turns on its own facts.

The appellants in this case operated their own company and knew how important it was to make the DAS remittances. In addition to being directors of the company, they held half of its shares and were its president and vice-president. They were among the three signatories of the company’s cheques and regularly attended the directors’ meetings. During July, when the business was facing serious production problems, they met every Sunday evening. They were therefore thoroughly involved in the company’s management.

Did they exercise diligence and care by never inquiring into the status of accounts payable, more particularly of DAS remittances? I do not believe so. First of all, it seems to me unlikely that they never spoke of the matter with Rémy Tremblay. They had invested more than $23,000 of their money and had guaranteed a $100,000 line of credit. Why would they be interested only in accounts receivable and not in accounts payable? CEA, which had invested only $13,674 in its preferred shares and lent $20,000, had consulted the list of accounts receivable and accounts payable. As shareholders and guarantors, the appellants had an interest in doing so, as CAE did. All the accounting records were available to them.

Even if it is true that the appellants never discussed accounts payable with Rémy Tremblay, I do not believe in the circumstances that they showed diligence in exercising their duties by not consulting the monthly financial statements prepared by Rémy Tremblay. The appellants stated that they had relied on Rémy Tremblay, the appellant who was at the same time controller, co-director and co-shareholder, as well as CAE and its representative Claude Asselin, to make the DAS remittances. As outside directors and not employees, they did not have to check to see whether the DAS were being remitted. I cannot accept this view of the appellants. First of all, the Act does not distinguish between employee directors and outside directors. The position of director is not an honorary position. Directors are elected by the shareholders to manage the company. They are the company’s top men. They must ensure that the administrative policies are in place for the business’s proper management, including payment of the DAS, and check to see that those administrative policies are complied with. It is not normal for a controller to state that he was never questioned on the subject of the DAS at any time in a 20-year career when the directors’ responsibility for DAS had existed since 1981.1 share the view of Judge Goetz, who stated in Quantz v. Minister of National Revenue? [4] that directors must inquire into outstanding accounts and cannot delegate their obligations and powers to the other directors:

He cannot, as he suggests, delegate the statutory responsibility of the Company to the other directors. He had the opportunity and a duty, at all meetings that he attended, to at least enquire about the running accounts owing to the Receiver general.

(his emphasis)

Judge Bonner made similar remarks in Barnett v. Minister of National Revenue. [5] Directors cannot be exempted by stating that they delegated their powers to the company’s officials:

In my view subsection 227.1(3) does not afford the Appellant any relief. The evidence does not show that the Appellant took any step to prevent the failure to remit source deductions. It would appear that the Appellant did not pay the slightest attention to the performance by the company of its duties under subsection 153(1), and subsections (4) and (5) of section 227. The Appellant stated in evidence that he was unaware whether the company maintained a separate bank account for employee source deductions. The Appellant cannot rely on delegation to Mr. Wyler in the circumstances of this case.

(my emphasis)

In this instance, the appellants did nothing to ensure that the DAS were being remitted in toto and that Canadian taxpayers’ money was not being used to finance the company’s operations. If they had consulted the monthly balance sheets prepared by Rémy Tremblay, they would have noted that the DAS remittances were being made only in part and they would have been in a position to give Rémy Tremblay instructions.

As counsel for the appellants attached considerable importance to three decisions by this Court, I shall comment on them in closing. There were two decisions by Judge Brûlé and one by Judge Sarchuk. In my view, these

three cases have no bearing on the instant case for the same reason: the directors in those three cases had been misled. In Snow v. Minister of National Revenue^ [6] and Edmondson v. Minister of National Revenue? [7] Judge Brulé concluded that fraud had been committed by the manager and the controller of the companies in question. He described the situation in Edmondson as follows, at page 1544:

As to Jennings’ act of not forwarding the cheques to Revenue Canada being “fraud”, such was intended to deceive, and in the Oxford English Dictionary, fraud is defined to include “to cheat or deceive” and “to withhold (something) fraudulently”.

On the basis of the evidence it can be concluded that Jennings acted fraudulently in relation to the actions of the Appellant.

There is no evidence that Rémy Tremblay acted in a fraudulently in this case. He did not pay 100 per cent of the remittances, but his intention was to pay the arrears as soon as he had the necessary cash. The evidence showed that this is what he had done in part. These arrears appeared as accounts payable in the monthly balance sheets. Mr. Asselin realized this and the appellants could have done the same if they had taken an interest in the matter.

In Smith v. /?., [8] Judge Sarchuk did not go so far as to say there had been fraud, but the facts clearly showed that the taxpayer had consulted interim financial statements which did not reflect the DAS arrears as accounts payable. Furthermore, the evidence revealed that the taxpayers had received assurances that everything was in order and that that had misled them.

There is nothing in the instant case that shows that Rémy Tremblay misled the appellants. Mr. Tremblay even claims that he had never discussed the DAS with the appellants. If the latter had consulted the monthly balance sheets, they would have understood the true situation. The appellants have only themselves to blame because they were negligent in not performing the task that was incumbent upon them and by delegating it to other persons. The appellants did not exercise the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.

For these reasons, the appeals are dismissed, with costs to the respondent.

Appeal dismissed.