James v Barnett v. Minister of National Revenue, [1985] 2 CTC 2336, [1985] DTC 619

Bonner, TCJ:—This is an appeal from an assessment of the appellant for an amount which the respondent found to be payable under the provisions of subsection 227.1(1) of the Income Tax Act. That provision reads:

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 or has failed to remit such an amount, the directors of the corporation at the time the corporation was required to deduct or withhold the amount, or remit the amount, are jointly and severally liable, together with the corporation, to pay any amount that the corporation is liable to pay under this Act in respect of that amount, including any interest or penalties related thereto.

The respondent made the assessment on the basis that the appellant, as director of Canadian Frozen Food (Waterloo) Ltd (hereinafter “the company”) became liable as a result of the failure of the company to remit at the prescribed time moneys which it had deducted or withheld pursuant to section 153 of the Act from the wages of its employees.

The appellant attacked the assessment on two grounds. First it was asserted that the duty imposed on a director by subsection 227.1(1) of the Act . . . cannot be made paramount to the duty of a director to the corporation created by common law and codified by statute”. Secondly it was argued that the appellant exercised the degree of care, diligence and skill described in subsection 227.1(3) with the consequence that he was exonerated by that provision. It reads:

227.1 (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.

The first argument is summarized in the notice of appeal. It is that in performing their fiduciary duty to a corporation:

. . . directors may not place themselves in a position where their duty to the corporation may conflict with their own self-interest. It is to the company, and not to its members or anyone else, that the directors stand in a fiduciary relationship.

It is respectfully submitted that the taxpayer discharged his duties of good faith and diligence to the Corporation, by using all his efforts to attempt to keep the Corporation in operation. His only duty was owed to the Corporation, even though this meant postponing payment to certain creditors, including the Minister.

I can see no conflict between the obligation imposed upon a director who wishes to avoid liability under subsection 227.1(1) and the obligation which that director owed to the company under section 142 of the Business Corporations Act, RSO 1980, c 54. It was not suggested that the company failed to deduct or withhold. What it failed to do was to remit amounts deducted or withheld. That was common ground. The amounts withheld originally formed part of the wages earned by employees of the company. Those wages would, but for section 153 of the Income Tax Act, have been paid in full to the employees. The amounts so withheld were not moneys which the company had any right to use for purposes of its business. By virtue of subsection 227(4) of the Act the company was deemed to hold those amounts in trust for Her Majesty. By virtue of subsection 227(5) of the Income Tax Act the company was under an obligation to keep those moneys separate and apart from its own. It cannot be suggested seriously that a director of a corporation could ever be under an obligation to the corporation to cause to be used for the benefit of the corporation moneys which it holds as bare trustee for a thrid party. Thus, the first argument fails.

The second argument requires a somewhat more detailed examination of the circumstances revealed by the evidence. The appellant became a fifty per cent shareholder of the company in 1978. He took responsibility for marketing of the company’s product. The holder of the other fifty per cent, a Mr Carter, was responsible for general administrative and financial matters and, as well, for operations of the company’s plant. The business grew rapidly. In June of 1981 the appellant bought Mr Carter’s shares and the latter then left. It became apparent that as a result the company lacked expertise in financial management.

About a month after Mr Carter’s departure the appellant, acting on the advice of the company’s accountant, caused the company to employ a Mr Wyler to act as comptroller. Mr Wyler had previous experience as the comptroller of a small manufacturing company, Further, he had training as a chartered accountant, but he failed to successfully complete the examinations.

The appellant stated that he made it clear that Mr Wyler had complete authority and responsibility with regard to financial matters. Mr Wyler was directed to report to the appellant on what the appellant called “a bottom line basis”.

The appellant’s signature was one of two required for company cheques, but the appellant stated that he usually presigned cheques because he might be absent for a few days.

Four or five days after Mr Wyler started work he reported to the appellant that the company was “cash short” due to its recent expansion. A week and one-half after that a customer defaulted on a large payment due to the company with the result that the cash shortage became very severe. The appellant testified that Mr Wyler reported to him that the company was in a position which required it to “back-off on some accounts payable”. The appellant, who appears to have proceeded on the mistaken assumption that the Crown was an ordinary creditor in relation to sums which had been deducted under section 153 of the Act, thereupon instructed Mr Wyler to “pay the essential suppliers who keep us in business”. The others to be paid were left by the appellant to Mr Wyler’s discretion. The appellant proceeded to concentrate his attention on sales in an attempt to increase cash flow and profit.

Mr Jenkins, counsel for the appellant, submitted that no director is under a duty to constantly monitor the actions of corporate officials. One must, he said, recognize commercial reality and on that basis conclude that it is entirely appropriate for a director to delegate day-to-day management to officials who are apparently competent. In summary, he said any delegation to a person who is apparently competent to carry out the task delegated is sufficient to meet the 227.1(3) test.

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. The instructions given by the appellant to Mr Wyler against the background of a rapidly worsening financial crisis could quite reasonably have been taken by Mr Wyler as a direction to use for general corporate purposes moneys deducted at source which moneys were, as I infer was the case, mingled with others in a general corporate bank account. Reasonable prudence in those circumstances demands a higher level of diligence.

For the foregoing reasons the appeal will be dismissed.

Appeal dismissed.