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Maddin: Failure to Inquire Leaves Director Liable

In Maddin v. The Queen (2014 TCC 277), the taxpayer was a director of a corporation in the marble and granite industry (the “Corporation”) which failed to remit nearly $300,000 of source deductions related to salaries, wages and other remuneration paid to employees. The sole issue before the Tax Court was whether the taxpayer could make out a due diligence defence under subsection 227.1(3) of the Income Tax Act (Canada).

For earlier blog posts on directors’ liability see our blog posts here and here.

The evidence established that the taxpayer intended to play a limited advisory role in the Corporation. Mr. Barker, another director, was in charge of managing the daily operations of the Corporation. However, the Tax Court also noted the following additional facts:

  • The taxpayer was in the office 2-3 days a week;
  • The taxpayer was familiar with the Corporation’s business structure, its banking operations and the accounting systems;
  • The taxpayer executed various letters on behalf of the Corporation;
  • The taxpayer had a close relationship with the initial bookkeeper and communicated with her generally throughout the period at issue;
  • When a new bookkeeper (the mother of another director) was hired, the taxpayer was aware that she did not necessarily understand the bookkeeping systems; and
  • The taxpayer knew of the Corporation’s financial difficulties.

Ultimately, the Tax Court held that these factual circumstances should have prompted Mr. Maddin to inquire into the financial health of the Corporation. Mr. Maddin did not exercise the appropriate standard of care, diligence and skill required of a director to avoid being held personally liable for the unremitted source deductions.

This case is another reminder that the Courts will, in general, hold directors to a relatively high standard of conduct. In order to successfully argue a due diligence defence, directors involved in the business must take active steps to inquire into the financial state of affairs and communicate regularly with staff to obtain reports that source deductions are being remitted in a timely manner.

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Maddin: Failure to Inquire Leaves Director Liable

Gariepy: When is a director’s resignation effective?

In Gariepy v. the Queen (2014 TCC 254), the Tax Court considered (i) whether two directors had effectively resigned from their positions, and (ii) if not, whether the directors were duly diligent in seeking to prevent the failure of the company to remit source deductions.

In Gariepy, the two directors argued that they were not liable under subsection 227.1(1) of the Income Tax Act (Canada) (the “Act”) for $500,000 in unremitted source deductions of 1056922 Ontario Limited (the “Corporation”) on the basis that they had resigned as directors more than two years prior to the assessment. In the alternative, the two directors put forth a due diligence defence.

The two appellants were the only directors of the Corporation, but it was in fact managed and operated by their husbands. After approximately two years, the husbands decided it was time for their wives to cease to be directors and have themselves appointed. One of the husbands – Mr. Chriss – contacted the Corporation’s law firm to advise of the change of directors.

There was conflicting or confused testimony presented in the 10-day hearing of the appeals, but the Tax Court held that there was sufficient evidence that the two directors had resigned in 2001 and the limitation period in subsection 227.1(4) of the Act had passed – even though written resignations prepared by a corporate law firm had not been signed by either of the directors.

The Tax Court examined e-mails between the parties and their lawyers, corporate records, and minute books and determined that there was sufficient documentary and oral evidence to demonstrate the resignations were “meaningfully communicated” to the Corporation in 2001. The resignations were valid and effective as of the date the resignations were prepared by the corporate law firm. Although the Court noted serious credibility issues by both directors with respect to the resignations, it was held that these credibility issues were not relevant to decide the merits of the case but would be relevant to determining any cost awards.

The Tax Court noted that this conclusion was consistent with the Court’s earlier decisions in Perricelli v. The Queen (2002 GSTC 71)Walsh v. The Queen (2009 TCC 557)Corkum v. The Queen (2005 TCC 755)Irvine v. M.N.R. (91 DTC 91), and Cybulski v. M.N.R. (88 DTC 1531).

Although the above finding was sufficient to dispose of the appeals, the Court went on to discuss the directors’ alternative argument – whether it was nonetheless reasonable for the directors to think they had resigned and, if so, whether their complete failure to act or concern themselves with the company’s affairs during the non-remittance periods could support a due diligence defence.

On this alternative argument, the Tax Court came to different results for the directors. The Tax Court held that one of the directors – Mrs. Chriss – reasonably relied on her husband and the corporate law firm that her resignation was valid. Conversely, the Tax Court held that for the other director – Mrs. Gariepy – it was not reasonable for her to think that she had ceased to be a director. For Mrs. Gariepy, the evidence did not support a finding that she asked for, was advised of, or was otherwise aware that Mr. Chriss had been asked to or did contact a law firm to advise of the resignations.

Gariepy provides a reminder of the importance of meticulous record-keeping for directors when they resign from their positions. A signed resignation letter would have obviated the need for a lengthy proceeding, and would have clarified at the outset the potential liability of the directors for the company’s unremitted source deductions.

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Gariepy: When is a director’s resignation effective?

Roitelman: Fraud and the Due Diligence Defence

In Roitelman v. The Queen (2014 TCC 139), the Tax Court considered whether a director could establish that he had been duly diligent in his attempts to prevent his company’s failure to remit source deductions where he had delegated responsibility for the company’s bookkeeping and tax filings to an employee.

Background

The taxpayer owned an electrical contracting business that focused primarily on commercial and industrial contracting, installations and service work. Initially, the taxpayer personally completed all payroll and remittance filings. As his business expanded, the taxpayer was required to travel more frequently, thus spending less time in his office. Consequently, the taxpayer hired and trained a bookkeeper. He oversaw her work and at the outset ensured remittances were made in a timely fashion. After the employee assumed responsibility for the bookkeeping, the corporation did not remain current in its remittance obligations.  From August 2005 to March 2008, the CRA sent five letters to the corporation regarding repeated failures to remit. From October 2006 to March 2008, the CRA sent seven Notices of Assessment in respect of the unremitted source deductions. The taxpayer did not receive nor was he personally aware of many of these letters and assessments. Later, after the bookkeeper had been dismissed, the taxpayer discovered hidden documents and unsent remittance cheques in various locations in the office.

For 2006 and 2007, the CRA assessed the taxpayer for directors’ liability for unremitted source deductions under subsection 227.1(1) of the Income Tax Act. The taxpayer appealed to the Tax Court and relied on the due diligence defence under subsection 227.1(3) of the ITA.

Tax Court

The Tax Court allowed the appeal. The Court found the taxpayer established a due diligence defence and thus he was not personally liable for the unremitted amounts.

The Court reviewed the key decisions on the issue, and noted that the applicable test from Buckingham v. The Queen (2011 FCA 142) is objective and contemplates the degree of care, diligence and skill exercised by the director in preventing a failure to remit. The Court also cited Balthazard v. The Queen (2011 FCA 331) for the proposition that after-the-fact behavior and corrective measures can be relevant in certain circumstances.

In Roitelman, the Court compared the personal actions of the taxpayer to the reasonably prudent person and emphasized that the director’s interaction with the bookkeeper should not be analyzed on in hindsight but, rather, with a view of the circumstances that existed during the relevant period:

[28] The test does not dictate that the positive steps taken must be effective in ensuring future compliance but only that a director takes those steps and that those steps would be the proactive steps that a reasonably prudent person would have exercised in comparable circumstances.

The Court stated that it was reasonable for the taxpayer to expect his bookkeeper to bring any essential correspondence to his attention, and it was reasonable for him to believe that when he signed remittance cheques that they were being forwarded to the Receiver General. There was no evidence that the taxpayer benefited or intended to benefit in any way from the company’s failure to remit.

Despite his actions (i.e., hiring and training the bookkeeper, delegating responsibility, etc.), the taxpayer was unable to discover or ascertain the extent of the remittance failures. The bookkeeper thwarted his attempts to ensure compliance. The Court held that the taxpayer could not reasonably have known that the bookkeeper would engage in fraudulent and misleading activities.

Roitelman is an interesting case because there are very few decisions in which a taxpayer is able to establish a due diligence defence where he/she delegates responsibility for bookkeeping/remittances and relies on the work of that other person. In Kaur v. The Queen (2013 TTC 227), the Tax Court stated, “… The director’s oversight duties with respect to [remittance obligations] cannot be delegated in their entirety to a subordinate, as was done in the present case.” In Roitelman, the taxpayer had admitted that he relied on “blind faith” that the remittances had been made in a timely fashion. However, the result in Roitelman reminds us that such reliance may still be reasonable where there was deceit and fraud perpetrated on the director by a subordinate.

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Roitelman: Fraud and the Due Diligence Defence