Date: 20010118
Docket: 1999-497-GST-G; 1999-1307-GST-G; 1999-1308-GST-G
BETWEEN:
RONALD MERCIER, HOSAM EL-DIN IBRAHIM, and FAWZY H. MORCOS
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Counsel for the Appellants: Horst G. Wolff
Counsel for the Respondent: David I. Bessler
____________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench at Edmonton, Alberta, on October 20, 2000)
McArthur J.
[1] These appeals were heard on common evidence and involve assessments of goods and services tax as against the Appellants under subsection 323(1) of the Excise Tax Act, which subsection provides:
323(1) Where a corporation fails to remit an amount of net tax as required under subsection 228(2) or (2.3), the directors of the corporation at the time the corporation was required to remit the amount are jointly and severally liable, together with the corporation, to pay that amount and any interest thereon or penalties relating thereto.
Subsection 323(3) of the Act states:
323(3) A director of a corporation is not liable for a failure under subsection (1) where the director exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.
The parties agree that the sole issue in these appeals is whether the Appellants met what is commonly described as the due diligence test.
[2] On March 26, 1998, the Minister of National Revenue assessed the Appellants the amount of $66,399. The liability for that amount is joint and several and includes interest of $6,945 and penalty of $9,076. Subsection 323(3) of the Excise Tax Act is identical to subsection 227.1(3) of the Income Tax Act and a great deal of litigation has arisen from these sections. The decision that is referred to most frequently by this Court in recent years is Soper v. The Queen,[1] which sets out the tests to be applied. It also describes the standard of care under subsection 227.1(3) of the Income Tax Act as “objective/subjective” and differentiates between inside and outside directors. Despite the mountain of jurisprudence, it is a question of fact whether a director meets the due diligence test.
[3] In my analysis, I am guided by the reasoning of Bowman J. in Holmes v. The Queen,[2] where he stated:
Essentially, however, whether a director meets the test under subsection 227.1(3) is a question of fact.
It is obvious from the many cases that have been decided under section 227.1 of the Income Tax Act and the corresponding section of the Excise Tax Act, section 323, that each case must be decided on its own facts, and no single factor predominates, nor can one test apply that fits all circumstances. For example, we know from Soper that although inside directors may find it more difficult to meet the due diligence test than outside directors, not every inside director will be found liable. Similarly, a director may not escape liability under section 227.1 by remaining wilfully blind to a deteriorating financial condition in a corporation, or by claiming ignorance of his or her obligations as a director. However, directors have been held not liable for a corporation’s failure to remit source deductions where economically it was impossible to ensure that the required remittances be made (Fancy v. M.N.R. 88 DTC 1641) or where the directors were completely excluded from the affairs of the corporation by an autocratic and domineering owner of all the shares of the corporation (Fitzgerald et al. v. The Queen, 92 DTC 1019).
[4] The Appellants in the present appeal are of different backgrounds. All three directors testified. Fawzy H. Morcos is a medical doctor who, in addition to his practice as a gynecologist and obstetrician, lectures at the University of Alberta. Hosam El-Din Ibrahim has been a pharmacist for over 35 years and operates his own pharmacy in Edmonton. Ronald Mercier has a B.Sc. degree from the University of Alberta and has been a realtor in the Edmonton area for about 26 years. They were the sole directors of Lojim Management Ltd. which from about 1989, owned and operated a shopping plaza in Stettler, Alberta. The plaza was unsuccessful from the outset and the shareholders were called on each year to pay a deficit. In acquiring the shopping plaza, all three shareholders personally guaranteed the repayment of a $500,000 first mortgage. In 1993, they were desperate to rid themselves of the plaza as well as their personal guarantees.
[5] In paragraph 2 of the Notices of Appeal, the Appellants set out the transaction as they understand it upon which the assessments are based and it reads:
Pursuant to an agreement dated December 17, 1994, Lojim entered into a complex real estate transaction with 552293 Alberta Ltd. ... pursuant to which it agreed to exchange its equity in a commercial complex in Stettler, Alberta for the equity owned by 552293 in ten condominium units in Edmonton which 552293 was in the process of purchasing from 529198 Alberta Ltd. ... and as part of the overall transaction, the condominium units would be disposed of to owner/occupants and a corporation controlled by the Appellant and a corporation controlled by the spouse of another director of Lojim.
Counsel for the Respondent describes the transaction in this manner:
Simply put, 529198 Alberta Ltd. transfers the condominiums to 552293 Alberta Ltd., which transfers the condominiums to Lojim Management Ltd., which then in turn transfers to what's been referred to as the end purchasers.
The only transactions for the purposes of this decision wherein the corporation may have been required to ultimately collect and remit tax was upon the sale of the condominiums by it to the group of purchasers.
[6] In a nutshell, Lojim purchased 10 condominium units from 552293 in exchange for the shopping plaza and sold them to various purchasers. The fact that there was but one registered conveyance from 529198 to the end purchasers does not change the reality of what actually took place. The director Morcos' corporation, F.H.M. Properties Ltd., took two units; the director Ibrahim’s corporation, Alberpharm Ltd., took two units; and Mercier took six units and he in turn, sold them to six individuals at a substantial loss. F.H.M. Properties and Alberpharm continue to retain their units as rentals. I believe F.H.M. Properties has paid GST on the acquisition of its two condominiums.
[7] James Cox, a lawyer who acted on behalf of Lojim, the individual Appellants, F.H.M. Properties and Alberpharm testified on behalf of the Appellants. The Appellant Mercier was the most active and knowledgeable of the three directors and he was the one who put together the transaction at issue. Basically, the directors felt they were better off with condominiums in Edmonton than a losing shopping plaza in Stettler. Prior to the present situation, in an entirely different transaction, Mercier had to pay GST as a vendor. Because of that poor experience, he included in the Agreement of Purchase and Sale between 552293 and Lojim a clause (paragraph 8) which reads in part: "GST to be paid by the vendor". In a letter dated February 2, 1995, Mr. Abbi, solicitor for the vendor 552293, refers to the purchaser as paying the GST. Mr. Mercier reminded the solicitor, Mr. Cox, of paragraph 8 in the Agreement of Purchase and Sale and in turn, Mr. Cox directed the vendor’s solicitor, Mr. Abbi, to that clause by letter dated February 3, 1995 which letter reads in part:
With respect to the GST, the offer in clause 8 provides that the Vendor is to pay the GST and you might want to call me about that.
On the same date Mr. Abbi replied, in part:
... you are at liberty to disregard all references to GST in our trust letter aforesaid ...
After the closing, Mr. Abbi advised Mr. Cox that GST had been paid. Apparently, Mr. Abbi no longer practices law in Alberta and cannot be located. 552293 has no assets and is apparently judgment-proof and Lojim has been dissolved voluntarily.
[8] The position of the Appellants is that they were aware of the existence of GST and they provided for the payment of it in the Agreement of Purchase and Sale. Mr. Cox was acting on behalf of Lojim. It was his responsibility to see that the provisions of the agreement were carried out. Mr. Mercier had reminded him of paragraph 8 on February 2 or 3, 1995 and upon being advised by solicitor Abbi, Mr. Cox was satisfied that the GST had been paid.
[9] Counsel for the Appellants submitted that it was really one transaction. It was a disposition of the Stettler property and flipping on behalf of 552293 of 10 condominiums for cash. No cash went to Lojim at any time. Both Mr. Cox and his three director clients felt GST had been dealt with. Counsel for the Appellants added further that subsections 323(3) of the Excise Tax Act and 227.1(3) of the Income Tax Act were aimed at
...directors who see a company going down, they collect this trust money, use it to fund operations to make or are willfully blind to the fact that remittances may not be being made on a routine basis and then throw up their hands when the Receiver walks in and says, why didn’t you take pains to ensure it was being remitted.
Counsel further referred to the decision in Soper, supra, and stated:
Justice Robertson tries to outline some of the criteria. But it's my submission that even those criteria are not on point here, because it was sort of one transaction, and most of the other due diligence cases, it's usually an ongoing mess, where companies are going deeper and deeper in the red and remittances simply aren't being made.
[10] The position of the Respondent includes the following: Both 552293 and Lojim were registrants under the Excise Tax Act and for practical purposes, Revenue Canada treated the 552293-Lojim transaction as a wash for GST purposes. Counsel for the Respondent stated:
The amount Lojim failed to report, though, or to remit, was the GST that formed part of the purchase price from those end users.
The case of Franklin Estates Inc. v. The Queen,[3]essentially sets out the proposition that it is not an optional one that the parties to the transaction can opt out of. At page 5, bottom of paragraph 11, the Court stated:
... A payment to a person not cloaked with the authority to collect the tax as agent of the Crown cannot be regarded as payment of the tax.
Counsel added:
Similarly here, Lojim could not escape its liability for the tax by simply contractually obligating 552293, the vendor.
The issue ... is simply where there's been due diligence by the directors. It's the crown's position that none of the directors took steps to ascertain Lojim's obligations with respect to the GST, nor did they take any steps to ensure that the GST was paid. In that sense they didn't exercise the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.
He also quoted the Soper, supra case and specifically, Justice Marceau as saying:
I simply cannot imagine that such a duty may ever have been seen as having been fulfilled by a director who, as here, has never put his or her mind to the requirement and has remained completely uninterested and passive with respect to it.
Finally he concluded:
Essentially, in a nut shell, this case is about, was that sufficient. That if you have a real estate transaction, a lawyer handling the deal, is that sufficient for your obligations. It's the crown's submission that knowing that there was problems in this area, having had that experience, they should have at least asked.
Analysis
[11] The approach I will try to take is that one set out by Bowman J. in Cloutier et al v. M.N.R.[4] where he states:
The question therefore becomes one of fact and the court must to the extent possible attempt to determine what a reasonably prudent person ought to have done and could have done at the time in comparable circumstances. Attempts by courts to conjure up the hypothetical reasonable person have not always been an unqualified success. Tests have been developed, refined and repeated in order to give the process the appearance of rationality and objectivity, but ultimately the judge deciding the matter must apply his own concepts of common sense and fairness. It is easy to be wise in retrospect and the court must endeavour to avoid asking the question “What would I have done, knowing what I know now?” It is not that sort of ex post facto judgment that is required here. Many judgment calls that turn out in retrospect to have been wrong would not have been made if the person making them had the benefit of hindsight at the time.
Section 227.1 is an example. That section imposes a standard of care on directors that requires reasonable prudence and skill in ensuring that the money raised through the SRTC program be in fact used for scientific research or else that the Part VIII tax be paid either out of the money so raised or otherwise. In determining whether that standard has been met one must ask whether, in light of the facts that existed at the time that were known or ought to have been known by the director, and in light of the alternatives that were open to that director, did he or she choose an alternative that a reasonably prudent person would, in the circumstances, have chosen and which it was reasonable to expect would have resulted in the satisfaction of the tax liability. That the alternative chosen was the wrong one is not determinative. In cases of this sort the failure to satisfy the Part VIII liability usually results either from the making of a wrong choice in good faith, or from deliberate default or willful blindness on the part of the director.
[12] In these appeals, I must determine if the three Appellants chose an alternative that reasonably prudent persons would have chosen under the circumstances. This is a single transaction. It is in contrast to the majority of due diligence cases where there is a continuing deterioration of a business and the taxpayer is using Revenue Canada’s money to help keep his or her business afloat. The Appellants were dealing with a complex real estate transaction and a highly complex Act, particularly in the early years of its inception. They were aware of GST and they signed an agreement that provided for the payment of any GST. They were not aware of the decision in the case of Franklin Estates, supra. They retained a lawyer to carry out the provisions of the agreement on their behalf and their lawyer was satisfied that this was done. To insist that they should have spoken to an officer in the GST office or not have completed the transaction without an official receipt is, in my mind, beyond what a reasonably prudent person is required to do. Surely, having retained a lawyer to assure that the GST was paid in accordance with the terms of the agreement is sufficient. While I do not accept the Appellants’ position that there was no sale to Lojim, that in itself does not make the Appellants liable.
[13] The Respondent stated in paragraph 15 of the Reply to the Notice of Appeal that the money collected, presumably by Lojim, was trust money. In fact, there was no money collected by Lojim and there was no money to be remitted. The Appellants were not trying to escape paying GST. They innocently believed GST had been taken care of. They were not lawyers or accountants. They were faced with a complicated transaction and a more complicated Act. They acted prudently and reasonably by relying on their solicitor who, in turn, relied on a less than straightforward vendor’s lawyer. This was a single transaction under unusual circumstances. It was not the case of continuing fault. Therefore, the appeals are allowed, with one set of costs, and the assessments are vacated.
Signed at Ottawa, Canada, this 18th day of January, 2001.
"C.H. McArthur"
J.T.C.C.