Date: 19990901
Docket: 98-1777-IT-I
BETWEEN:
ROBERT D. McDONALD,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Beaubier, J.T.C.C.
[1] This appeal pursuant to the Informal Procedure was heard at Regina, Saskatchewan on August 27, 1999. The Appellant and his son Grant were the only witnesses.
[2] The Appellant has appealed an assessment based upon director's liability pursuant to section 227.1 of the Income Tax Act (the "Act") respecting a corporation known as Channel One Entertainment Ltd. ("Channel One") during the period January to May, 1995.
[3] Assumptions (a) to (z) contained in paragraph 9 of the Reply to the Notice of Appeal read:
9. In so assessing the Appellant, the Minister made the following assumptions of fact:
(a) the facts admitted or stated in this Reply, some of which are repeated here for ease of reference;
(b) at all material times the Corporation was a valid and subsisting corporation under the Saskatchewan Business Corporations Act;
(c) the Appellant became a director of the Corporation on November 30, 1990;
(d) at all material times the Appellant was a director of the Corporation;
(e) the Appellant ceased being a director of the Corporation on or about June 1, 1995;
(f) the Appellant was an experienced businessman;
(g) Appellant was also a director of Target Resources Ltd. ("Target");
(h) Appellant's son Grant handled the payroll accounts and made remittances for both corporations;
(i) Target's remittances of the federal and provincial income taxes, CPP contributions and UI premiums that it had withheld from the wages it had paid to its employees were frequently late;
(j) the Corporation did not remit the federal and provincial income taxes, CPP contributions and UI premiums that it had withheld from the Compensation it had paid for the months of April and May 1993 until July 19, 1993;
(k) on or about December 2, 1993, the Corporation received an assessment of $7,354 for the unremitted federal and provincial income taxes, CPP contributions and UI premiums that it had withheld from the Compensation, plus the applicable penalties and interest;
(l) on or about December 2, 1993, the Minister received a payment of $3,436 with respect to the assessment referred to in the previous subparagraph;
(m) the Corporation did not remit the federal and provincial income taxes, CPP contributions and UI premiums that it had withheld from the Compensation it had paid for the months of November and December 1993 until March 1, 1994;
(n) on or about April 27, 1994, the Corporation received an assessment totalling $891 with respect to unremitted federal income tax for the 1993 taxation year;
(o) on August 22, 1994, the Corporation received an assessment in the amount of $12,028.18 for the unremitted federal and provincial income taxes, CPP contributions and UI premiums that it had withheld from the Compensation for the months of March to July 1994, plus applicable penalties and interest;
(p) the Appellant was aware that the remittances referred to in the previous subparagraph were not made on the dates specified in the legislation;
(q) the Corporation did not remit the federal and provincial income taxes, CPP contributions and UI premiums that it had withheld from the Compensation for the months of August and September, 1994 until October 13, 1994;
(r) on October 13, 1994 the Corporation paid $3,000.00 as partial payment of the amount outstanding from the assessment referred to in subparagraph 9(k) supra and gave two post-dated cheques for $2,000.00 each;
(s) the Appellant was involved in the negotiation of the payment arrangement referred to in the previous subparagraph;
(t) on January 27, 1995, the Corporation's bank forwarded to the Department, pursuant to a Requirement to Pay, $11,509.58, which was the amount of unremitted federal income tax, provincial income tax, CPP contributions and UI premiums, plus penalty and interest, the Corporation owed as of January 24, 1995;
(u) the Corporation did not remit the federal and provincial income taxes, CPP contributions and UI premiums that it had withheld from the Compensation for the months of October to December 1994 and January to July 1995;
(v) on July 13, 1995, the Corporation received assessments for the federal and provincial income taxes, CPP contributions and UI premiums that it had failed to remit for the months of November and December 1994 and January to May 1995;
(w) on July 20, 1995, the Corporation received an assessment for a late filed penalty with respect to the 1994 taxation year;
(x) on October 13, 1995 the Corporation received an assessment for additional CPP contributions and UI premiums it had failed to remit in 1994;
(y) during the 1994 taxation year and January to May 1995 (the "relevant period") the Corporation failed to remit to the Receiver General federal income tax withheld from the Compensation in the total amount of $5,832.19;
(z) the Corporation failed to pay penalties and interest relating to the unremitted federal income tax referred to in the previous subparagraph in the amounts of approximately $983.21 and $1,599.28, respectively;
[4] Of these assumptions, only subparagraphs (p) and (s) were refuted. Of the remaining assumptions subparagraph (pp) is in dispute and the rest were not refuted.
[5] The Appellant is now 69 and his son Grant is in his late 30's. Both have resided in Saskatchewan throughout their lives. The Appellant graduated from high school in Regina and attended two years of university. He commenced his working career in 1954. Over a period of years he worked for a surveyor, Mobil Oil and in 1981 or 1982 he and a partner formed a corporation, Condor Resources ("Condor"). Grant graduated with honours from high school in Regina in 1979. He took two accounting courses in high school and worked during the summers in the accounting department of Saskatchewan Oil. He also did part time accounting for Condor Resources at home. He began studies for a Bachelor of Administration degree at the University of Regina, but quit to join a rock bank during his first year. He then became a full time employee of Condor Resources until his father sold out his interest in Condor Resources in about 1985.
[6] The Appellant started Target Resources Ltd. ("Target") in 1983 or 1984 with Grant as an equal shareholder. The Appellant attended to the field and oil side of operations and Grant attended to the accounting side. Target owned and managed stripper wells in south-east Saskatchewan. It acquired a management contract for over 100 wells from a Calgary firm, but lost that contract in 1993. Until 1993 the Appellant was in Target's offices 60% of the time. The Appellant was aware that Target was sometimes late with its remittances to Revenue Canada while it was in business, but he never checked to see if they were paid. On May 31, 1995 he resigned as a director of Target. Two months later it was bankrupt.
[7] On November 30, 1990, the Appellant and Grant took control of Channel One, which was then a shelf corporation. Target loaned it start up capital of $20,000 or $30,000. The Appellant and Grant changed its name to Channel One on April 10, 1991; the Appellant signed the Articles of Amendment as President. By October 24, 1991 the shareholders of Channel One were
Appellant 35 shares
Grant McDonald 35 shares
John Vancise 15 shares
Robert Vancise 15 shares
That remained the shareholdings until Channel One ceased operations. The Appellant was president and a director until he resigned as director on May 31, 1995.
[8] Channel One operated a night club for the young. Its premises were a few blocks from Target's offices at 8th Avenue and Broad Street in Regina, but the Appellant only visited it about four times throughout its operation. He received no wages or dividends from Channel One. Its books and records were kept at Target's offices. The Appellant thinks that he had signing authority, but he never signed a cheque and he states that he did not participate in Channel One's management. Grant or John Vancise signed its cheques. Grant kept its books and signed most of the cheques. John Vancise apparently managed the operations. Grant visited the Channel One's premises frequently. He testified that he was in love with the business and that Channel One booked top musical night club performers into its premises. Grant testified that, after Channel One's financial troubles were well under way, he did an informal audit and calculated that about $1,000 per week was either being stolen or disappeared from Channel One's operation during its existence.
[9] In the late fall of 1993 the Appellant was 65. He and his wife began taking annual trailer trips of a month or more each year. He considered himself to be retired. Grant admitted that by mid-1993 Channel One began to fall behind in its withholding remittances to Revenue Canada. This continued thereafter. Both Grant and the Appellant testified that the Appellant didn't know about this until about January 30, 1995 when he received a letter dated January 24, 1995 from Revenue Canada (Exhibit R-4). That letter notified him that Channel One owed unpaid source deductions of $11,509.58, and advised him of his liability as a director to pay.
[10] The Appellant phoned Grant, made a written list of things for Grant to do, met him for a breakfast meeting and, in Grant's words, asked Grant "What the hell is going on?" The Appellant had never spoken to Grant like that before. Grant had not told the Appellant of Channel One's previous remittance problems, but he told the Appellant Revenue Canada had been looked after. In fact Revenue Canada had been paid by garnishing Channel One's bank account. The Appellant gave Grant a list of his concerns and stressed that the remittances must be looked after. Grant told him that they had been looked after. Grant believes that the two met again for breakfast a week or two later where they also discussed Target's "late reports" and again Grant assured the Appellant that things were being looked after.
[11] The Appellant did not do anything else.
[12] At this time Channel One was behind with all of its suppliers and creditors. Grant was dealing with them from Target's offices and paying "who was barking at my door" on a day to day basis.
[13] In April 1995 the landlord locked Channel One's premises doors and attempted to seize its assets. But they were secured with a debenture to Target so the seizure failed and the landlord allowed Channel One to reopen. However, this made the news in the Regina Leader Post. The Appellant knew about this. Grant testified that he commented on it to Grant and at various family dinners asked Grant how things were and Grant reassured him.
[14] On May 31, 1995 the Appellant and Grant met with their lawyers. The Appellant testified that he then learned of Channel One's true financial situation and of his liability as a director. He resigned as a director of Channel One. In June of 1995 Channel One "wound up".
[15] In Grant's testimony and the Appellant's testimony there were allegations of a possible failing memory of the Appellant and that the Appellant was not knowledgeable in accounting. The Appellant testified for about one and one-half hours and he appeared to have the competence and memory which is average for his age, and also to be a competent experienced businessman.
[16] The Appellant argues that he was an outside director, that he checked with his son Grant as soon as he learned of the difficulties and that he was entitled to rely on Grant's reassurances. Therefore, he has complied with his duties under the Act. In particular, because Grant is his son, it is argued that he was entitled to rely more on Grant than on a stranger.
[17] Subsection 227.1(3) relieves liability where a director "exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances".
[18] In the Court's view, the Appellant's alleged failure to check on or to know about the operations of a corporation which had its office management in Target's two or three man office premises is astonishing. This is especially so since he was a director, had 35% of the shares, and Target was owed money by and had a debenture on Channel One's assets. Moreover, Target and Channel One shared the same office manager and office accountant - Grant.
[19] The criteria as to whether the Appellant was an inside or outside director and his consequent duties was discussed thoroughly by Robertson, J.A. in Neil Soper v. The Queen (F.C.A.) 97 DTC 5407. In that case, the Federal Court of Appeal unanimously agreed that:
The standard of care set out in subsection 227.1(3) of the Act is, therefore, not purely objective. Nor is it purely subjective. It is not enough for a director to say he or she did his or her best, for that is an invocation of the purely subjective standard. Equally clear is that honesty is not enough. However, the standard is not a professional one. Nor is it the negligence law standard that governs these cases. Rather, the Act contains both objective elements — embodied in the reasonable person language — and subjective elements — inherent in individual considerations like "skill" and the idea of "comparable circumstances". Accordingly, the standard can be properly described as "objective subjective".
...
At the outset, I wish to emphasize that in adopting this analytical approach I am not suggesting that liability is dependent simply upon whether a person is classified as an inside as opposed to an outside director. Rather, that characterization is simply the starting point of my analysis. At the same time, however, it is difficult to deny that inside directors, meaning those involved in the day-to-day management of the company and who influence the conduct of its business affairs, will have the most difficulty in establishing the due diligence defence. For such individuals, it will be a challenge to argue convincingly that, despite their daily role in corporate management, they lacked business acumen to the extent that that factor should overtake the assumption that they did know, or ought to have known, of both remittance requirements and any problem in this regard. In short, inside directors will face a significant hurdle when arguing that the subjective element of the standard of care should predominate over its objective aspect.
...
In my view, the positive duty to act arises where a director obtains information, or becomes aware of facts, which might lead one to conclude that there is, or could reasonably be, a potential problem with remittances. Put differently, it is indeed incumbent upon an outside director to take positive steps if he or she knew, or ought to have known, that the corporation could be experiencing a remittance problem. The typical situation in which a director is, or ought to have been, apprised of the possibility of such a problem is where the company is having financial difficulties. For example, in Byrt v. M.N.R., 91 DTC 923 (T.C.C.), an outside director signed financial statements revealing a corporate deficit and thus he knew, or ought to have known, that the company was in financial trouble. The same director also knew that the business integrity of one of his co-directors, who was the president of the corporation too, was questionable. In these circumstances, having made no efforts to ensure that remittances to the Crown were made, the outside director was held personally liable for amounts owing by the corporation to Revenue Canada. According to the Tax Court Judge the outside director had, in contravention of the statutory standard of care, failed to "heed what is transpiring within the corporation and his experience with the people who are responsible for the day-to-day affairs of the corporation" (supra at 930, per Rip, J.T.C.C.).
...
It is important to note that whether a company is in serious financial difficulty, such as to suggest a problem with remittances, cannot be determined simply by the fact that the monthly balance sheet bears a negative figure. For example, many firms operate on a line of credit to deal with fiscal fluctuations. In each case it will be for the Tax Court Judge to determine whether, based on the financial information or documentation available to the director, the latter ought to have known that there was a problem or potential problem with remittances. Whether the standard of care has been met, now that it has been defined, is thus predominantly a question of fact to be resolved in light of the personal knowledge and experience of the director at issue.
Applying the foregoing analysis of the law to the facts of this case, I find that the taxpayer was under a positive duty to act which arose, at the latest, in November of 1987 when he received the balance sheet of RBI revealing that the company was experiencing what the Tax Court Judge found, as a matter of fact, to be "extremely serious" financial problems (Appeal Book at 43). In light of that finding by the Tax Court Judge, and given the taxpayer's ample experience in the field of business, the balance sheet of November 1987 should have alerted the taxpayer to the existence of a possible problem with remittances. This is all the more true since there was no indication or evidence that RBI's financial troubles were merely temporary in nature. In the circumstances, however, the taxpayer made no inquiries in respect of remittance of employee withholdings.
[20] Based on these criteria, the evidence is that the Appellant was an outside director. As an outside director the Appellant clearly became aware of the fact that Channel One was in serious financial difficulty on January 30, 1995 when he received Exhibit R-4, the letter from Revenue Canada to him. It advised him of Channel One's failure to remit $11,509.58 and his personal liability as a director to pay this deficiency. His actions thereafter were confined to meeting with his son Grant and relying on Grant's assurances. This is the case despite the fact that he knew that Grant had allowed Target's remittances to fall into arrears before this. The Appellant's denial that he did not know of his duties pursuant to section 227.1 until he met with the lawyers on May 30, 1995 is not credible in view of the explicit statements in Exhibit R-4. Similarly his and Grant's protestations about the Appellant's accounting ignorance lack credibility insofar as they relate to a corporation's duty to remit employee withholdings. Anyone who has been an employer or an employee knows this about an employer. That duty is a part of every small business. The Appellant was well aware of that duty when Target fell behind in its remittances. He remained aware of that at the time he received Exhibit R-4.
[21] A director's duty under subsection 227.1(3) is to prevent the failure. In Channel One's case the failure occurred in Grant's area of responsibility and Grant had already failed that duty in Target's case to the knowledge of the Appellant. This is the prime reason why merely speaking to Grant and giving him a list or reminding him or checking with him does not satisfy his director's duty in this case. The Appellant knew that Grant had been remiss before in these same tasks for Target. Grant was part of the problem and the Appellant knew that on January 30, 1995.
[22] As an outside director, the Appellant's failure commenced on January 30, 1995. At that date he was aware of the remittance problem and he phoned Grant. That was not enough. With his knowledge of Grant, his business experience, and his knowledge of Channel One's failure at that date proper care, diligence and skill required him to do more than merely speak to Grant and give him a list and then rely on Grant to remedy the problem and prevent further failures by Channel One.
[23] For these reasons, the Court finds that commencing on January 30, 1995 and thereafter, the Appellant is liable for unpaid remittances by Channel One.
[24] It is not clear from the pleadings if the amounts assessed in January, 1995 commenced on or after January 30, 1995, or if they became due from Channel One before that date. For this reason, the parties will be contacted by the Registrar for a phone conference to occur within 30 days of this date in order that they may submit particulars by affidavit respecting the amounts and dates when remittances were due and conduct arguments for final judgment in this matter.
Signed at Ottawa, Canada this 1st day of September, 1999.
"D.W. Beaubier"
J.T.C.C.