Tax Court of Canada Judgments

Docket: 2001-2757(IT)G

BETWEEN:

GORDON MURRAY McKINNON,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

____________________________________________________________________

Appeal heard on November 25, 2003 at Vancouver, British Columbia.

Before: The Honourable D.G.H. Bowman, Associate Chief Justice
Appearances:
For the Appellant:	The Appellant himself
Counsel for the Respondent:	Kristy Foreman Gear

____________________________________________________________________

JUDGMENT

          The appeal from the reassessment made under section 227.1 of the Income Tax Act, notice of which is dated April 14, 2000 and bears number 13405, is allowed, and the assessment is vacated.

The appellant is entitled to his costs, if any.

Signed at Montréal, Quebec this 3^rd day of December, 2003.

"D.G.H. Bowman"

A.C.J.

Citation: 2003TCC884

Date: 20031203

Docket: 2001-2757(IT)G

BETWEEN:

GORDON MURRAY McKINNON,

Appellant,

And

HER MAJESTY THE QUEEN,

Respondent.

REASONS FOR JUDGMENT

Bowman, A.C.J.

[1]      This is an appeal from an assessment made under section 227.1 of the Income Tax Act based on a failure by the appellant's company to remit payroll deductions in respect of its employees. The total amount assessed is $25,465.02 consisting of $11,755.47 for federal tax, and the rest is for Canada Pension Plan, employment insurance amounts not remitted and penalties and interest. The penalties and interest amount to more than the amounts that the Crown alleges ought to have been remitted by the company.

[2]      The appellant is the president, sole shareholder and sole director of Fast Track Glass and Aluminium Limited, (the "company" or "Fast Track") a company incorporated by him in 1993, after another company by which he had been employed ceased operations. His purpose was to start a small business which was intended to engage in the business of fabricating and installing glass doors and windows.

[3]      He had considerable experience in this field. In preparation for the business venture he attended a course about operating a small business at St. Mary's University in Halifax. He also approached a number of banks and other financial institutions to obtain a line of credit but was not successful. He endeavoured to interest other investors including the Annour Group Limited and the St. Mary's University Micro Enterprise Equity Fund but was unsuccessful.

[4]      He submitted business plans to proposed lenders and investors and although the business plans were reasonable and conservative and were regarded by at least one proposed investor as excellent, he was unsuccessful in attracting capital either by way of loan or equity except for a line of credit of $4,000 from Credit Union Atlantic. Nonetheless, the company started business and the results by the end of 1996 seem to have justified his initial optimism and initiative. On April 29, 1996, Mr. McKinnon wrote to Peat Marwick Thorne and stated that the company had contracts for $125,000 and by the following month, $230,000. According to the company's income statement for December 1, 1995 to November 30, 1996, the company's total revenues were over $486,000.

[5]      There was one problem in 1996, but it was not insuperable. The progress billings and payment of the progress billings were later than the need to pay workers who were paid either every week or every two weeks. Accordingly, the payments to the Receiver General for Canada of payroll deductions were often late, but they did get paid. If the only problem were late payment of payroll deductions this case would not have arisen. The problem is non-payment of two amounts on March 12, 1997 of $5,403.82 for 1996 and $6,351.65 on May 6, 1997 for 1997. There was simply no money available to make these payments. The last payment was made by the company on April 29, 1997, in the amount of $5,000.

[6]      The cash flow shortfall that made it impossible for the payments to be made to the Receiver General for Canada was attributable to two events, neither of which could have been foreseen by Mr. McKinnon. The first was the loss of a greeting card distribution business carried on by him through the company. This source of revenue made up a sufficient portion of the company's revenues to enable its obligations to be met, including its obligation to pay the payroll deductions to the government. In March of 1996 the greeting card company terminated its business relationship with the appellant and accordingly this source of cash flow came to an end.

[7]      The second and far more serious development occurred in the company's relationship with a contractor Rideau Construction Incorporated ("Rideau"). Fast Track was engaged as subcontractor to install the glass at the Halifax Air Traffic Control Tower and the Antigonish Court House. Rideau was the general contractor on these two projects. The price on the Halifax project was $105,500 and $47,000 for the Antigonish project. Mr. McKinnon had dealt with Rideau before and had not had problems being paid. His taking these contracts was consistent with his conservative practice of choosing only low risk projects involving municipalities or other governments.

[8]      Rideau in 1997 arbitrarily and improperly refused to pay the full amount of the contract price and in the result improperly withheld a total of $58,000 from the amount owing to Fast Track based on spurious deficiencies which it concocted. Legal actions were taken by Fast Track on the instructions of Mr. McKinnon but they had to be dropped in the year 2000 due to lack of funds. Mr. McKinnon testified that when he received the assessment he could not fight both the government and Rideau. This is of course not germane to the decision here but it does demonstrate the degree of frustration and indeed despair felt by the appellant. He lost everything he owned, including his house, and moved to British Columbia were he works as a senior estimator.

[9]      I was impressed with the appellant and with his demeanour in the witness stand. I found him honest and straightforward. He worked with his wife to make the Fast Track business a success but it failed through circumstances beyond his control.

[10]     Counsel for the respondent, in her usual fair and thorough way, stated that the appellant's lack of due diligence[1] manifested itself at two points in time:

(a)               when he started the business without ensuring that sufficient capitalization was in place by means of larger lines of credit;

(b)              when he failed to terminate the business once he started to have cash flow problems when the greeting card company withdrew its business from the appellant.

[11]     Counsel referred me to a number of decisions where the facts bear a certain resemblance to the facts here. Short v. R., [1999] 3 C.T.C. 435 involved, as here, a construction company in a Maritime province. Both the Tax Court and the Trial Division of the Federal Court found on the facts that Mr. Short did not display the degree of care, diligence and skill required to bring himself within the provisions of subsection 227.1(3) of the Act. The same conclusion was reached by Margeson J. in Blanchard v. R., [2000] 4 C.T.C. 2131, by Lamarre Proulx J. in Ruffo v. R., [1998] 2 C.T.C. 2203, by Mogan J. in W.F. Zwierschke v. M.N.R., [1991] 2 C.T.C. 2783 and by Archambault J. in Fauteux v. R., [1997] 3 C.T.C. 2277.

[12]     Each of these cases depended on its own facts and is based in some measure upon the trial judge's assessment of the director's credibility, character and general demeanour in the witness stand. As Rothstein J.A. said in a concurring judgment in Worrell v. R., [2000] G.S.T.C. 91-1 at 91-24, "whether the due diligence defence will be successful is fact-driven in each case; i.e. always comparing what the directors did to prevent the failure with what a reasonably prudent person would have done in comparable circumstances". I think it is fair to say that prior to a number of Federal Court of Appeal decisions to which I shall refer presently, some of the judges of the Tax Court of Canada were placing the barrier unrealistically high. This approach has been mitigated substantially by the Federal Court of Appeal. The first of these cases is Soper v. R., [1997] 3 C.T.C. 242, in which Robertson J.A. enunciated a number of principles relating to the standard of care.

[13]     The next case is the decision of the Federal Court of Appeal in The Queen v. Corsano et al., 99 DTC 5658, where Noël J.A. agreed with the analysis of the standard of care in subsection 227.1(3) stated by Létourneau J.A.

[14]     A passage which I find particularly helpful is that found in Smith v. The Queen, 2001 DTC 5226 at p. 5231, paragraphs [31] and [32], where Sharlow J.A. said:

[31] The Tax Court Judge appears to have recognized the efforts made by Mr. Smith in an after June of 1995, but he noted, at paragraph 138:

      The actions that he took did not have the effect of ensuring that Revenue Canada received any of the monies here.

And, at paragraph 142:

The Court is satisfied that the actions taken by the Appellant did nothing to prevent the failure.

[32] It appears to me that these comments reveal another error in the Tax Court Judge's application of the due diligence defence. A director is required only to act reasonably in the circumstances. The fact that his efforts are unsuccessful does not establish that he has failed to act reasonably.

This comment was followed by Linden J.A. in Cameron v. The Queen, [2001] DTC 5405.

[15]     The guidance which the Federal Court of Appeal has given us in these cases is helpful in deciding this case. In Fremlin v. R., 2002 G.S.T.C. 65 at 65-8 to 65-9, I referred to these cases and outlined the approach which I followed and which I believe was consistent with the Federal Court of Appeal decisions.

30     I turn then to a consideration of whether the appellants have            exercised the degree of care, diligence and skill that a            reasonably prudent person would have exercised in       comparable circumstances.

31     There have been numerous cases involving directors' liability           under section 323 of the Excise Tax Act and section 227.1 of            the Income Tax Act. Two recent cases in this court reviewed        the decisions of the Federal Court of Appeal and noted the        less stringent test enunciated in that court.

32     In Mosier v. R., [2001] T.C.J. No. 692 (T.C.C. [General             Procedure]), I dealt with a director of a company whose      finances were completely controlled by the bank. At       paragraphs 33-35 the following appears

[33] One has to ask: what could he have done that he did not do? The answer is absolutely nothing. The case is in some ways reminiscent of Holmes v. R., [2000] 3 C.T.C. 2235, where the directors were unable to ensure that the CCRA be paid because the company's finances were completely controlled by their supplier. At pages 2241-2242 I referred to an earlier decision as follows.

I set out in Cloutier v. Minister of National Revenue (1993), 93 D.T.C. 544 (T.C.C.) at pp. 545-6, my approach in these cases.

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 judgement that is required here. Many judgement 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 of 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 wilful blindness on the part of the director.

I find as a fact that there is nothing that Mr. and Mrs. Holmes could reasonably have done to prevent the failure. They struck me as decent, honourable people who did all they could to ensure that the corporate obligations were fulfilled, but the economic circumstances rendered that impossible.

[34] This approach is one that I have followed in other cases and one that is, I believe, consistent with the series of cases in the Federal Court of Appeal which have invariably modified the more stringent standards applied in this court. The cases in the Federal Court of Appeal to which I am referring are The Queen v. Corsano et al. (supra), Worrell v. R., [2000] G.S.T.C. 91, Smith v. The Queen, 2001 D.T.C. 5226, Cameron v. The Queen, 2001 D.T.C. 5405, and Soper v. The Queen, 97 D.T.C. 5407.

[35] I need not quote from them. They stand for the proposition that section 227.1 of the Income Tax Act and subsection 323(3) of the Excise Tax Act require only that directors act reasonably. They do not demand the impossible. I have no hesitation in following that approach.

[16]     I revert then to the question "what could Mr. McKinnon reasonably have done to prevent the failure?" The single most significant contributing factor was the wholly unexpected refusal of Rideau to pay the agreed amount. Mr. McKinnon instructed his lawyer to proceed with legal actions but this is time consuming and expensive and was met with stonewalling, prevarication and arrogance by Rideau and its lawyers. Mr. McKinnon did all he could to keep the company afloat and ensure that its obligations were met. I regard the Canada Customs and Revenue Agency's stock response of "You should have pulled the plug and let the whole business go down the drain" as neither commercially realistic nor morally defensible. It implies that a person, such as Mr. McKinnon, who has put all he owns and all his time into the creation of a business can simply walk away from it and abandon all he has built up and leave his employees and their families in the lurch. If everyone did this it would mean that many more businesses that manage to survive would simply fold as soon as the going gets rough.

[17]     These cases are usually difficult. We start from the irrefutable fact that the payroll deductions or goods and services tax were in fact not remitted and so the CCRA looks to the directors. If one is so minded it is as a rule easier to dismiss an appeal by a director than to allow it. Frequently the director who is assessed is in difficult financial straits, cannot afford a lawyer and attempts to represent himself or herself. It is easy for the CCRA or the judge, with the benefit of hindsight, to tell the director all of the things he should have done. Here the CCRA is telling Mr. McKinnon "you should not have gotten into the business in the first place and once in it you should have gotten out sooner" I dare say that might have prevented the failure but everyone, including the government would have lost. That course of action would have been unreasonable.

[18]     Another argument that is frequently made in these cases and which I regard as fallacious runs somewhat as follows: "You were stealing from money held in trust for the Crown to run your business and pay your employees". This is, I think, an inaccurate and unfair characterization. It implies that there is a separate account (or cookie jar if you will) into which the payroll deductions are put and then withdrawn to pay the company's expenses. The fact is there is no cookie jar, real or notional, and no money to put into it even if there were. The net amount paid to the employees is all there is to go around. The employees, suppliers and other creditors are paid because if they are not the business will be closed down. Where, as here, unforeseen supervening events make it impossible for the payroll deductions to be paid to the government, I do not think there is anything the appellant could reasonably have done to ensure the payment.

[19]     The appeal is allowed and the assessment is vacated.

[20]     The appellant is entitled to his costs, if any.

Signed at Montréal, Quebec, this 3^rd day of December, 2003.

"D.G.H. Bowman"

A.C.J.

CITATION:

2003TCC884

COURT FILE NO.:

2001-2757(IT)G

STYLE OF CAUSE:

Gordon Murray McKinnon v.    Her Majesty The Queen

PLACE OF HEARING:

Vancouver, British Columbia

DATE OF HEARING:

November 25, 2003

REASONS FOR JUDGMENT BY:

The Honourable D.G.H. Bowman, Associate Chief Justice

DATE OF JUDGMENT AND REASONS FOR JUDGMENT:

December 3, 2003

APPEARANCES:

For the Appellant:

The Appellant himself

Counsel for the Respondent:

Kristy Foreman Gear

COUNSEL OF RECORD:

For the Appellant:

Name:
Firm:

For the Respondent:

Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada

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