This article originally appeared in the March 2010 issue of Canadian Lawyer Magazine
The Tax Court of Canada and the Federal Court of Appeal have predominantly held that the standard of care required of directors to meet the due diligence defence test in Section 227.1(3) of the Income Tax Act (Canada) is subjective. Not only is the basis for these decisions questionable, but the resulting inconsistencies and uncertainties depart from a coherent system of rational law.
Section 227.1(3) enables directors to escape personal liability for non-remittance by corporations of taxes and other source deductions withheld at source if they can establish that they "exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances." The language used in Section 227.1(3) mirrors the standard of care language contained in subsection 122(1)(b) of the Canada Business Corporations Act.
The Supreme Court of Canada in Peoples Department Stores Inc. v. Wise (2004) held that Section 122(1)(b) is an objective test, thereby modifying and elevating the subjective common law standard of care established in the seminal case of City Equitable Fire Insurance Co., Re. The latter held that a director is only required to demonstrate the degree of care, skill and diligence that could reasonably be expected from him, having regard to his knowledge and experience.
Regrettably, the Federal Court of Appeal in Soper v. R. (1997) held that Section 227.1(3) largely adopted the common law subjective test (and also included an objective element). The Court described its "inherently flexible" (and contradictory) test as nothing less (clear) than "objective subjective". Soper has since, for the most part, been followed. Bucking the trend however, Justice Margeson of the Tax Court of Canada in Jarrold v. R. (2009) correctly held that the test in Soper was superseded by Peoples.
It is difficult to reconcile the Court's conclusion in Soper. Section 227.1(3) refers to "a reasonably prudent person", not to "a person of his knowledge and experience". Clearly, the subjective elements of the common law test were replaced by the objective "reasonably prudent person" test.
In Soper, the Court also held that the words "in comparable circumstances" embrace the subjective elements of an individual director's knowledge and experience. Again, the distinction between the words "in comparable circumstances" and "having regard to his knowledge and experience" is self-evident. As was held by the Tax Court of Canada in White v. Minister of National Revenue: "The word 'circumstances' in my opinion, refers to the operational and administrative situation of the corporation in which the director who has responsibility finds himself, not to the personal attributes or characteristics which he brings (or does not bring) to the corporate duties." This interpretation was confirmed in Peoples which held that the words "in comparable circumstances" require the context in which a given decision was made be taken into account, as opposed to subjective elements relating to the competence (or incompetence) of any given director.
Finally, in Soper the Court concluded that by using the words it did, Parliament intended to retain the subjective elements of the common law test. Justice Robertson stated: "...had Parliament wished to strengthen the standard of care imposed at common law, it could have easily done so by adopting appropriate language." Adopt appropriate language it did - language which departs conspicuously from the common law test. Had Parliament intended to retain the subjective test, it would have used the same or similar words. By using different words, Parliament must therefore have intended a departure from the common law test. This interpretation was confirmed in Peoples which found that the language in Section 122(1)(b) emulates the language proposed by the Dickerson Report (1971) which recommended an objective standard of care and preceded the enactment of the Canada Business Corporations Act by four years.
Given that Parliament intended an objective standard in using the words it did in Section 122(1)(b), and given that the same Parliament subsequently used identical words in drafting Section 227.1(3), the principle of presumption of statutory coherence requires a harmonic interpretation between the two provisions.
The subjective test is uncertain and unpredictable. Requiring that a director only exercise the degree of care which is commensurate with his knowledge and experience harks back to the days when equity was measured by the length of the Chancellor's foot. No two directors have exactly the same knowledge and experience. Section 227.1(3) imposes liability on all directors of a corporation, not just those who are familiar with the tax remittance requirements. As the time-honoured adage goes, nul n'est censé ignorer la loi.
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