Directors of Corporations have liabilities under various statutes, which, for example, result in liability for wages and vacation pay, environmental liabilities, workplace liabilities and liabilities under corporate statutes. However, it is with respect to amounts owing to the Crown for various taxes that most directors incur liability. Taxing authorities have been very zealous in recent years in going after directors for unremitted source deductions, unpaid sales taxes and for Part VIII Tax Liabilities which arose as a result of the Scientific Research Tax Credit fiasco of several years ago.
Most director’s liability claims are with respect to unremitted source deductions. This includes income taxes, unemployment insurance premiums and Canada Pension Plan premiums which have been withheld by the employer and not remitted to Revenue Canada. What frequently happens in the case of businesses that are struggling financially is that source deductions are used by management to finance the Corporation in an attempt to keep operating rather than close the doors. When the Corporation subsequently goes out of business, Revenue Canada has the statutory right to go after the directors of the Corporation. The directors are liable for the unremitted source deductions plus interest and penalties.
For Revenue Canada to successfully claim against a director it must meet certain requirements under the Income Tax Act. In particular a certificate in respect of the Corporation’s tax liability must have been filed, and Revenue Canada must then attempt to levy execution against the Corporation and the execution must be returned unsatisfied. Alternatively, in the case of a liquidation or bankruptcy, Revenue Canada must prove its claim within a 6-month period of time. If these pre-requisites have not been completely met by Revenue Canada then the director has no liability. Technical differences based on a failure by Revenue Canada to fulfil all of its requirements under the Income Tax Act are often successful.
Furthermore, the Tax Act gives Revenue Canada only 2 years to attempt to collect from a director for this liability. If the 2-year period has not been met then the director escapes any liability for these unremitted deductions.
In assessing whether an individual has potential liability for unremitted source deductions, it is important to determine as a matter of law whether the individual who Revenue Canada claims was a director of the Corporation was in fact a director in law at the time that the source deductions were not remitted. For example, the individual might never have properly been appointed as a director in accordance with the appropriate corporate statute, or might have resigned prior to the failure to remit.
Even if the person was a director at the relevant time, the Courts have held that if he had no freedom of choice or power to act as a director on the relevant date then he might not be liable. Such freedom of choice may not exist where, for example, there is a unanimous Shareholders Agreement removing the director’s power to act, or in a situation where a receiver has been appointed by a creditor of the Corporation and the Receiver is actually running the business.
Finally, even if all of the above tests have been met, a director can still avoid liability by availing himself of the “due diligence” defence set out in the Tax Act.
The Tax Act provides that a director is not liable for a Corporation’s failure to remit source deductions where he exercises the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.
Much of the recent case law has focused on the questions of the due diligence defence. The Courts tend to look at a variety of factors before deciding whether a director has acted diligently. The personal background of the director including general capability as a director, business knowledge and education have been examined. The Courts has also examined actions taken by the director to prevent the failure. The Courts have stated that there is a positive duty to take action to prevent these failures. Accordingly, every director should:
- Familiarize himself with the withholding and remittance requirements;
- Ensure that an appropriate system to withhold and remit has been implemented by the Corporation; and
- Require regular written reporting ensuring that the remittance procedures are functioning.
- For companies that are in a precarious financial position even more stringent steps may have to be taken.
The Courts have also said where a Corporation reaches the point where it cannot issue a remittance cheque for fear that it will not be honoured, it is time to lock the door and go out of business. Accordingly, the mere decision to try to keep the Corporation in business may result in the director’s reducing his ability to rely on the due diligence defence.