Canada V. Chriss – Directors Tax Liability Defences – Toronto Tax Lawyer Case Comment
Introduction – Canada v. Chriss & Directors Tax Liability Defences
Under Canadian tax law, the directors of corporations can be held personally liable for the unpaid GST/HST or payroll remittances of their corporation. This liability is not unrestricted, and can be eliminated under certain circumstances including if the Canada Revenue Agency waits until two years or more have elapsed since the director resigned or if the director can show he or she diligently attempted to prevent the failure to remit. Canada v. Chriss is a recent case from the Federal Court of Appeal which deals with both of these limits to directors’ tax liability.
The directors in Canada v. Chriss had resignations prepared, but did not execute them properly. Their resignations were accepted as effective by the Tax Court, but subsequently rejected by the Federal Court of Appeal. This underscores the importance of observing the relevant corporate formalities when resigning as a director. The taxpayers also made two due diligence defences that were ultimately rejected by the Federal Court of Appeal.
Background – Directors Tax Liability for Payroll and GST/HST Remittances
The Canadian Income Tax Act and the Canadian Excise Tax Act (GST/HST) contain provisions which allow the CRA to assess the directors of a corporation personally for unremitted payroll withholdings and GST/HST. The Canada Revenue Agency’s ability to assess directors is not unrestricted; in particular, directors cannot be assessed for the remittance arrears of a corporation once two years have elapsed since they resigned. Another limitation on directors’ liability is that if a director can show they exercised the degree of care, diligence and skill to prevent the failure to remit that a reasonably prudent person would have exercised in comparable circumstances, they are not personally liable for the corporation’s remittance arrears.
In Canada v. Chriss, the court considered both of these limitations. The directors in the case argued both that they had successfully resigned and that they had exercised sufficient due diligence to shed the tax liability. If you are concerned about whether you are liable for the unpaid remittances of a corporation of which you are a director or former director, please consider contacting one of our top Toronto tax lawyers.
Facts – Canada v. Chriss Directors Tax Liability Defences
George Chriss and Derek Gariepy carried on an unsuccessful business through a corporation, CG Industries which eventually became insolvent with significant remittance arrears. Mr. Chriss and Mr. Gariepy decided to take another shot at the same business, and opened a new corporation, 1056922 Ontario Limited (“105 Ltd”), to continue their business. Mr. Chriss and Mr. Gariepy decided that they would not serve as the directors of 105 Ltd, and instead their wives Mrs. Sally Anne Chriss and Mrs. Donna Elizabeth Gariepy (the “Directors”) became the directors of 105 Ltd.
By 2001, 105 Ltd had run into significant financial difficulties and the Directors informed their husbands, who owned 105 Ltd and served as its officers, that they wished to resign. Mr. Chriss instructed the solicitors of 105 Ltd to prepare resignations for the Directors. Resignations forms were prepared for both Directors, but never signed. Both forms also contained a blank date field, and never left the offices of 105 Ltd’s solicitors. The Directors did not take any action to prevent 105 Ltd from failing to remit tax withholdings.
A few months later, Mr. Gariepy instructed Mr. Paul Caroline, a lawyer at a different firm, to prepare a resignation for Mrs. Gariepy. This second resignation could not be recovered at the time of trial. A backdated version of this second resignation was later created and given to the CRA. Mr. Paul Caroline was also a major creditor of 105 Ltd, and during its financial difficulties he exercised significant influence over the company’s activities.
105 Ltd failed to remit any tax withholdings between 2000 and 2005. In 2008, the Canada Revenue Agency assessed the Directors for 105 Ltd’s remittance arrears.
Trial Decision at the Tax Court of Canada - Canada v. Chriss Directors Tax Liability Defences
The Directors through their Canadian tax lawyers argued that they were not liable on the basis that they were assessed more than two years after they resigned in 2001. In the alternative, the Directors argued that they met the standards of the due diligence defence for directors liability.
The Directors provided two different grounds as to why their inaction still qualified them for the due diligence tax defence. First, they argued that it was reasonable for them to believe they had resigned in 2001, and that a reasonable person in comparable circumstances who believed they resigned would also have not taken any actions. Second, they argued that even if they didn’t believe they had resigned, Mr. Caroline had effectively taken control of the company, which made it impossible for them to take any steps to prevent the failure to remit anyways.
The tax court found that both Directors had successfully resigned in 2001. The basis for this decision was that Directors had communicated their intention to resign to the company and a written resignation was prepared, even though it wasn’t signed or dated. The tax court pointed out that since the Directors told their husbands they wanted to resign, all of the officers, directors, and shareholders of the corporation knew the Directors intended to resign. In response, Mr. Chriss acting as an officer of the corporation had resignation documents prepared. The tax court was prepared to overlook the fact that the resignations were not signed. On this basis, the Tax Court of Canada found in favor of the taxpayers. The court did not find sufficient evidence for the existence of Mrs. Gariepy’s supposed second resignation and did not accept the backdated version.
The court also considered the Directors’ alternative arguments. The tax court accepted Mrs. Chriss’s due diligence defence on the grounds that she had a reasonable belief that she resigned, which justified her lack of positive action to prevent the failure to withhold. The tax court rejected Mrs. Gariepy’s parallel due diligence defence on the basis that she did not have a reasonable belief that she resigned since she and her husband later had a second resignation prepared. The court also rejected the due diligence argument based on Mr. Caroline taking control of the company for both Directors. The court points out that the fact that the influence Mr. Caroline had was due to him being a key creditor who needed to be paid to keep business operations going. In the view of the tax court, this type of economic influence is not sufficient to remove the powers of the directors and officers of a company over its affairs, and so does not remove the need to take positive action to live up to the standard required for the due diligence tax defence.
Appellate Decision at the Federal Court of Appeal – Canada v. Chriss Directors Tax Liability Defences
The Federal Court of Appeal overturned the Tax Court of Canada’s decision and rejected all of the arguments made by the Directors. The Federal Court of Appeal rejected the efficacy of the resignations on the basis that the Ontario Business Corporations Act requires the corporation to receive a written resignation from a director in order for that director to resign. The court pointed out that may limitation periods require a precise date for when a director resigns, and that many third parties also need to be able to check who the directors of a corporation are. As a result, the law requires written resignations so that the status of directors is capable of objective verification. This lead the court to conclude that the unsigned letters of resignation with no effective date that never left the file of 105 Ltd’s solicitors did not constitute a written resignation received by the corporation.
The Federal Court of Appeal rejected the tax due diligence argument on the basis of a reasonable belief in resignation for both Directors. The court states that the scope of the tax due diligence defence is informed by the nature of the responsibility in question. In the opinion of the court, the question of whether or not a person is a director is fundamental to corporate governance and by nature requires an unambiguous answer. Therefore, a reasonable belief in resignation must be attentive to the actual requirements of resignation. Since in this case, the directors never executed the written resignations or were told they were sent to the corporation, they cannot be judged to have a reasonable belief in having resigned. Additionally, the court emphasized that directors must carry out their duties on an active basis, and should not be allowed to rely on their own inaction. In this case, the court points out that a reasonable director would have insisted on being satisfied that their intention to resign had been implemented.
The Federal Court of Appeal also rejected the tax due diligence argument on the basis of Mr. Caroline’s control of the company for both Directors. The Federal Court of Appeal concurred with the Tax Court of Canada, and emphasized that despite the economic influenced wielded by Mr. Caroline as a creditor, the legal power to decide how to dispose of 105 Ltd’s funds still remained with 105 Ltd under the stewardship of its directors.
Tax Tips for Taxpayers – Canada v. Chriss Directors Tax Liability Defences
The main lesson for taxpayers from Canada v. Chriss is not to cut corners with formalities when resigning as a director. If the taxpayers in this case had signed and dated the resignations they had prepared in 2001 and delivered them to the Corporation, the Canada Revenue Agency would not have been able to successfully assess them for the tax remittance arrears of 105 Ltd in 2008. It is clearly worth the time, effort, and money to ensure that a director resign properly.
Another tax tip is that the demands of creditors like Mr. Caroline are not enough relieve them of their responsibility to ensure that their corporation remits tax as required. The courts have approved tax due diligence arguments based on the loss of control to creditors, but only when creditors had the legal ability to prevent the company from remitting funds. Typical examples include when remittance cheques signed by the company are not honored by the company’s bank or when all cheques must be approved by lender appointed monitors who refuse approval to remittance cheques. If a receiver is appointed or the company goes bankrupt, the directors’ loss of legal control over the company to a person acting in the interest of the company’s creditors is also sufficient to ground a tax due diligence argument.
In other cases such as Franck v. The Queen and Canada v. McKinnon the courts have considered in more detail how the directors of companies on the verge of default should behave. Directors who oversee a company which temporarily fails to remit tax source deductions in order to continue operating can be successful in making a tax due diligence defence argument if the company’s financial difficulties are due to unforeseen circumstances and the directors are actively taking steps to ensure the remittances will be paid. The presence of severe economic pressure on the company by itself however, is not enough to ground a tax due diligence defence for the company’s directors. If you would like to learn more about the types of tax due diligence defences that have been successful, please consider contacting one of our knowledgeable Toronto tax lawyers.