In the recent decision of Her Majesty the Queen v Colitto, 2020 FCA 70 ("Colitto"), the Federal Court of Appeal (the "FCA") unanimously overturned the Tax Court of Canada's (the "TCC") reasons in Colitto and provided further clarity regarding cascading assessments and a director's liability for his or her corporation's failure to withhold source deductions.
We previously commented on the TCC's 2019 decision, Colitto v Her Majesty the Queen, 2019 TCC 88 , provided an overview of the preconditions for section 227.1(1) of the Income Tax Act, RSC 1985, c 1 (5th Supp) (the "Act") to apply, and commented on that provision's interplay with section 160 in the context of cascading assessments for unremitted source deductions. Our overview of Colitto can be found here.
The sole issue in the appeal was whether Mr. Colitto's liability under section 227.1(1) of the Act was "in or in respect of" his 2008 taxation year, within the meaning of subparagraph 160(1)(e)(ii) of the Act.
The FCA agreed with the TCC that a textual, contextual and purposive analysis of 227.1(1) was required in order to determine when a director's liability crystallizes. However, the FCA did not agree with the TCC's analysis and undertook its own.
Casting its textual analysis first to the wording of subsection 227.1(1) of the Act, the FCA disagreed with the TCC's position that the language contained therein was silent on when a director's liability arises, stating that the provision of the Act was, at the least, ambiguous. Specifically, the FCA held that the phrase "the directors of the corporation at the time the corporation was required to deduct, withhold, remit or pay the amount are jointly and severally, or solidarily, liable, together with the corporation, to pay that amount" was ambiguous in the sense that it could be read to specify:
- Only which directors of the corporation are liable for the corporation's failure to deduct, withhold, remit or pay (the directors in place at the time of the failure); or
- Both that the directors in place at that time are liable, and also that the liability arises at the time of the failure.
Moving on to a contextual analysis, the FCA held that any ambiguity found in the textual analysis of section 227.1(1) is eliminated, finding that the most important contextual factor can be found subsection 227.1(2).
While the TCC read subsection 227.1(2) to strongly suggest that a director's liability does not arise until the relevant preconditions found therein are met, the FCA read otherwise. The FCA held that 227.1(2) is actually a relieving provision that sets out specific circumstances when director's liability imposed by subsection 227.1(1) could be avoided. The FCA contextually interpreted 227.1(2) to read as "a director is not liable under subsection 227.1(1) unless." where the TCC had impermissibly read this subsection as "unless and until". Further, when read in the context of the entire Act, the FCA determined that 227.1(2) serves as a mechanism of avoiding double taxation in the Act; its intention is to prevent the Minister from collecting an amount in excess of that owing by a corporation, not to delay the commencement of a director's liability for their corporation's failure to remit tax.
The contextual analysis of 227.1(2) undertaken by the FCA revealed that the similar analysis performed by the TCC did not fit within the context of section 227.1(1) nor the other sections of the Act this subsection animates. Contrary to the TCC's analysis, the FCA found that 227.1(2) does not render 227.1(1) a form of "to-do list" the Minister must see through before assessing directors of a corporation.
Finally, the FCA moved on to a purposive analysis of section 227.1. The FCA turned to their 2001 decision of Smith v Canada, 2001 FCA 84 [Smith], wherein the court determined that section 227.1(1) was enacted to embolden the Crown's ability to enforce on the obligation of corporation to remit source deductions. Citing Smith, the FCA determined the underlying purpose of section 227.1:
It was perceived that a corporation, particularly a corporation in financial difficulty, might prefer to default on its obligation to remit taxes, in order to satisfy creditors whose claims were more immediately pressing." The director's liability provision was enacted to deter corporations from pursuing such a course. The provision was "based on the presumption that a decision by a corporation to default on its remittance obligations would originate with the directors."
According to the FCA, if a director's liability does not crystallize "unless and until" the Minister exhausts all collection remedies against a corporation and files a certificate with the Federal Court, the above-described purpose is rendered "nugatory and pointless". The TCC's interpretation would provide a director significant time to reorganize his or her financial affairs and "creditor-proof" against liability under subsection 227.1(1) by transferring assets away to non-arm's length parties before the time the director would be considered liable for tax.
Based on the text, context and purpose of 227.1(1), the FCA held that a director's liability for unremitted source deductions arises at the time the corporation was required to deduct, withhold, remit or pay such deductions. Therefore, Mr. Colitto's liability as director crystallized in 2008 when Precision failed to remit source deductions.
Rounding out its decision, the FCA took the opportunity to comment on the TCC's reliance on Canada (Attorney General) v. McKinnon, 2000 CanLII 16269 (FCA) ("McKinnon") when reaching its decision. Although the FCA in McKinnon did explicitly say that "as a matter of law, the liability of a director for unremitted source deductions and GST does not crystallize until the conditions prescribed in subsection 227.1(2) have been satisfied", the Court of Appeal in Colitto emphasized that reliance on this statement was misplaced for two reasons. First, these comments were made in obiter and carry little precedential value - it was not necessary for the FCA in McKinnon to make this interpretation of subsection 227.1(2). Second, the FCA clarified that its statements in McKinnon are not diametrically opposed to those in this appeal - the requirement that a director's liability for a corporation's debt be maintained "unless and until" the requirements of 227.1(2) have been met is not inconsistent with the director's liability arising in or in respect of an earlier taxation year.
Overall, the TCC's decision in Colitto effectively left directors in a position where they could avoid responsibility for unremitted source deductions so long as they had the foresight to plan accordingly. By virtue of the FCA's decision in this appeal, subsection 227.1(1) has its broad scope restored and, in conjunction with section 160 of the Act, puts the Minister in a position to recover outstanding amounts transferred by a director to a non-arm's length transferee from the time the corporation failed to remit source deductions. This decision confirms that subsection 227.1(1) exists to discourage corporations from prioritizing creditors over the CRA, and works in tandem with section 160 of the Act to discourage conveyances from directors to non-arm's length parties when a corporation has failed to properly remit tax withheld at source.
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