Directors can be held liable for a corporation's debt
Under Canadian tax law, directors of a corporation can be held personally liable for certain components of a corporation's tax debt which the corporation cannot pay, such as in the case of an insolvency.
Generally speaking, corporations are required to collect payroll source deductions and GST/HST and remit them to the Canada Revenue Agency (CRA). These amounts collectively are referred to as Trust Amounts as they are being held in trust by a corporation on behalf of the CRA.
Oftentimes when a corporation runs into financial trouble, they fail to remit these source deductions and GST/HST amounts. Instead they use them to continue to make the payroll or pay suppliers.
When the CRA collector is satisfied that a corporation will not be able to service this debt they start proceedings to have the directors of the corporation be held personally accountable for the debt.
However, certain conditions must be met for the CRA to go after an individual director.
There are defences against Directors' Liability Assessments
According to s.227.1(2) of the ITA and 323(2) of the ETA (the wording in these two provisions are almost identical). A director of a corporation is not liable for unpaid source deductions or GST/HST unless one of the following conditions are met:
- A certificate for the amount of the corporation's liability has been registered in the Federal Court under either section 223 or 316 and execution of that amount has been returned unsatisfied in whole or in part;
- The corporation has commenced liquidation or dissolution proceedings or has been dissolved and a claim for the amount of the corporation's liability referred to in that subsection has been proved within six months after the earlier of the date of commencement of the proceedings and the date of dissolution; or
- the corporation has made an assignment or a bankruptcy order has been made against it under the Bankruptcy and Insolvency Act and a claim for the amount of the corporation's liability referred to in that subsection has been proved within six months after the date of the assignment or bankruptcy order.
Defence against Director's Liability
There are several ways directors can defend themselves against CRA's director's liability assessments.
Under s.227(1.4) of the ITA and s.323(5) of the ETA, an assessment of any amount payable by a person who is a director of a corporation shall not be made more than two years after the person last ceased to be a director of the corporation. If the CRA hasn't attempted to collect any tax debt from the individual director since their proper resignation, the director will escape any liability arising from either unpaid source deductions or unremitted GST/HST. Note that a proper resignation should always be delivered by the director to the corporation in writing.
However, if a director continues to act as a de facto director after resignation, the 2-year limitation will only be calculated based on the day they stopped acting as the de facto director as opposed to the previous resignation date. A de facto director is a person who assumes to act as a director. They are held out as a director by the company, and claims and purports to be a director, although never actually or validly appointed as such. Courts have also held that a director may not be held liable if they had no freedom of choice or power to act as one at the relevant time. One example would be a shareholder agreement that essentially strips any director the power to act.
Due diligence defence
A director is not liable for a failure to remit source deductions or GST/HST where the individual exercised a reasonable degree of care, diligence and skill to prevent the failure. Courts will usually examine the director's general capabilities such as business knowledge and personal education, and also actions taken by the director to prevent any failure. Some positive due diligence actions include:
- Ensuring an appropriate system such as separate accounts for remittance of payroll deductions and GST/HST;
- Regularly monitoring the status updates on the remittances and confirming each remittance has been made on time.
Section 160 Assessment
The CRA has expansive powers to go after not only the directors of a corporation, but also parties in a non-arm's length transaction. Under s.160 of the ITA, a transferee in a non-arm's length transaction can be held jointly and severally liable for tax debts incurred by the transferor prior to or during the taxation year in which the property was transferred. Unlike director's liability, the CRA can initiate a s.160 assessment at any time as there is no limitation period. Although there is no due diligence defence regarding s.160 assessment, there is no liability if the transferee could prove:
- The parties of the transaction were at arm's length; or
- The transferee paid fair market value for the property transferred.
A Director can always Challenge an Assessment
The director and the corporation are two separate taxpayers and case law indicates that one cannot be bound by the outcome of a separate proceeding involving another even though they are connected to each other. Therefore, a director can always challenge a corporate assessment even if the corporation chose not to do so.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.