Keeping up with our tax obligations is challenging when times are good, and even more so when the economy turns. Painful though it is to manage our own tax obligations, becoming liable for taxes actually payable by other people can cause even greater distress.
The Canada Revenue Agency (CRA) has amazingly broad collections powers bestowed upon it by the government, and it is in no way shy about using them.
Directors’ Liability
Many of us are asked to serve as directors of incorporated entities, whether for profitable corporations or non-profit entities like charities. Such service does not come without responsibilities, and the wise director will ensure they understand these obligations.
The CRA can collect GST/HST and source deduction arrears from directors where the legal entity they oversee fails to remit them. These are considered “trust funds”, in that the organization collects them from third parties (clients or employees) on behalf of the government – they are not the organization’s own funds.
Especially in times of financial challenge, it is all too tempting to prioritize payments to other creditors, such as suppliers and staff whose continued goodwill is vital to business continuing. While most business people will recognize that penalty and interest charges can result, the potential for personal liability is often a surprise to directors.
Two provisions which provide the CRA with significant collection powers are the Income Tax Act Section 160 and the Excise Tax Act Section 325. Defending oneself against such a claim can be challenging. Before assessing a director, the CRA is required to execute a Writ of Seizure and Sale against the corporation in court. Some cases have failed because the CRA could not demonstrate this had been done.
Often, the defence for directors is limited to establishing that they exercised due diligence to ensure these amounts were remitted in timely fashion. The courts have set this standard fairly high. For example:
- the belief and intention, however heartfelt, that a shortfall will be made up at a later date will not protect the director. The courts have held (for example, in the Maxwell case, 2015 TCC 74) that the director is required to take steps to prevent failure to remit these amounts, not just to make up for shortfalls later in the expectation that funds will become available.
- one director’s reliance on another director active in the business is not sufficient, especially when he had previously received correspondence indicating source deductions were in arrears – the court held that a reasonable person would take independent steps to verify remittances were made (Helgeson, 2016 TCC 114).
- a director was not liable when he requested financial information and took other steps to ensure the financial health of the corporation, but was intentionally deceived by others involved in the business.(Thistle; 2015 TCC 149).
- similarly, a director placing trust in a manager where there is no reason to doubt that person’s competence or honesty may be due diligence (Attia, 2014 TCC 48, and Roitelman, 2014 TCC 139).
- an employee who accepted a directorship under pressure by her employer, but had no power to influence remittances to CRA was not liable (Qian, 2013 TCC 386).
The CRA must issue assessments no more than two years after an individual ceases to be a director. The writer has personally experienced a case where a director obtained a copy of the list of directors from corporate registry (including himself), resigned, and obtained a listing, a week later, showing he was no longer a director. While never assessed by CRA, he was contacted and threatened with an assessment.
In some cases, the timing of a resignation is challenging to prove. For example, the bankruptcy of an underlying corporation does not mean a directorship ends. (Jobin, 2014 TCC 326). The CRA can revive corporations to issue assessments.
The courts have exonerated individuals who were listed as directors, but never actually accepted the office (Macdonald, 2014 TCC 308). By contrast, a formal resignation while continuing to act as a director resulted in the individual remaining liable as a de facto director (McDonald, 2014 TCC 315).
The courts are unsympathetic to individuals who become directors of organizations for the benefit of others, often family members.The courts are unsympathetic to individuals who become directors of organizations for the benefit of others, often family members. For example, in a case where the spouses of the business owners and operators were named as directors on incorporation, but later advised legal counsel they wished to resign, but did not complete the resignations, they were still liable (Chriss & Gariepy, 2016 FCA 236). Similarly, the 23-year-old son of a business principal who took on a directorship was not protected from liability (Whissell, 2014 TCC 350).
Directors should be conscious of their obligations, and ensure that their organizations have proper processes to remain current with their GST/HST and employer obligations. Even where the directors were ultimately not liable, they incurred the costs and stress of CRA assessments and court appeals.
Transfers from Non-Arms-Length Parties
Two provisions which provide the CRA with significant collection powers are the Income Tax Act Section 160 and the Excise Tax Act Section 325. These provisions allow the CRA to collect income taxes and GST/HST from a person to whom the actual tax debtor transfers assets. The taxes must be owing at the time of the transfer, but need not be assessed, so this can apply even where the parties are all unaware that anyone owes taxes.
The rule only applies to transfers between persons not acting at arm’s length, which includes all related parties (including parents, children, spouses and siblings). To the extent that the recipient of the property paid less than fair market value for assets received, the transferor’s taxes become the recipient’s debt.
For example, assume Tony and Tina are married. They own their home, worth $500,000, jointly. Tina owes taxes, and transfers her half-interest in the house to Tony. She has also effectively transferred liability for her taxes, up to the $250,000 value of her half-interest.
If there was a $350,000 mortgage on the house, Tony’s assumption of half of the mortgage is partial consideration for Tina’s interest, so he only received $75,000 (half of the house, $250,000, minus half the mortgage, $175,000), so he only becomes liable for $75,000 of Tina’s taxes.
The CRA must issue assessments no more than two years after an individual ceases to be a director.The breadth of this provision can be frightening. Some examples include:
- a taxpayer’s widow was liable for his taxes to the extent of RRSP funds she received on his death (Kuchta, 2015 TCC 289).
- A corporation transferred assets to a second corporation, so its tax debt transferred as well. The second corporation paid dividends to a related individual, which also transferred the tax debt to that individual (Lupien, 2016 TCC 2).
- A medical doctor directed health care revenues to a joint account from which his wife made payments. She was liable for his taxes. Payment of their joint household expenses did not reduce the transfer, but payment of the husband’s business expenses could be a form of consideration, and reduce the amount (Klundert, 2016 TCC 160).
- A transfer in settlement of matrimonial property rights is exempt from this liability. However, earlier transfers during the marriage can still attract liability which continues after the parties are divorced (Sokolowski Romar, 2013 FCA 10).
- Repaying the transferor does not reverse liability – where an individual allowed her common-law spouse to deposit funds to her bank account, then returned the funds to him, she was still liable for his tax debts up to the amounts deposited (McDonald; 2015 TCC 73).
- Similarly, where funds were deposited by a tax debtor to an account owned by a corporation controlled by a business acquaintance, then paid out to the tax debtor, the corporation was liable for the tax debtor`s taxes owing to the extent of funds which had flowed through its bank accounts (9101-2310 Quebec Inc., 2013 FCA 241).
Unlike the directors’ liability provisions, there is no time deadline for a S. 160 assessment – these assessments are often made many years after the asset transfer.
Put Them Together
Many of us are asked to serve as directors of incorporated entities, whether for profitable corporations or non-profit entities like charities. Such service does not come without responsibilities, and the wise director will ensure they understand these obligations.
As powerful as these collections abilities are separately, they become even more problematic in combination. Where a director was assessed for a corporation’s unremitted GST/HST, and then transferred cash and other assets to her husband, she was assessed for directors’ liability, after which her husband was assessed under Section 160 (Benaroch, 2015 TCC 93). In this case, however, the CRA could not demonstrate it had filed the required Writ, so both assessments were invalid.
What if the Taxes are Wrong?
Several court cases have held that the director or property recipient can challenge the underlying taxes assessed to the person who originally owed the tax. Often, the original taxpayer was insolvent and may not have challenged an excessive assessment. However, this requires obtaining information from the initial taxpayer, which may be challenging depending on how closely connected the parties are. Records may also have been lost or destroyed with the passage of time.
Overall
The CRA’s reach as the tax collector for the citizens of Canada is long, and they have powerful collection tools at its disposal. Caution should be exercised to ensure that you, as a director, don’t become liable for someone else’s tax bills, in addition to your own.
About Hugh Neilson
