A great new year’s resolution for Directors of a Canadian private corporations is to brush up on GST/HST and income tax compliance!  The reason is that where a corporation incurs a tax debt for GST, HST or income tax source withholdings, the directors of those corporations can be held personally liable.  For GST/HST purposes, this potential liability encompasses virtually all the net tax obligations of the corporation!  

A recent case demonstrates the high standard directors need to uphold, even when imposed with incredibly difficult situations in which the government has played a hand.

Director’s Liability for Tax Debts

Jafarnia v. The King (2023 TCC 171)concerned a director trying to appeal a personal liability assessment related to his corporation’s failure to properly deal with some $400,000 of payroll source deductions in 2011 and 2012.  The corporation had acquired the assets of a foundry plant in receivership with the aid of Iranian private investors (the appellant owned 10% of the corporation’s shares, whereas the other investors owned 90%).

The corporation ran into a number of difficulties, including dealing with the federal government’s economic sanctions against Iran, and the Nova Scotia provincial government’s refusal to grant loans to the corporation to stay in business.  This lead to an operational loss of $3 million in 2012, leaving the corporation to use its investment proceeds to maintain payroll, but not its payroll remittance obligations.  

Before the Tax Court of Canada (“TCC”), in appealing his personal assessments, the director relied on the “due diligence defence” available in subsection 227.1(3) of the Income Tax Act (a similar due diligence defence exists for GST/HST purposes in subsection 323(3) of the Excise Tax Act) and took the position that he was aware of the Corporation’s remittance obligations and could not control how funds were used.

This was to no avail, as the TCC noted that the due diligence defence was an objective test, focused on what a reasonably prudent person in similar circumstances would do, and not what the motivations of any particular individual director were:  see para 54.   The TCC also noted that a director cannot totally delegate their oversight duties to a subordinate, and must instead take “active steps to prevent the failure to remit, rather than simply having taken steps after the fact to remedy the failure to remit. …”

Each of these elements work to erase the distinction between passive and active directors – and the TCC noted that only an active director may exercise the due diligence defence.  

While the TCC acknowledged the Appellant’s good faith in his attempts to generate a financial success out of the corporation before remitting, but those decisions could not support a due diligence defence, and the director ultimately lost.

Takeaways

The bottom line is that directors need to appeal these types of assessments to the TCC, and be able to make out a case that they actively took tangible steps to address their corporations’ tax defaults – which means that directors need to know their duties!

An even better approach we be to ensure that the corporation was compliant in the first place!

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