In light of the inherent risks of serving as director of a corporation, business owner-operators may be tempted to appoint their spouse or family member as the sole director of their corporation, despite the fact that that person may be completely uninvolved with or unknowledgeable about the corporation’s operations.  This is primarily done with a view to “creditor-proofing”.  However, as the Federal Court of Appeal (FCA) decision of Constantin v. The Queen (2013 FCA 233) illustrates, this strategy is far from invincible when it comes to GST/HST remittances.

In Constantin, the Appellant’s common-law spouse operated a sign installation and lighting business, which failed to remit over $135,000 in GST, and was assessed by CRA accordingly.  Although the Appellant was not involved in the operation of the business, she was its sole director and shareholder and was assessed for the arrears under the director’s liability provisions of the Excise Tax Act (ETA). 

In her defence, the Appellant relied on section 323(3) of the ETA, arguing that she was not liable for the arrears on the basis that she exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. It was her evidence that she was completely unaware of the GST arrears as her spouse did not keep her informed of the company’s financial difficulties until well after the period covered by the assessment.  In fact, he had consistently lied to her about the status of the business when she made general inquiries.  Furthermore, she argued that she had abdicated all of her responsibilities as director to her spouse.

The Tax Court of Canada (TCC) dismissed the appeal.  It cited Buckingham v. Canada (2011 FCA 142), for the proposition that the due diligence test is an objective one, which asks what a reasonably prudent person would do in the Appellant’s particular circumstances.  It noted that the Appellant knew there were risks of being the director of the company but sought out no information regarding those risks.  It held that a reasonably prudent person, in comparable circumstances, would inquire about the potential risks related to her director position and ask more than general questions about the business’ affairs.  Events such as the Appellant’s frequent trips with her spouse to cash chequing centres should have triggered further inquiry.  

The FCA also dismissed the appeal, accepting the TCC’s conclusion that the Appellant was not concerned about the GST arrears and took no concrete action to prevent the company's failure to remit same.  It agreed that the Appellant could not have been unaware of the fact that the company had serious financial problems, or failed to wonder about the company’s debts, including its tax debts.  Accordingly, it agreed that the Appellant failed to meet the due diligence defence.

As is evident from this example, the TCC and FCA have placed a high threshold for a director to meet when the director is relying upon the due diligence provision in the ETA.  Accordingly, the strategy of using an uninvolved spouse as a sole director of a corporation is typically not a good one to avoid potential director’s liability.  Even if the director-spouse has nothing to do with the running of the corporation, doing nothing will not allow the spouse to evade director’s liability for GST/HST arrears. 

Employing this strategy could even double the risk of director liability in light of the possibility that a court concludes that the non-director in law, with day-to-day management of the company (e.g. the Appellant’s spouse in this case) is de facto director.  This can include an analysis of, inter alia, the extent to which the individual acted on behalf of the corporation.  Accordingly, in a situation such as the one in this case, there is risk that both the spouse running the business and the uninvolved director-spouse could both be considered directors and therefore liable for corporate GST/HST arrears pursuant to the director liability provisions of the ETA.

This article was published in the July 2015 edition of Tax for the Owner-Manager.