Remitting is not Optional: Personal Liability of Directors for Source Deductions and Sales Taxes – The Best Intentions are Not Always a Defence


This article has been contributed to the blog by Steven GolickSachin Kanabar and Brian Lynch. Steven Golick is a partner in the Insolvency and Restructuring Group of Osler Hoskin & Harcourt LLP, Sachin Kanabar is an associate in the group and Brian Lynch is a student-at-law at the firm.
The Federal Court of Appeal for Canada (the “Court”) recently considered the limits of the statutory due diligence defence available to directors of a corporation under Canadian Income Tax Act (“ITA”) and sales tax under the Excise Tax Act (“ETA”).  The case involved a director of a corporation who caused the corporation to make payments to some of its creditors in an attempt to save the corporation from financial difficulty rather than paying the funds (the “Remittance Funds”) to the government in connection with employee source deductions under the ITA and sales taxes under the ETA  (together, the “Remittances”).

In Buckingham v. Canada, Kevin Buckingham was the chair of the board of directors of Mosaic Technologies Corporation (“Mosaic”) and also its largest shareholder.  Buckingham played a significant role in Mosaic’s daily operations.  Due to financial difficulties, Mosaic failed to remit sales tax amounts owing in March and June of 2003, as well as the associated penalties and interest.  Mosaic also failed to remit the amounts owing as employee source deductions for the period of October 2002 to August 2003, as well as the associated penalties and interest. Source deductions are the amounts that employers are required to deduct from employees’ wages amounts for income tax, employment insurance and Canada pension plan and then remit to the government.
In 2002 Mosaic was experiencing financial difficulties.  Mosaic took measures in 2002 and until the end of February 2003 to attempt to address its financial difficulties.  Such measures included attempts to secure a line of credit, reductions in expenditures, and attempts to merge with another company.
Following the failure to secure new financing, after February 2003 Mosaic turned its attention to selling its assets with a view to satisfying its creditors.  Mosaic sold assets for $1.6 million in May 2003 in order to pay its creditors, including the Remittances owed to the government.  Buckingham expected that the proceeds of the sale would fully satisfy creditors, including the government.  Unfortunately, Mosaic did not receive sufficient proceeds of the sale to satisfy its debts.  Mosaic and its various subsidiaries subsequently ceased operations.
The government then sought to hold Buckingham liable, in his personal capacity as a director o Mosaic, for Mosaic’s failure to duly remit the Remittances pursuant the provisions of the ITA and the ETA.  These statutes provide for the personal liability of the directors of a corporation for the company’s failure to make its remittances in certain circumstances.
Both the ITA and the ETA provide for a due diligence defence.  In order to rely of this defence the director of the corporation must demonstrate that he or she exercised the degree of care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances to prevent the failure to remit.
Buckingham submitted that he met the statutory due diligence defence. Buckingham maintained that as long as he had made serious and reasonable efforts to resolve the financial difficulties of Mosaic, he satisfied the requisite standard of care to succeed in the defence.  The Court rejected this argument.
The Court confirmed that the requisite standard for the statutory defence is an objective one.  However, it is an objective standard with a contextual element.  This means that the Court may take the particular circumstances of the director into account but must consider them against the objective standard of a reasonably prudent person.  In order to rely on the statutory defence in the context of Remittances, the director must show that he turned his attention to the required Remittances and exercised the duty, diligence and skill of a reasonably prudent person in the circumstances with a view to preventing a failure by the corporation to make the Remittances.
The Court found that Buckingham could successfully invoke the statutory due diligence defence until the end of February 2003.  It was a finding of fact by the trial court that during this time Buckingham had a reasonable expectation that Mosaic’s efforts would result in the Remittances being made.  As a result, Mosaic’s efforts were directed toward preventing a failure to remit and Buckingham satisfied the elements of the statutory defence.
However, the trial court had also made a finding of fact that after February 2003 Mosaic’s focus shifted to curing the failure to remit instead of preventing it.  This was at the time that Mosaic began to focus on selling assets.  Therefore, from this point in time forward, Buckingham no longer had any reasonable expectation of preventing the failure of Mosaic to make Remittances.   Once Buckingham no longer had a reasonable expectation that the failure to make the Remittances could be prevented, he could not rely on the due diligence defence where he condoned the continued operation of the business by directing or allowing Mosaic to use the funds to pay the creditors and not pay the Remittances. The effect of this was to make the government an involuntary creditor.  Thus, from February 2003 forward, Buckingham could not rely on the statutory due diligence defence in respect of  Mosaic’s breach of the ITA and ETA for non payment of the Remittances
This case highlights the potential personal risk to directors of a company who allow or authorize a company to fail to meet its obligations with respect to source deductions and various sales and goods and services taxes.  While a director can rely on a due diligence defence in certain circumstances, extreme caution is required as the facts must completely support the defence.  It is generally not acceptable for directors to cause a company to pay certain creditors, while not at the same time ensuring that all remittances for source deductions and sales and goods and services taxes are made. Doing so can expose directors to personal liability for these unremitted amounts.

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