Directors of Canadian corporations are exposed to potential liabilities under a variety of statutes, including the Income Tax Act ("ITA"), the Excise Tax Act ("ETA"), the Air Travelers Security Charge Act ("ATSCA"), the Excise Act, 2001, the Employment Insurance Act ("EI") and the Canada Pension Plan ("CPP"). In the current economic climate, where many businesses are struggling to meet their cash flow commitments, it is especially important for directors to remember that amounts collected or withheld under Acts such as these are held in trust for the Crown and are not operating funds.
Directors are jointly and severally liable with the corporation for any failures to remit these amounts, plus penalties and interest. Thus, if corporations facing extreme financial pressure use amounts held in trust for the Crown to meet obligations and even to preserve the existence of the business, the directors of the corporation face significant potential personal liability.
Directors are not liable for all of the tax debts of a corporation, but they are potentially liable for the certain amounts, including:
- income tax source deductions, including withholdings from:
- salary and wages;
- pension benefits;
- retiring allowances;
- death benefits;
- fees, commissions or other amounts for services;
- payments under deferred profit sharing plans; and
- taxable payments to non-residents;
- goods and services tax owing at the end of a reporting period;
- air travelers security charge under the ATSCA;
- excise duty under the Excise Act, 2001;
- employee premiums under the EI; and
- employee contributions under the CPP
This joint and several personal liability of directors protects the tax base by giving the Canada Revenue Agency ("CRA") other pockets to reach into, when a corporation fails to meet these obligations, and also gives directors a powerful incentive to ensure that corporations remain compliant.
There are three basic requirements for personal liability of directors:
- the CRA must demonstrate that it is unable to collect the amounts in issue from the corporation;
- the CRA cannot assess a director more than two years after that person ceased to be a director; and
- a director is not liable where the director exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.
CRA's Obligations Prior to Issuing an Assessment
The CRA must take certain steps before issuing a director's liability assessment. The CRA must first attempt to collect outstanding amounts from the corporation, including filing a claim in Federal Court and taking steps to seize corporate assets. In appropriate circumstances, it is recommended that directors who have received assessments request proof that the CRA has confirmed that the corporation has no assets to seize.
Limitation Period Defense
A director ceases to be a director by resigning, or by operation of law (for example, by becoming a bankrupt). A resignation should be submitted in writing, although oral resignations have been upheld as valid. There is no obligation on a director to ensure that the federal or provincial corporate registry be updated, as this is an obligation of the corporation (which, upon resigning, the director is no longer able to influence). Directors remain directors even after a trustee, receiver or liquidator is appointed.
When a director first becomes aware that a corporation may be failing with outstanding liabilities for which directors may be liable, it may be prudent for the director to immediately resign, if practicable, to start the clock running on the two year limitation period for director's liability assessments.
Due Diligence Defense
Directors should be careful to ensure that the corporation is withholding, collecting, remitting or paying amounts that are due. However, directors are not liable for the failures of the corporation if they exercise the diligence that a reasonably prudent person would have exercised in comparable circumstances. Perfection is not required, and a director is not obliged to absolutely guarantee that the corporation has met its obligations to the Crown. Rather, the director must use reasonable care to prevent such failure or default.
The CRA has offered the following examples of duly diligent behaviour:
- establishing an account for withholdings from employees and remittances of deductions, and accounts for GST amounts, ATSCA amounts and Excise duty; and
- reviewing the status of withholdings and remittances with officers of the corporation and confirming that these have been made.
Although directors are entitled to rely on the officers and managers of the corporation to manage the enterprise, where the corporation experiences financial difficulties, directors have a greater obligation to ensure that amounts owing to the Crown are paid, given the propensity for corporations to sometimes use amounts withheld and collected as operating funds. Additionally, directors may be responsible for obtaining an undertaking from the corporation's financial institution to pay amounts due to the Crown when due and to not block or restrict accounts used for this purpose. If the corporation is bankrupt or in receivership, directors should notify the trustee or receiver of the banking arrangements in place for paying amounts due to the Crown.
Demonstrating due diligence requires taking reasonable steps to prevent failures to withhold and remit amounts. It is insufficient to take steps to rectify failures after the fact, although a Court may adopt a favourable view of a director who takes positive, if unsuccessful, steps to later rectify a failure.
The test for due diligence is both objective and subjective. The test is objective in the sense that a director must perform to the standard of a reasonable person. The test is subjective in the sense that the director must have done what a reasonably prudent person would have done in the particular circumstances of the director. Subjective factors include the director's skills, knowledge and experience.
De Facto Directors and Directors in Name Only
Being a director "at law" is not determinative. In some cases, individuals who hold themselves out as directors and/or who perform the functions of directors, without being legally appointed, may be found to be de facto directors and may be liable as such. Further, if a director resigns but continues to act as a director, that person may be found to be a de facto director.
In other cases, individuals have been found not to be directors even though indicated as such in the provincial or federal corporate registry or documents in a corporate minute book. This can occur where the individual did not consent to be a director and/or was unaware that he or she was designated as a director.
What to do if you Receive a Letter Proposing to Assess You as a Director?
When the CRA concludes that a director may be liable for a corporation's failure to withhold, collect, remit or pay amounts due to the Crown, it will write the director to state that an assessment is being considered. Typically, the director will be given thirty days to respond, although extensions of time are usually readily granted. It is recommended that directors who receive proposal letters retain counsel to assist in preparing submissions to the CRA to dissuade it from assessing the director. Prevention of course remains the best medicine. Directors should respond forcefully to any suggestions from management that the corporation needs to temporarily "borrow" amounts due to the Crown, even when it is confidently declared as being necessary to avoid imminent financial collapse.