http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/120495/index.do
Hall v. The Queen (October 13, 2015 – 2015 TCC 240, C. Miller J.).
Précis: The appellants, Mr. and Mrs. Hall, were the directors of an alarm system company, Petco Holdings Inc. (“Petco). Commencing in 2004 they ran into financial problems and fell behind in their remittances for employee tax, EI and CPP. They resigned as directors in 2009 but were assessed in 2011 in respect of withholdings for the period prior to their resignations.
The Tax Court dismissed their appeals holding that they had made a conscious choice to pay other creditors while their withholdings went into arrears.
Decision: This was a sad and all too familiar story:
[1] Kenneth Hall and Arlene Hall (the “Appellants”) were assessed on September 12, 2011 as directors of Petco Holdings Inc. (the “Company”) pursuant to section 227.1 of the Income Tax Act (the “Act”). The Appellants object to the assessments on three grounds:
i. the Minister of National Revenue (the “Minister”) has been unable to prove that the amounts assessed accurately reflect the amounts actually owed by the Company for employee source deductions;
ii. the Appellants ceased to be directors prior to September 12, 2009; and
iii. the Appellants exercised due diligence in attempting to prevent the Company’s failure to remit source deductions.
[2] Hall was the only witness for the Appellants. He testified that he was the decision-maker when it came to deciding what the Company should pay and what it could defer. Mrs. Hall looked to him for direction in that regard. She had no authority to make payments if Mr. Hall, as he put it, went down a different path.
[3] The Company was in the alarm system business and had been for many years prior to the 2004 to 2005 taxation years, the years in which the Company failed to remit the source deductions at issue. In the late 1990’s, the Company built a new building, which ultimately caused greater expense than anticipated. Mr. Hall left me with the impression this was the beginning of the Company’s financial woes. By 2004, Mr. Hall acknowledged that the Company was not making the payments it should have been making, but in fact paid whoever would allow for the continued operation of the Company. The Halls were well aware in 2004 and 2005 of the Company’s financial problems specifically relating to source deduction remittances. This arose due to the Company’s cash flow difficulties. The Halls maxed out the mortgage on their residence to put money into the business. They cut their own salaries significantly, ultimately taking home less than their employees. They pushed their suppliers to the limit to the point that no credit was left with them.
[4] Mr. Hall acknowledged that he decided to pay employees before he paid the Canada Revenue Agency (“CRA”). He suggested his dilemma was whether he should pay the CRA recognizing the directors’ liability, should he pay the employees, again recognizing potential directors’ liability and the harm the workers would suffer if he did not, or should he pay the Worker’s Compensation Board again recognizing directors’ liability, or should he make loan payments recognizing the Halls could possibly lose their home if he did not. He opted against paying the CRA on a timely basis, though the Company did make significant payments of $165,000 from September 2004 to April 2007 to North Central Bailiffs Ltd., the bailiff attempting to collect on writs issued pursuant to Federal Court certificates. I will discuss this in greater detail shortly.
Put simply, Mr. Hall made a decision to pay other creditors and was liable as a consequence:
[22] Have the Halls, as directors, simply condoned the continued operation of the Company by diverting source deductions to other purposes? I find they have. Where it is clear, as here, that it is the director himself, in Mr. Hall’s case, who made the decision to pay other creditors rather than remit the source deduction funds to the CRA, it is difficult to see exactly what steps such a director could have taken to meet the due diligence standard. This is not a situation of a director playing only the role of director, but the director is also the manager – the decision-maker. There are several examples of what the non-manager/director might do when cash flow is a problem and remittances are at issue:
- instruct management to actively seek funding;
- instruct management to establish separate accounts;
- instruct management to trim expenses;
- instruct management to lay-off employees;
- obtain financial advice or assistance;
- fire the financial officer or CEO;
- devise a new business plan;
- approach the CRA before default.
These all presuppose that the directors have some ability to act, unlike in a situation such as in the case of Worrell v Canada where it was found the bank had control over such decisions.
[23] What can the director, who is also charged as manager with deciding who to pay when cash flow is a problem, do? This is more problematic. I do not intend to revert to any active versus passive director distinction as far as the test or standard to be met. The objective standard of how the reasonable director exercises his or her duty of care, diligence and skill is the same. But, it is simply an uncomfortable reality for the managing director that options are more limited: for example, it is unrealistic to expect such a director to fire himself.
[24] Mr. Hall did seek other financing through personal loans and did cut back wages to himself and Mrs. Hall, but ultimately still opted to pay others to keep the business afloat. Also, those actions were instituted with a view to repay already failed remittances. So, obviously, these efforts did not prevent the failure. Are they sufficient to have met the duty of care, diligence and skill? What would the reasonable director have done differently? With the greatest respect to Mr. Hall, who struck me as an individual of integrity, who cooperated fully and helpfully after the defaults to see the CRA paid, and whose world has since collapsed around him, the reasonable director would have considered shutting the door and stopping the bleeding, or hiring new management. This is in hindsight easy to say and, perhaps getting to my earlier point, easier for the non-managing director to do.
This applied to both of the Halls, even though Mrs. Hall was a passive director:
[27] Does a director, such as Mrs. Hall, who apparently followed Mr. Hall’s instructions escape liability? It is for Mrs. Hall to prove that she acted reasonably to prevent the failure. She knew the Company was in financial straits and, effectively, let Mr. Hall take the lead. This is not sufficient to escape liability
As a result the appeals were dismissed.