Directors' Liability for Tax Debts

Becoming a director of a corporation involves significant obligations, not the least of which is vicarious liability for certain income tax and GST/HST obligations of the corporation, should it become insolvent and fail to make remittances. Understanding the limits of that liability may help you avoid becoming a target for the Canada Revenue Agency (CRA). 

When a corporation encounters financial difficulty, tax amounts withheld or collected are often diverted from the CRA to more insistent creditors, potentially leaving CRA holding the bag if the business fails altogether. Section 227.1 of the Income Tax Act puts the onus on directors to avoid this result. The section allows the CRA to pursue directors for uncollected or unremitted amounts for source deductions on salaries and withholding taxes on payments to non-residents.¹  It does not assign liability for unpaid federal or provincial corporate income taxes. Subsection 323(1) of the Excise Tax Act provides a similar rule for GST/HST collections, which has caused a dramatic increase in assessments targeting directors since the introduction of the GST/HST.

The CRA is required to pursue the corporation first, and generally may only issue an assessment to a director when collection from the corporation is unsuccessful or a claim has been proven under a dissolution or bankruptcy proceeding. At that point, an assessment may be issued to the director for the unremitted amounts together with any related penalties or interest.

De facto and deemed directors

A person who acts like a director without being formally qualified as such, or continues to act as a director after resigning his or her position, may be found to be a de facto director under the common law. Furthermore, the applicable provincial business corporations legislation may include provisions "deeming" such persons to be directors. Both deemed and de facto directors generally have been found to be subject to the directors' liability provisions under the Income Tax Act and the Excise Tax Act. In the 2007 Tax Court case Bremner², the sole shareholder was found to be a deemed and de facto director after the last actual director (his spouse) had resigned. The court upheld the CRA's assessment to Mr. Bremner, as a de facto director, for unremitted GST/HST amounts. Ironically, it appears the activities in which Mr. Bremner engaged during the relevant period – ultimately rendering him liable for the corporation's GST/HST debts – consisted primarily of the filing of GST/HST returns and remittance of GST/HST payments.

Preventing or defending an assessment

There are various defences to an assessment under these provisions. Two of these defences are particularly important to consider in advance, as their effectiveness can be improved significantly by actions of the director if undertaken on a timely basis.

1.  Due diligence

A director will not be held liable if he or she is found to have exercised the "degree of care, diligence and skill that a reasonably prudent person would have in similar circumstances" to prevent the failure to remit. This defence is cited frequently, but the courts generally have held directors to a relatively high standard of conduct to apply it successfully. In some cases, directors with financial expertise have been held to a higher standard of care, and once it becomes obvious that the company is in dire financial straits, directors are expected to increase their diligence to ensure amounts are remitted. "Outside" directors who are not involved in the day-to-day business, generally are held to a lesser standard, although the CRA notes ominously that "lack of involvement in the affairs of the company may not absolve them from liability." Outside directors can help protect themselves by ensuring minutes of Board meetings document confirmation by management or managing directors that all source deduction and GST/HST remittances have been made on a timely basis, especially once it becomes clear cash is tight and management might be tempted to postpone payments to the CRA.

The CRA also suggests directors require that a separate bank account be established for payroll and GST/HST remittances, and regularly confirm the status of the account with management. In practice, however, this rarely happens. It is CRA policy to notify a director in advance of a potential assessment, and consider any response or supporting information provided by the director before rendering an assessment. Having solid documentation supporting the exercise of due diligence may avoid the assessment from the outset.

It is important to note that "due diligence" does not refer to best efforts to ensure the corporation's survival, but rather efforts to safeguard the particular amounts owed to the CRA. The fact that the funds were diverted to more urgent needs of the business generally will not provide a defense.

2.  Two-year limitation period

The CRA is required to commence an action under these provisions within two years of the date a person ceased to be a director. Therefore, once it appears a corporation is in financial difficulty, a director should evaluate whether it would be prudent to resign in order to start the clock on the two-year limitation period. The requirements of resignation are a matter of corporate law that may vary from province to province – consultation with your corporate lawyer is essential.  Directors also should avoid acting as de facto directors after resigning, as discussed above. An individual who suspects he or she has been acting as a de facto director at any time might wish to provide to the corporation an explicit notification of ceasing to act in that capacity.

Based on the number of court cases pursued by the CRA on this issue, it is a popular target for our tax collectors. If you choose to serve as a director, take care that your focus on saving the business does not expose you to personal liability.

Dean Woodward is a tax partner in the Calgary office of Collins Barrow.

¹ Section 227.1 also applies to tax withheld from patronage dividends and certain other taxes. Similar provisions apply to source deductions for Canada Pension Plan, Employment Insurance, and to excise duties and certain provincial sales taxes. Provincial employment standards legislation may also hold directors liable for unpaid wages.

² Bremner v. R., 2007 CarswellNat 2625 (TCC)