Are You a Director of a Corporation? Do You Know Your
Liability?
If you sit on a Board of Directors of a corporation
then exposure to liability exists under various statutes. For example,
unpaid wages and vacation pay, workplace liabilities, liabilities under
corporate statutes as well as environmental liabilities are a major
concern of the corporate director.
Amounts owing to the Crown with respect to taxes are
the most common of the liability claims. Unremitted source deductions
which consists of income taxes, employment insurance and Canada Pension
Plan premiums from employee wages is the liability that the Crown has
been very aggressive in collecting in recent years. The Crown is also
being more aggressive in the collection of other taxes such as unpaid
sale taxes and the ever controversial Goods and Service Tax (GST).
A common scenario in creating director’s liability is
that a business that is struggling financially is using the unremitted
source deductions as capital to keep the corporation in business rather
than close the doors. However, when the corporation realizes that the
unremitted source deductions is not enough capital to keep the
operations going, the company goes out of business. Canada Revenue
Agency (CRA) has a statutory right to go after the directors for
unremitted source deductions plus interest and penalties.
For CRA to successfully claim against a director it
must meet certain requirements under the Income Tax Act. CRA must file a
certificate in respect of the corporations tax liability and CRA must
attempt to have execution against the corporation and the execution must
be returned unsatisfied. In the case of a liquidation in bankruptcy, CRA
must prove its claim within 6 months of the date of bankruptcy. If these
actions have not been met by CRA then the director has no liability.
CRA also has only 2 years to attempt to collect the
liability from the director. If the 2-year period passes then the
director escapes any liability for the unremitted deductions. In order
to attempt to collect from the director, it must be established that the
funds could not be collected from the corporation or from the Receiver
or Trustee in bankruptcy.
CRA has first priority on all assets of a bankrupt
company. If a company files a bankruptcy CRA has priority over all other
secured creditors even those who had security on the assets of a company
prior to CRA having a debt owed, such as a General Security Agreement by
a banking institution. This priority is given to CRA through the Income
Tax Act. If the company continues to go forward in a receivership CRA
must be paid for any arrears in crown taxes.
There are only a few defenses available to a director
in order to avoid payment of the liability. In order to be liable you
must be a ‘director in law” at the time the source deductions were not
remitted. For example, the individual may not have been properly
appointed as a director or may have resigned prior to the failure to
remit.
If the above exemptions do not apply then the only
defense is the “due diligence” defense as set out in the Income Tax Act.
This defense provides that the director is not liable for the
corporation’s failure to remit source deductions where he/she exercises
the degree of care, diligence and skill to prevent the failure that a
reasonably prudent person would exercise in a similar situation.
In determining if a director has acted with due
diligence the court will look at a variety of factors such as, the
capability of the person, their business knowledge, education and the
actions taken by the director to prevent the failures. The courts have
stated that there is a positive duty to take action to prevent the
failures.
To prevent failure the director should familiarize
himself with the withholding and remittance requirements. Ensure that an
appropriate system is in place to withhold and remit all taxes and
require on a timely basis written reports to ensure that the remitting
procedures are being done correctly.
It is human nature especially for most entrepreneurs
to do anything to find away to keep the doors of their company open.
This determination sometimes leads to the careless use of unremitted
source deductions and other government taxes to fund the operations. The
courts have said where a corporation reaches the point where it cannot
issue a remittance cheque for fear that it won’t be honored it is time
to close down the business. Thus, the mere decision or will of the
entrepreneur to keep the doors open may result in the director reducing
his/her ability to rely on the due diligence defense.
Article by: Joel Easter V.P. ~ Scott & Pichelli Ltd.
