Director of 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 consist of income taxes, employment insurance, and Canada Pension Plan premiums from employee wages, are the liabilities 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 when a business which is struggling financially uses unremitted source deductions as capital so as to stay 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. The Canada Revenue Agency (CRA) has a statutory right to go after the directors for unremitted source deductions, plus interest and penalties.


For the CRA to successfully make a claim against a director it must meet certain requirements under the Income Tax Act. The CRA must file a certificate in respect of the corporation’s tax liability, attempt to have execution against the corporation, and the execution must be returned unsatisfied. In the case of a liquidation in bankruptcy, the 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.


The 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 licensed insolvency trustee.


The 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 the CRA having a debt owed, such as a General Security Agreement by a banking institution. This priority is given to the CRA through the Income Tax Act. If the company continues to go forward in a receivership the 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 a way 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 honoured, 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.