Leaving a Sinking Ship

The following article on resignation as a director of a corporation and directors’ liability under the Income Tax Act (Canada) appeared in the latest edition of the Hamilton Law Association Law Journal.

A director of a corporation can be held personally liable for the corporation’s failure to withhold and remit source deductions in respect of salary and wages (that is, income tax withheld at source, CPP and EI). A director of a corporation that pays an amount to a non-resident can also be held liable for failing to withhold and remit amounts as required under Part XIII of the Income Tax Act (Canada) (the “Act”), which imposes withholding taxes on certain payments to non-residents, including payments of interest, dividends, deemed dividends and royalties. Finally, a director can be held personally liable for unremitted GST and provincial sales tax.

How does a director protect herself from liability? The Act exonerates a director who exercises due diligence in respect of source deductions, and dozens of Tax Court cases have addressed whether directors have met that standard. The due diligence defence, however, is beyond the scope of this article. Instead, this article considers a much more straightforward method for avoiding personal liability when the finances of a corporation start to go south: resignation.

Resignation can help a director in two ways. An individual cannot be held liable for unremitted source deductions if the failure to remit occurs after the individual resigns as a director. In addition, even if a director might otherwise be liable for a failure to remit, the director will avoid liability unless the Canada Revenue Agency (the “CRA”) assesses the director within two years of the director’s resignation as such. Subsection 227.1(4) of the Act provides that

No action or proceedings to recover any amount payable by a director of a corporation [in respect of unremitted source deductions] shall be commenced more than two years after the director last ceased to be a director of that corporation.

Well, then, resignation seems to be just the remedy for a director at risk. Of course, many directors continue as such after their corporations begin to encounter financial difficulties. They gamble that they can turn things around. Or they are clueless about their potential exposure and they fail to take the steps necessary to effect a resignation. The result is that the CRA gets to chase another taxpayer for unpaid taxes.

What steps should be taken to resign as a director? The requirements of the Ontario Business Corporations Act (the “OBCA”) are simple enough: subsection 121(2) of that statute provides that “a resignation of a director becomes effective at the time a written resignation is received by the corporation or at the time specified in the resignation, whichever is later.”

Note what is not required. The OBCA says nothing about filing a statement with the Corporations Branch notifying it of the resignation. Nonetheless, a director who wishes to resign would do well to ensure that such a statement is filed and that the resignation is placed in the minute book of the corporation. In our experience, the CRA will treat a resignation that is not accompanied by such a filing with extreme prejudice, as in Burton v. The Queen, 2005 TCC 762:

[7] The Appellant’s resignation was never filed with the Ontario Corporations Branch. This is where the problem arises. An officer of CRA testified that he did not accept that the Appellant had signed a resignation in December 2001, believing it was signed probably after the Appellant was assessed in 2004. His scepticism is understandable. It was not sent to anyone and not placed in the Minute Book. At the time he recommended that the Appellant be assessed, he did not have the benefit of the four witnesses [who testified that he resigned at the time claimed].

Perhaps a director who expects trouble from the CRA should consider executing his resignation before a witness who can then swear an affidavit of execution.

The resignation must also be “received by the corporation”. A resignation that is placed in the minute book or sent to the registered office of the corporation (perhaps by registered mail or delivered by hand in the presence of a witness) should meet this requirement.

What happens if an individual is the last director of a corporation because, like rats leaving a sinking ship, all of the other directors have resigned. Is the resignation of the last-to-resign effective? The CRA seems to think not; it seems to believe that a corporation must have a director and that, therefore, the last director cannot resign without a successor being appointed. The OBCA does not seem to support this position. Clause 121(1)(a) provides that a director ceases to hold office when the director resigns, and this rule is subject only to subsection 119(2), which provides that “until the first meeting of shareholders, the resignation of a director named in the articles shall not be effective unless at the time the resignation is to become effective a successor has been elected or appointed.”

It does no good, however, for an individual to resign as a director and then continue to manage the affairs of the corporation as if he or she were still a director. Subsection 1(1) of the OBCA provides that ‘director means a person occupying the position of director of a corporation by whatever name called’, and the tax courts have had little trouble concluding that a person can be held liable as a director under the Act if, de facto, the person fulfills the functions of a director. In Hartrell v. The Queen, 2006 TCC 480, Justice Paris wrote:

However, in circumstances such as those in this case, where a corporation operates without having been properly organized and the only director of record plays no part in running the corporation, those persons who take it upon themselves to direct the affairs of the company may be held to be de facto directors, whether or not they have explicitly represented themselves as directors to any third party. The essential question is whether those individuals have, in fact, taken on the role of director of the corporation.

After reviewing business records and correspondence that showed the appellant was intimately involved in the operation of the business, the Court concluded that he was a de facto director and therefore liable for unremitted source deductions (unless he could prove due diligence). See also McDougall v. The Queen, [2001] D.T.C. 1 (T.C.C.).

Of course, active involvement in a business by itself is usually not enough to engender liability for source deductions: after all, the officers of a corporation are also actively involved in its business affairs, but the Act does not impose liability on them: see Mosier v. The Queen, [2001] G.S.T.C. 124, 2002 G.T.C. 28, 2001 CanLII 829 (T.C.C.). Perhaps the Court in Hartrell was influenced by evidence that the appellant and the other investors in the business consistently referred to themselves as partners. (Unfortunately for the appellant, he and one of his “partners” started fighting, and they began communicating only in writing, much to the delight, no doubt, of the CRA auditor.) Of course, “partners” of a corporation (its shareholders) are not liable for source deductions either: see Netupsky v. The Queen, [2003] G.S.T.C. 15, 30 B.L.R. (3d) 46, 2003 G.T.C. 591, 2002 CanLII 2289 (T.C.C.).

An individual does not cease to be a director of a corporation merely because the corporation goes bankrupt or it dissolves. In The Queen v. Kalef, [1996] D.T.C. 6132, the Federal Court of Appeal held that Mr. Kalef did not cease to be a director of a corporation merely because he no longer had the power to manage the corporation’s affairs after it made an assignment in bankruptcy. The Court found that under the OBCA Mr. Kalef remained a director, if only in name. As a result, he could not take advantage of the two-year limitation period provided by subsection 227.1(4) because he had not ceased to be a director before the CRA assessed him for unremitted source deductions.

The dissolution of a corporation by itself will not help a director who fails to resign. In Leger v. The Queen, 2007 TCC 322, the Court held that, if a corporation that was dissolved is revived, the revival takes effect from the date of dissolution (cf subsection 241(5) of the OBCA). As a result, the corporation is revived and, in effect, so are its directors:

[26] It therefore follows that the revival of a corporation is retroactive to the date of its dissolution and that, for all intents and purposes, it is deemed to have never been dissolved. That being so, the Crown’s position that the appellant never ceased to be a director of RSL [the corporation that failed to remit source deductions] after his original appointment on August 18, 1987, is correct. That approach is consistent with subsection 136(5) of the NBBCA [the New Brunswick Business Corporations Act] and with the relevant case law. The appellant’s position as director of RSL was in a state of suspension during the time between RSL’s dissolution and its revival. Since the revival of RSL returned that corporation to the same position as it would have been in if it had not been dissolved, the appellant also returned to his position as director. The appellant never resigned as director of RSL even though it ceased operating in December 1998. There is no evidence that it ceased to exist as a corporation after that date.

[27] Accordingly, the two-year limitation period imposed by subsection 227.1(4) of the Income Tax Act and subsection 323(5) of the Excise Tax Act has not expired and the Minister is therefore not barred from assessing the appellant.

Can an individual resign as a director of a corporation while it is dissolved? Leger implies that he or she could by delivering a resignation to an officer of the dissolved corporation on its behalf. The resignation would have no effect — it would be “suspended” — while the corporation was dissolved (one cannot deliver a resignation to something that does not exist). The revival of the corporation, however, would have retroactive effect from the date of dissolution, which should mean that the resignation was revived as well with effect from the date of ‘delivery’.

The CRA, on the other hand, might take another view of the matter. The CRA might argue that the resignation was without effect because it could not be delivered. On this view, the directors of a dissolved corporation would remain as such, like flies trapped in amber, just waiting for the CRA to come along and apply for an order of revival so that it can assess the directors for unremitted source deductions.

Conclusion

Corporate directors need to be quite careful about all matters pertaining to source deductions, including the manner in which the directors walk away from a corporation that is having problems remitting them. The moral of the story is that a director who has no choice but to walk away from a corporation must give thought to the timing of a resignation, and he or she must be meticulous about documenting it. The courts hold directors to a high standard in this area, and so form matters a great deal. As lawyers, we owe it to our clients who are directors to provide the advice they need to follow the forms and procedures necessary to limit or eliminate their personal liability.