The HST Blog : Canada Harmonized Sales Tax Lawyer Cyndee Todgham Cherniak for Assessments, PST & RST Issues in Ontario, British Columbia & Quebec

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The recent Tax Court of Canada decision in Elliott v. The Queen (written by Justice D'Arcy) (January 28, 2011) summarizes the thinking of the Court when considering a request to apply the due diligence defence by directors who have been assessed personally for failures by a corporation that cannot pay the goods and services tax (GST) and harmonized sales tax (HST) debts.  In this case, a restaurant corporation failed to remit HST that had been collected from patrons at the restaurant.  The restaurant closed and was assessed HST by the Canada Revenue Agency (CRA) for amounts that had been reported on GST/HSTreturns as having been collected, but was not remitted.  The HST debt was not collected from the corporation.  The CRA, Collections went to the Federal Court for a certificate and eventually sent the sheriff with a writ or search and seizure to collect from the corporation.  Only after the sheriff failed to collect any money did the CRA assess the 3 directors of the restaurant corporation.

The directors appealed the assessment and argued that the CRA auditor did not adequately consider the due diligence defence.  Pursuant to subsection 323(3) of the Excise Tax Act, a director is not liable under subsection 323(1) where "the director exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances."

The directors in this case had argued that they exercised due care:

Their counsel argued that the Company's failure to remit was the result of an immediate catastrophic event (the smoking ban) that was beyond the control of the Appellants. He focused on various steps that the Appellants took to keep the business running after the City of Fredericton imposed the smoking by-law. These steps included reducing operating hours, reducing variable costs, and the injection of substantial capital by the Appellants in the form of shareholder loans. The Appellants' counsel emphasized that the Company received professional advice that the downward trend in the Pub's business would be short-term and sales would "come back."

However, the directors were focusing on the wrong test.  Judge D'Arcy applied the due diligence defence test applied in GST/HST directors liability cases that was noted by the Federal Court of Appeal in (Attorney General) v. McKinnon, [2001] 2 F.C. 203 (FCA) (at paragraph 28):

"…in deciding whether a director has “exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have shown in comparable circumstances”, the court must take into account the characteristics of the directors whose conduct is in question, including their levels of relevant skill, experience and knowledge. The court must then ask whether, if faced with similar circumstances, a reasonably prudent director, with comparable levels of skill, experience and qualifications would have acted in the same way as these directors……"

In Elliott, based on the facts, the directors did not take reasonable steps to prevent the failure to remit the HST.  The appellants were inside directors and, as a result of another Court decision in Soper, they have the most difficulty in establishing the due diligence defence since they are involved in the day-to-day management of the company and influence the conduct of its business affairs.  Since the directors did nothing to "prevent" the failure to remit, their appeals were disallowed by the court.  It was clear to the Court that the directors made decisions to not remit the HST and to pay other creditors instead of remitting HST that had been collected from patrons.

Judge D'Arcy was sympathetic - he must have been- as he did not award that the appellants pay costs to the CRA for pursuing the appeal.

In this case, the Appellants did not understand what was the due diligence defence test for GST/HST purposes.  Had they understood the test and discussed their appeal with a GST/HST lawyer, they may have saved themselves the legal costs of filing appeals with the Tax Court of Canada.  By the way, Judge D'Arcy was one of the best GST/HST lawyers in the business.  His decision is well written and should help future appellants (and their non-specialist counsel).