Director’s Liability Overview, Plus A Due Diligence Defense We Are Unlikely To See Used Again

I had a nice long conversation with a client the other day regarding the potential that either the Canada Revenue Agency (CRA) or the Provincial government (in Ontario) were going to pursue a Director’s Liability assessment against him for the debts of his now-deceased corporation.  Part of the discussion surrounded how the Canada Revenue Agency and the former Ontario Retail Sales Tax (RST) group handled assessments, and the criteria they used when reviewing whether or not to pierce the corporate shield, plus the importance of a due diligence defense.

Director's Liability Section from the Income Tax Act and Excise Tax Act.
Director’s Liability Section from the Income Tax Act and Excise Tax Act.

During my employment at the Canada Revenue Agency (CRA), I felt I needed to gain a more thorough understanding of Director’s Liability and figure out why there were so few assessments raised in our office compared to other offices.   I personally had not raised any Director’s Liability assessments mainly because I was effective on the phone and combined with meetings, was able to resolve many debts prior to the assessment stage.  Still, Senior Management encourage the Collections staff to utilize this collection tool more, so as the Resource and Complex Case Officer, I asked for, and was given, the Director’s Liability inventory to control.

By controlling the Director’s Liability inventory, that meant I needed to know the ins and outs of Director’s Liability – section 227.1 of the Income Tax Act and section 323 of the Excise Tax Act, because if anyone in our office wanted to raise an assessment, I would have to review their account, ensure all of the much-needed grunt work had been completed, then ensure they had spoken to the Director(s), given them sufficient notice, provided them time for a Due Diligence Defense, at which point I could sign off and begin to track the file.

After organizing that inventory and rolling out the new procedures, I began to scour the accounts in our office for potential Director’s Liability assessments, then, in addition to my other inventories, provide recommendations and suggestions to the staff on how to proceed if I felt there was a possibility for an assessment.  Management decided instead of burdening the staff, I should just take those accounts I felt were ready for Director’s Liability assessments and work them, plus all of the other accounts I was tracking where assessments were raised too.

It was a fair amount of work, but more importantly, it was very enlightening, to review the government’s policies on Director’s Liabilities plus review the procedures in place, compare that to how other office’s handled their files and really tighten up the process.  If an account was a sure-fire Director’s Liability assessment, it was raised, and if there was no chance, or not the right time, the file was returned to active collections.

I found the first common misconception around Director’s Liability was that the issuance of the Director’s Liability Pre-Assessment Proposal Letter (which notifies director’s that we are reviewing them for Director’s Liability) was being used as just another letter by the Collections staff to remind directors of their obligations, when in fact the CRA intended on using this letter to notify Directors’ that an assessment was beginning.  Internally, the Canada Revenue Agency was actually starting to investigate the personal ability to pay of the director(s) at the time this letter was issued.

Going forward, that letter was not to be used lightly, and it was not to be sent to the Director(s) numerous times.  A Director would then have the assessment raised against them and wonder why it was raised this time, and not earlier when one of those letters went out, so in order to prevent a possible loss in Tax Court, the decision was made to send it once, and then follow-up with the Due Diligence defense letter before raising the assessment.

Ignoring the Due Diligence defense letter (which happens often) meant the one opportunity a Director had to start their case on the record was lost, and with the CRA building their case in the permanent diary, the Director(s) stood little chance of preventing the Canada Revenue Agency from raising the Director’s Liability.

Once that waiting period passes, the file usually gets very quiet…

From the Director’s point of view, either the assessment is raised and they receive a letter from the CRA stating that, or the assessment is raised and the letter gets lost in the mail (tossed out), or the assessment is raised and before the Director is notified, their personal assets come under fire.  There is of course, the possibility that nothing happens and the Director(s) are left in limbo, but without having a dialogue with the CRA, or experience around the policies and procedures, there is no way that the Director(s) will know when and if the CRA is coming – if at all.

Once raised, the Director(s) have quite limited options.

A recent court case, which I will highlight below demonstrates a situation where an assessment was raised, and in Tax Court, the decision was turned over and the assessment cancelled.  I guarantee it won’t happen again, as the CRA will ensure their processes are tightened even more to close this loophole.

The case was Bekesinski V The Queen.

The link to the case on the website for the Tax Court of Canada, is here.

In this case, Bekesinski was the Director of a corporation who was personally assessed by the Minister of National Revenue (CRA) in the amount $477,546.08 for the corporation’s unremitted income tax (T2) and employer contributions of CPP and EI for payroll (source deductions) plus penalties and interest for the 2001, 2002 and 2003 fiscal years.

Under Director’s Liability, the CRA can assess directors for payroll and for GST/HST, but not Corporate Tax liabilities.

The Tax Court of Canada held that since the taxpayer had resigned as a director of the corporation more than two years after the CRA’s assessment, the CRA was statue barred from raising the Director’s Liability assessment.

This was something the CRA should have known before raising the assessment and something that the director (or his representatives) should have mentioned at any point during the pre-assessment proposal period, especially at the due diligence defense stage, but was never mentioned.

Brief Overview of the Facts

In 1992 the taxpayer purchased D.W. Stewart Cartage Ltd., a general cartage, trucking and warehousing company where he served as a Director of the corporation.

When the corporation fell behind on filing obligations and as the balance owing to the CRA began to grow, the Director began to receive numerous letters from the CRA warning him that he could be held personally liable for the corporation’s tax debts as a Director of the corporation.  He did not notify the CRA at any time that he had resigned as a Director of the corporation.

On October 15, 2010 the CRA raised Director’s Liability and issued a Notice of Assessment (NOA) to the taxpayer for unremitted income tax, employer contributions plus penalties and interest in the amount of $477,546.08.

The Director then argued that he should not have been assessed as a Director because he resigned as Director of the corporation on July 20, 2006 by way of a Notice of Resignation which would have made the raising of the assessment statute barred.

The CRA argued that the taxpayer was in fact a director and that the taxpayer had backdated the resignation to qualify for the exception, which happens more than you could imagine, and to counter this trick, the CRA often requests an “ink date test” to determine the authenticity of the Notice of Resignation.

Unfortunately for the CRA, the results from the ink date test was excluded by the Tax Court because the CRA did not advise the Court that they felt the Notice of Resignation was back-dated.  Even the judge felt the Notice of Resignation was backdated, however since the CRA failed to mention it, it was not open for review in the Court.

In summation, Bekesinski avoided Director’s Liability for the corporate tax debts due to a litigation misstep on the part of the CRA, a mistake they are unlikely to be repeat.

It is highly advisable for corporate directors to carefully document their resignations so as to avoid potential future Director’s Liability assessments, because I guarantee, the CRA will challenges to the authenticity of backdated resignations on each and every case going forward.

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Is the Canada Revenue Agency (CRA) looking after your best interests?

The Canada Revenue Agency (CRA) does an adequate job at what they are mandated to do, and that is to collect tax revenue and tax information from taxpayers while using their debt management (collections) division to collect from the unwilling or pre-occupied.

From the inside the CRA trains the collectors to understand that those who do not file or pay are “debtors” and that actions should be taken to bring these debtors into compliance right away.

They are also trained that if you can collect from – or force into bankruptcy – these individuals and corporations, that you are doing them a service but forcing them to make decisions that they are unwilling or unable to make on their own.  You’re doing them a favour by putting them out of business.  You stop the “bleeding”.

Those of us who have worked in the “real world” understand that behind the account numbers and names there are real people who are trying to run real businesses and who find taxation either complicated or overbearing and cannot comply with the rules and regulations.

Since failure to comply with some tax laws can result in criminal actions, I believe that the tax rules are complicated and with little forgiveness on the party of the government, one small mistake can shut a business down, or result in significant monetary penalties.

The most frustrating part, I find, is trying to explain to the CRA that their actions – while justified internally – have serious implications on more than a business or a person.

Take for example one of my clients;

I spent the last week in serious discussions with just about everyone at the Winnipeg Tax Services Office, trying to convince then that if they keep a garnishment on a corporate bank account that they will shut down this corporation.

The corporation’s issue, which the collector, team leader, technical advisor, section manager and director felt justified these actions?

They were in collections for 2-years. They had a trust exam and fell behind.

GASP.

I mentioned the accounts I am resolving for them right now involving people and corporations in collections for 15-20 years. 2-years is a drop in the bucket.

I also let them know of the tragic circumstances surrounding this corporation involving a death, an illness and a mass exodus of employees which left one director now trying to keep his corporation alive. That was until the CRA placed the garnishment and wanted to shut down the corporation.

So the collector – new – and the technical advisor – new – find words to justify their actions and the director did not return my calls or letters (yet, apparently) did not feel compelled enough to get back to me and intervene.

The CRA’s solution instead of putting 3 employees out of jobs, and a family man without income to support his young family was to drag out the process and ask for a payment arrangement on a corporation with no income… From their actions.

So whose interests are the CRA looking after?

Theirs?

No.

By not allowing the corporation to operate and earn income they are going to lose out on revenue to pay their liability.

Or when the CRA finally “allows” the business to continue operations and removes the Requirement to Pay from the business bank account, the CRA fails to take into consideration that the business will now need to back back rent, phone bills, internet bills, and likely replenish inventory before they have any funds abailable to pat themselves or the CRA anything.

Is the CRA then looking after the best intentions of the corporations?

Heck no!

By not being able to operate and by stringing along the director, this corporation is bleeding a slow death. Customers are losing faith, employees are quitting or being laid off, and with no money, the corporation cannot afford to fight any more.

It becomes very clear at this point that the CRA is looking after no one’s interests.

The CRA takes actions which are told to them from people who have no concept of reality.  Their actions are destructive and cause more damage than good, most of the time.  They don’t understand that sometimes, no action is the very best action.

Frustrating?

Absolutely it is.

In our specific case, after one whole week of trying to talk sense into the CRA, the collector agreed to lift the garnishment today.  Instead of receiving a payment, however, the CRA will get a plan on how this corporation plans to recover from a poorly executed collection action which got the CRA one payment and now nothing for at least a month.

At the end of the day, because of our involvement, everybody is going to win, but my job would be so much easier if the CRA understood that they need to listen to the experts and let the account resolve itself.

We all would be so much further ahead – the corporations director might have actually slept in the past month – if the CRA had slowly taken actions to remedy the situation rather than freezing the business bank account and not telling the business owner why they were trying to shut him down.

I’m looking out for the corporation’s best interests.  I’m also looking after the best interest of the CRA because we all need them on our side, and not against us.

Someone has to!