Director Liability and the Delegation of Duties
By: Bobby B. Solhi and Khalid Tariq
In a recent case from the Tax Court of Canada in Kaur v. The Queen (2013 TCC 227) the Court held that the taxpayer, a director of a British Columbia corporation, was personally liable for unremitted GST amounts plus interest and penalties assessed against her corporation.
The taxpayer argued in her defense that she exercised due diligence as a director and should not be liable as the financial and tax matters were dealt with, or delegated, to another officer of the corporation.
Kaur walks us through the fundamentals of director liability and considers whether a director can delegate their duties to someone else as a means to avoid personal liability.
Director liable for Tax Obligations of Corporation
A director of an Ontario or other Canadian corporation must be very cautious in exercising their duties. While the general understanding is that a corporation is an ideal vehicle to protect its shareholders and investors from personal liabilities stemming from the operations of the business, the same protections do not necessarily extend to its directors and officers. There are a number of ways that one can be personally liable for their conduct as a director.
One of the primarily responsibilities, and source of liability, to a director is meeting the tax obligations of the corporation. Each director must ensure that reasonable effort is made so that the tax obligations of the corporation are appropriately met.
Defence to Director Liability
There are generally two main defences to director liability: 1) due diligence and 2) cease being a director.
To put it simply, the due diligence defence provides that a director who has exercised diligence that a reasonably prudent person would exercise in comparable circumstances to ensure that the corporation fulfills its tax obligations, should not be held personally liable for the mistakes of the corporation.
The question at the centre of Kaur is whether a director had exercised due diligence by appointing or delegating their duty to review financials and ensure tax compliance onto a third party.
Tax Court’s Decision
The taxpayer’s appeal was dismissed. The Court held that the taxpayer did not exercise due diligence by simply delegating or assuming that the tax issues of the corporation were being dealt with by an officer of the company. Accordingly, the taxpayer was held to be personally liable for the unremitted GST plus interest and penalty amounts against the corporation.
What were the facts in Kaur?
Satpal Kaur served as the sole director of 644346 BC Ltd. (the “Corporation”), a company involved in the construction and sale of residential properties in British Columbia. As a GST registrant, the Corporation was responsible for charging, collecting and remitting GST on the sale of new homes.
In 2002, Kaur along with Sirus Familamiri, a local BC developer, undertook two real estate projects. Kaur secured financing for both projects, including personally guaranteeing several construction loans. Kaur delegated all operational and financial responsibilities to Familamiri, relying on his experience in the construction industry to manage the project accordingly.
The first project began in 2002 and involved the construction of six townhouses on a vacant lot purchased by the Corporation in East Vancouver. Two of the townhouses were sold after completion of the project in 2004. The remaining four townhouses could not be sold and were instead transferred to Kaur in 2006 to be leased.
The second project began in late 2004 and involved the construction of 26 townhouses on a vacant lot in Port Coquitam, B.C. More than half of the units to be built were sold pre-construction.
By 2005, a real estate surge in BC led to a labor shortage for the Corporation and soaring project costs. Financial hardships totally depleted the funds available to the Corporation and the Port Coquitam project faced catastrophic failure. Kaur was made aware of the Corporation’s financial difficulties near the end of December 2005 when Familamiri informed her that subcontractors were abandoning their jobs for more lucrative work elsewhere. Around the same time, Familamiri decided not to fully remit GST. Instead he chose to allocate the money towards completing the Port Coquitam project. This decision came to Kaur’s attention in 2007, and only after being notified by the Canada Revenue Agency (“CRA”).
As the sole director of the Corporation, the CRA determined that Kaur was personally liable for unremitted GST as outlined under subsection 323(2) of the Excise Tax Act (“ETA”).
Kaur appealed the CRA assessment using the due diligence defense found under subsection 323(3) of the ETA. In order to successfully utilize this defense, a director must demonstrate that he or she met the standard of care and due diligence expected of a reasonably prudent person in comparable circumstances. Kaur claimed that she should escape personal liability because she had delegated all GST oversight to Familamiri, who had made the decision not to remit without her knowledge or consent. Kaur supported her claim by arguing that she had nothing to gain from knowingly withholding GST because of her liability as a director.
Tax Court’s Analysis
In his analysis, Justice Hogan held that Kaur’s due diligence argument failed to meet the standard set out by the Federal Court of Appeal in Buckingham v. R. (2011 FCA 142). In that case, the Court held that “a director must carry out his or her duties on an active basis, and as such, will not be allowed to defend a claim for malfeasance in the discharge of his or her duties by relying on his or her own inaction.” Additionally, directors are held to an objective standard and must show that they exercised a duty of care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances.
Kaur failed to carry out her duties as director on an active basis instead choosing to delegate authority to Familamiri even after discovering the Corporation’s financial troubles in late 2005. Applying the objective standard in Buckingham, Justice Hogan concluded that Kaur did not exercise the care, diligence and skill a reasonably prudent person would have exercised upon discovery of the Corporation’s financial troubles. Rather than continuing to rely on Familamiri, a reasonable person would have recognized their tax responsibilities, investigated the financial position of the company, and taken measures to ensure that the Corporation’s GST would be remitted.
Furthermore, Kaur’s assertion that she had nothing to gain from knowingly withholding GST was found to be without merit. Because Kaur had personally guaranteed the Corporation’s construction loans, defaulting on these loans would have resulted in a personal liability equally as great, if not greater, than the unremitted GST. Using GST funds to clear bank loans, as the Corporation had done, removed Kaur’s personal guarantees with the bank and directly benefited her financial position.
Kaur highlights the importance of directors taking an active role in the oversight and control of their corporations. Directors are obligated to be aware of what is happening in their corporation and must maintain clear and open lines of communication with their officers and employees. While directors may delegate their statutory responsibilities to other officers or directors, they are nonetheless personally responsible for ensuring that the corporation’s tax obligations are fulfilled.
In many owner-managed businesses, the directors are often also shareholders in the company. While a corporation is an excellent vehicle to protect against personal liability those protections do not extend to shareholders acting in their capacity as a director.
 2011 FCA 142 (para 38).
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