Director Hit with Vicarious Tax Liability Because She Couldn’t Prove that a Written Resignation was Sent to the Corporation: Cliff v The Queen, 2022 FCA 16 – A Canadian Tax Lawyer’s Analysis

Introduction: Vicarious Tax Liability for Directors & Proof of Resignation

Under certain conditions, a director may become personally liable for a corporation’s unremitted net GST/HST or for its unremitted source deductions. Section 323 of Canada’s Excise Tax Act gives the Canada Revenue Agency a means of pursuing a corporation’s director for the corporation’s unremitted GST/HST. Likewise, section 227.1 of Canada’s Income Tax Act gives the CRA a means of pursuing a corporation’s director for the corporation’s unremitted source deductions for employee payroll (e.g., CPP, EI, and employee income-tax withholdings).

The director’s-liability provisions under section 323 of the Excise Tax Act and under section 227.1 of the Income Tax Act impose a 2-year limitation period. In particular, the CRA must assess the director within 2 years of the date that the director “last ceased to be a director” of the tax-debtor corporation. In other words, the Canada Revenue Agency cannot successfully assess a director for director’s liability if that director resigned more than two years previously.

This raises the question: How does a director prove the date of resignation if the CRA insists otherwise? This very question was at issue in Cliff v The Queen, 2022 FCA 16.

After examining the director’s-liability provisions under section 323 of the Excise Tax Act and under section 227.1 of the Income Tax Act, this article reviews the Federal Court of Appeal’s decision in Cliff. It then concludes by offering pro tax tips from our expert tax lawyers in Toronto.

Director’s Liability: Section 323 of the Excise Tax Act & Section 227.1 of the Income Tax Act

Section 323 of the Excise Tax Act and section 227.1 of the Income Tax Act expand the CRA’s power to collect a corporation’s unremitted GST/HST and source-deduction arrears when efforts to collect against the corporation prove futile. In other words, these provisions serve as tax-collection tools.

Specifically, if the corporation failed to remit GST/HST, subsection 323(1) of the Excise Tax Act confers vicarious tax liability on “the directors of the corporation at the time the corporation was required to remit.” In the same way, if a corporation failed to remit source deductions—e.g., non-resident withholding tax or employee payroll deductions for CPP, EI, and income tax—subsection 227.1(1) of the Income Tax Act renders derivative tax liability on “the directors of the corporation at the time the corporation was required to remit.” Each director becomes “jointly and severally, or solidarily, liable, together with the corporation, to pay” the amount that the corporation failed to remit, plus any related interest or penalty.

The vicarious tax liability applies to both de jure directors and de facto directors. A de jure director is one who is appointed in accordance with the governing corporate statute—that is, a legally appointed director.  A de facto director, on the other hand, is one who in fact fulfils the duties of a director despite no legal obligation to do so. This typically involves an individual who either (i) continued acting as a director even after properly resigning from that post or (ii) was never a legally appointed director yet took on the responsibilities of a director. In other words, the vicarious tax liability under the director’s-liability rules doesn’t discriminate between a person who acts like a director and a person who is a director. Each faces the same exposure to a director’s-liability assessment.

Still, the director’s-liability rules do not, however, confer limitless and unconditional liability. They contain three mechanisms that serve to both limit a director’s exposure and ensure that the Canada Revenue Agency first attempts to satisfy the corporation’s tax debt with the corporation’s assets before pursuing its directors.

First, the director’s-liability provisions say that a director isn’t liable for a corporation’s unremitted GST/HST or source deductions unless one of the following occurs:

• The Canada Revenue Agency registered a certificate for corporation’s unremitted GST/HST or source deductions with the Federal Court, and execution for that amount has been returned unsatisfied (e.g., the sheriff attempted to enforce the writ, but the assets available for seizure were insufficient to cover the debt);
• The corporation commenced liquidation or dissolution proceedings (or was involuntary dissolved), and the CRA proves a claim for the unremitted GST/HST or source deductions within six months of the earlier of: (i) the date that proceedings commenced and (ii) the date of the dissolution; or
• The corporation made an assignment in bankruptcy (or a creditor obtained a bankruptcy order against the corporation), and the CRA proves a claim for the unremitted GST/HST or source deductions within six months of the date of the assignment or the bankruptcy order.

Second, the director’s-liability provisions prescribe a two-year limitation period on a director’s exposure to a corporation’s unremitted GST/HST and source deductions. The Canada Revenue Agency cannot assess a director for a corporation’s GST/HST arrears and withholding-tax debts “more than two years after the person last ceased to be a director of the corporation.” The corporation’s governing corporate statute identifies the conditions under which a person ceases to be a director. Section 121 of Ontario’s Business Corporations Act, for example, says that a director of an Ontario corporation ceases to hold office upon death, resignation, removal by the shareholders, or disqualification (e.g., mental incapacity or bankruptcy). In addition, subsection 121(2) says that a director’s resignation takes effect on the later of: (i) the time that the corporation receives a written resignation and (ii) the time specified in the written resignation. (The second condition permits a director to deliver written resignation in advance of the proposed retirement.) If the person continues acting as a de facto director, however, the clock on the two-year period does not start running.

Third, the director’s-liability provisions protect a director who exercised due diligence. A director isn’t liable for the corporation’s GST/HST debts or withholding-tax debts if, to prevent the corporation’s failure to remit, the director “exercised the degree of care, diligence and skill” that “a reasonably prudent person would have exercised in comparable circumstances.”

Cliff v The Queen, 2022 FCA 16

In 2001, the appellant’s husband asked his accountant to incorporate a new corporation on his behalf. Following these instructions, the accountant incorporated Cliff Crucibles Inc. under Ontario’s Business Corporations Act. The accountant appointed himself as the first director and then stepped down. In their capacity as the corporation’s shareholders, the appellant and her husband appointed themselves as Cliff Crucibles’ directors effective May 18, 2001. Their appointments were reflected by signed resolutions and in the public registry maintained by the Ontario Ministry of Consumer and Commercial Relations (now known as the Ministry of Government and Consumer Services).

From the beginning, the appellant had been adamant that she would serve as the corporation’s director on only a temporary basis. As such, she informed her spouse that she wanted to be removed as a director. To that end, the appellant’s husband notified his accountant, and the accountant’s secretary prepared a Form 1 – Initial Return/Notice of Change. (This is the standard-form document that a corporation files with the Ontario Ministry to update the public registry of changes to its directors or officers.)

The Form 1 stated that the appellant’s directorship began on September 4, 2003, and that it ended on December 12, 2003. (At trial, the judge received no explanation about why the Form 1 indicated that the appellant began on September 4, 2003, while the public registry and original resolutions showed that she began on May 18, 2001.) The corporation’s minute book included a copy of the Form 1. And although the accountant testified that his office had sent the Form 1 to the Ontario Ministry, no evidence indicated when the document was sent to the Ministry, nor did the Ministry’s records reflect the changes that the Form 1 requested.

In 2013, Cliff Crucibles was dissolved. At the time of its dissolution, Cliff Crucibles owed GST/HST debts under the Excise Tax Act and withholding-tax debts under the Income Tax Act.  As a result, the Canada Revenue Agency personally assessed the appellant and her husband for vicarious tax liability under the director’s-liability provisions.

The appellant retained a Canadian tax-litigation lawyer who appealed the appellant’s director’s-liability assessment to the Tax Court of Canada. The Tax Court dismissed the appeal, holding that the appellant was indeed liable under the director’s-liability provisions. Specifically, the court reasoned that, under Ontario’s Business Corporations Act, a director’s resignation takes effect only if it contains the director’s personal signature. Because the Form 1 didn’t contain the appellant’s signature, the appellant remained a director.

In response, the appellant appealed the Tax Court’s decision to the Federal Court of Appeal. Appearing before the Federal Court of Appeal, the appellant argued that the Tax Court judge had erred by imposing a signature requirement. Specifically, the appellant’s experienced Canadian tax-litigation lawyer pointed out that subsection 121(2) of Ontario’s Business Corporations Act doesn’t require a director’s resignation to be signed; it merely requires that it be in writing.

The Federal Court of Appeal agreed with the appellant on this point. The appellate court confirmed that neither Ontario’s corporate statute nor the court’s own prior jurisprudence required that all resignations have a personal, physical signature to be effective. Indeed, according to the appellate court, a director may even resign by email or text. Regardless of the facts, concluded the court, a valid director’s resignation must involve no ambiguity about whether the corporation received the resignation in writing, and the resignation’s effective date must be certain.

The appellant went on to argue that subsection 121(2) only requires that the corporation possess written evidence of a director’s resignation. And this, the appellant claimed, was accomplished by the Form 1 in Cliff Crucibles’ minute book. Subsection 121(2) does not, according to the appellant, stipulate that the act of resignation itself be expressed in writing.

The court disagreed. First, the court observed that subsection 121(2) does in fact require that the act of resignation be expressed in writing. Second, the court pointed out that a Form 1 isn’t a resignation; it’s a notice entitled “Initial Return/Notice of Change.” Moreover, a Form 1 isn’t sent to the corporation from a resigning director; it’s sent to the Ontario Ministry from the corporation. “For a resignation to be effective,” the court explained, “there must be evidence that the corporation received a written resignation confirming that the appellant has resigned. While a Form 1 may reflect something that may have happened, it is not a substitute for a written resignation.”

The Federal Court of Appeal also highlighted the “irreconcilable difficulties in relying on [the] Form 1 as the appellant’s written resignation to the corporation.” First, there was an unexplained two-year gap between the date that the appellant testified that she had resigned, and the date indicated on the Form 1. Second, while the accountant took steps to formally resign his directorship immediately after incorporation, no such steps were taken contemporaneous to the appellant’s oral resignation shortly after incorporation. Finally, there was no explanation about why the Form 1 listed the date of the appellant’s appointment as September 4, 2003, whereas it was undisputed that she was appointed on May 18, 2001.

The Federal Court of Appeal ultimately dismissed the appellant’s appeal and held that she remained vicariously liable for the corporation’s tax debts under the director’s-liability provisions in section 323 of the Excise Tax Act and section 227.1 of the Income Tax Act

Pro Tax Tips & Expert Canadian Tax Lawyer Tax Guidance – Director’s Vicarious Liability for GST/HST and Withholding Tax & The Requirements of Resignation

If you’re a director (or merely acting as a director) of a corporation with GST/HST arrears or withholding-tax debts, you could become vicariously liable for the corporation’s unremitted GST/HST and source-deduction arrears.

You can limit your exposure by resigning—thereby starting the clock on the two-year limitation period. But the resignation must meet the requirements of the governing corporate law. A corollary of the Cliff case is that it doesn’t suffice if you simply file a notice of change removing yourself as the director on the corporate registry. On the other hand, the Cliff case does not mean that corporate-registry filings and minute-book contents are irrelevant. In Cliff, the taxpayer lost not only because of the failure to satisfy the resignation requirements in Ontario’s corporate statutes, but also because of the inconsistent records in the corporation’s minute book.

A director seeking to retire from the corporation must understand and satisfy the requisite steps in accordance with the governing corporate law. And even if not technically required, the corporation’s filings and records should reflect that director’s resignation. Consult one of our expert Canadian tax lawyers for advice on ensuring that your director’s resignation is not only valid but also capable of withstanding CRA collections or scrutiny.

A director wanting to remain involved with the business—but not in the capacity of a director—must guard against a claim of de facto directorship. You remain exposed to a director’s-liability assessment should you carry on as a de facto director. Speak with one of our experienced Canadian tax lawyers today. We thoroughly understand this area of law. We can advise on arranging your post-directorship involvement so that you reduce or avoid the risk of being personally assessed as a de facto director.

Frequently Asked Questions

Question: I’m the sole director and shareholder of a corporation with outstanding GST/HST debts and withholding-tax arrears. I understand that a corporation is a separate legal entity from its shareholders and directors. Therefore, I can abandon this corporation, and I face no personal exposure to these tax debts. Is that correct? 

Answer: No. Although a corporation is a separate legal entity from its shareholders and directors, a director may become personally liable for a corporation’s unremitted net GST/HST and for its unremitted source deductions. Section 323 of Canada’s Excise Tax Act gives the Canada Revenue Agency the means of personally assessing a corporation’s director for the corporation’s unremitted GST/HST. Likewise, section 227.1 of Canada’s Income Tax Act allows the CRA to personally assess a corporation’s director for the corporation’s unremitted source deductions for employee payroll (e.g., CPP, EI, and employee income-tax withholdings).

Question: I intend to retire from my position as my corporation’s director. What steps can I take to limit my exposure to a director’s-liability assessment under section 323 of Canada’s Excise Tax Act and under section 227.1 of Canada’s Income Tax Act.

Answer: The director’s-liability provisions prescribe a two-year limitation period on a director’s exposure to a corporation’s unremitted GST/HST and source deductions. The Canada Revenue Agency cannot assess a director for a corporation’s GST/HST arrears or for its withholding-tax debts “more than two years after the person last ceased to be a director of the corporation.” You can therefore limit your exposure by resigning—thereby starting the clock on the two-year limitation period. However, you must ensure that the corporation receives your formal written resignation.

Question: I previously served as a director for an Ontario corporation. I recently resigned from this position. To that end, my accountant prepared a Form 1 – Initial Return/Notice of Change and sent it to Ontario’s Ministry of Government and Consumer Services. My accountant says that this is all that’s required to limit my exposure to a director’s-liability assessment under section 323 of Canada’s Excise Tax Act and under section 227.1 of Canada’s Income Tax Act. Is this correct?

Answer: No. The resignation must meet the requirements of the governing corporate law. For example, subsection 121(2) of Ontario’s Business Corporations Act effectively requires you to prove that the corporation received your resignation in writing. A Form 1 doesn’t satisfy this requirement. First, a Form 1 isn’t a resignation; it’s a notice entitled “Initial Return/Notice of Change.” Second, a Form 1 isn’t sent to the corporation from a resigning director; it’s sent to the Ontario Ministry from the corporation. For a resignation to be effective, there must be evidence that the corporation received a written resignation confirming that the director has resigned. While a Form 1 may reflect something that may have happened, it is not a substitute for a written resignation. In short: A director seeking to retire from the corporation must understand and satisfy the requisite steps in accordance with the governing corporate law. Consult one of our expert Canadian tax lawyers for advice on ensuring that your director’s resignation is not only valid but also capable of withstanding CRA scrutiny.