Kempo, T.C.J. [Orally]: —I am delivering these reasons for judgment orally, however I expressly reserve the right to edit and expand upon them subsequently if need be.
This appeal is from an assessment issued by the respondent pursuant to subsection 227.1(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") commonly known as the directors' liability provisions.
The defaulted remittances occurred for amounts withheld from salaries paid by King Ornamental Iron Ltd. (the "company") to its employees in October and November 1986. The appellant seeks exculpation of liability in this case primarily under and by virtue of subsection 227.1(3) of the Act.
Facts
Viva voce evidence was heard from the appellant, from the company's bookkeeper, Candace Meyers who was in charge of the relevant matters and who is also the appellant's spouse, and from the appellant's full-time financial advisor, Steven Warnell, who is a certified general accountant and an experienced auditor.
The appellant had been the majority shareholder and president of the company since its incorporation in 1981. Its business was that of steel manufacturing and fabrication. The appellant's mother was a minority shareholder. Both of these individuals had invested their own moneys in the operations via shareholders' loans.
The year 1986 was a period not only of expansion and growth, but it also housed greater competitive forces with resultant lower profit-margins being experienced throughout the industry. This translated to a need for a greater volume of business to be generated, with better and larger contracts being sought to meet the business/economic exigencies of the time. Cash-flow problems were said to be the norm, but not because of actual losses being suffered on any particular project or projects. Recurring negative balances in the company's general account reflected its need for an operating line of credit pending its receipt, in the usual mode, of the receivables.
I have summarized by way of overview the business environment surrounding the company's operation, extrapolating the same from the totality of the evidence of all three witnesses heard. In my opinion, having observed their manner and demeanour, all are credible. Their answers to both direct and cross-examination were forthright and without equivocation.
There was unanimity of opinion that due to the above mentioned factors the company required more capital as the 1986 year progressed. Indeed, satisfactory investors had been found by August 1, 1986. Prior to full formal completion of the transaction these investors had advanced, unsecured, close to $100,000 to the company in late September or early October which was used by it in the main to pay down some of its liabilities. The appellant's recollection was that he believed a deal was had with the investors as at August 31, 1986.
In mid-November the appellant, acting for the company,decided to allocate corporate funds then on hand amongst most of its important trade creditors. On this basis, 75 per cent of October's payroll withholdings were then remitted to the Receiver General. Both the appellant and Mr. Warnell said they expected to be able to pay the balance of these withholdings (the federal tax portion was $3,188.38) by the end of November out of the remaining funds expected from the new investors. This amount approximated $30,000-$35,000 which was to be sourced by the investors from a Provincial venture capital fund. The appellant and Mr. Warnell anticipated that execution of the formalities, and receipt of the cash balance, would occur around December 1, 1986.
I accept the appellant’s evidence that in mid-November he was then without any knowledge of the estimating errors that had been made by an employee on the company's largest contract, the Waterfront Place structure. Full knowledge, and its attendant consequences, came to light only when the October month-end statements were available just after mid-November. The errors and cost overruns were translated into an anticipated contract loss in the range of $80,000 to $90,000.
The investors were immediately advised of the matter in the hope and expectation that they would continue with the arrangement. Two meetings followed, the last one being very close to month's end. At the last meeting it was put to the appellant that one of his options was to approach the 45 employees for their investment input but that he had no option other than to pay them out in full failing which he would immediately be sued and the bank's security acquired followed by virtual annihilation of the shareholders's equity. Legal advice was sought and different aspects were discussed.
Believing the whole matter could still be saved, a large receivable was collected from the Waterfront Place project and put into the bank account. A cheque for $105,000 repaying the loan was then written to the investors on November 27.
The company's general account and separate payroll account had been kept in the Dartmouth Savings and Credit Union. Candace Meyers supervised the payroll accounts and was then training the foreman's wife in this duty pending her own maternity leave. On December 1 the foreman, having heard of the financial problems presumably through his wife, attended upon the appellant in his office threatening physical harm if he was not paid immediately and that he would not be responsible for anything the other steelworkers would do if they were unpaid. The earned pay was not due until December 4. Out of fear and concern, payroll cheques were issued to the employees, the police were telephoned (to no avail), and the appellant then went to the bank with the plan and hope that it would financially assist the company until new investors could be located. The bank's official advised wind-up and receivership. Touche Ross Ltd. was called in and the appellant signed the required documents. On that day, December 1, the appellant's company was formally placed into receivership and that evening Mrs. Meyers delivered her baby. The next day the locks were changed on the business premises and thereafter the company's affairs were conducted under the umbrella of receivership and wind-up. The unremitted November federal tax withholding was $9,658.06.
The appellant was adamant that on December 1 he was of the firm opinion and belief a wind-up and sale of all the corporate assets could and would cover and pay for all of its unremitted payroll withholdings. By then this included the remaining October withholdings and all of the November withholdings. Indeed, the receiver's interim report, Exhibit A-7, Schedule 1 therein admits to prima facie corroboration of the appellant's belief at that time.
Analysis-The November Withholdings
The company had a good and working payroll system in place. It was without any history of failure or delay in making payroll remittances prior to the mid-November 1986 deferral decision.
That the appellant was operating under extreme mental pressure during the last two weeks of November has been graphically depicted. His described responses and conduct [were] the very antithesis to that of being unconcerned, indifferent or uncaring. I am well apprised of the danger inherent in a 20-20 hindsight approach being utilized in situations such as these. However one factor of note operating in this case is that the appellant was acting freely in his decision-making after having had the benefit of some professional advice, albeit under compressed conditions.
Succinctly put, the factors of the unexpected large loss on the largest contract, the stress suffered from the aforementioned threats inflicted by the investors and the foreman, the short time span within which a decision had to be made, no history of other remittance deferrals or defaults, plus the consistent cash-flow problems must be weighed against the appellant's bona fide belief that there were then sufficient assets on hand to pay all of the unpaid remittances. In my view a director acting reasonably under all of the aforenoted circumstances would have followed the bank’s advice and decision to forthwith end the corporate operation.
I do not wholly accept respondent-counsel's submission that the established and recurring cash-flow problem was really the essence of the whole problem with the consequence that it should thereby be the determining factor. It is true that this knowledge is to be considered as a significant circumstance. However in my opinion that particular matter should not be viewed in isolation. Rather, it must be weighed in concert with all of the other relevant and significant events when applying the doctrine of reasonableness, in both its subjective and objective senses, to the conduct and decision making of this appellant.
It is my considered opinion that the appellant's decision to accept wind-up and receivership of the company on December 1 had been reasonably made, both on a subjective as well as on the objective basis. Having so found, there is no need to comment on the aspect raised by respondent's counsel that the appellant had thereby voluntarily put it beyond his power or ability to cause payment of the unpaid remittances to be made thereafter. There is nothing in the evidence supportive of an inference that receivership was sought and employed as an avenue of escape from personal fiscal liability. On the contrary, the receiver's aforenoted interim report, Exhibit A-7, had opined a surplus of funds being available as at December 10, being ten days following the receivership, after statutory liabilities had been taken into account.
While the recent and yet unreported decision of Judge Rip of this Court in the case of Graham Keast v. M.N.R., IT-90-207, August 23, 1990 is authority for the proposition that the conduct of care, diligence and skill to prevent the company's failure to remit the withholdings are extant and must be exercised continuously at all times from the date of withholding until the date the payment is fiscally due, the facts of that case were such that Judge Rip was unable to find any degree of care, diligence or skill having been exercised at any time by that taxpayer. It is more than obvious this is not the factual situation in the case at bar, at least with respect to November's payroll withholdings.
Accordingly, and for the reasons given, I find that the appellant, on the evidentiary balance of probabilities, has satisfied the subject exculpatory provision concerning the non-remittance of November's payroll withholdings.
Analysis-The October Withholdings
I am unable, however, to come to the same conclusion concerning the unremitted balance of the October payroll withholdings.
Here, with sufficient cash on hand to pay it all, the appellant had freely, consciously and deliberately decided that the company should defer payment of 25 per cent of the remittances then due pending receipt of the expected investor funds within the following few weeks. Factually then, 25 per cent of employee withholdings had been deliberately appropriated to corporate use by way of diversion to corporate suppliers to the detriment of the respondent.
By operating the company in this manner the appellant, in my view, had accepted the risk of becoming personally liable for the company's indebtedness under subsection 227.1(1) of the Act. The amounts withheld were not funds the company had any right to use for its business purposes. Although liability under the subject fiscal provision is not absolute, the appellant's conduct is distinguishable from those circumstances where reasonable steps had been taken to make the remittances as and when required but other non- foreseeable, unexpected events had prevented that.
Of particular note is the absence of any evidence establishing, at midNovember, that the then cash-flow difficulties were all that much different from the continuum of the previous months. Payroll withholdings and timely remittances were known to all concerned to be of major importance. The diversion of employee withholdings to corporate use was not made within a crisis management situation countenancing corporate survival. The real state of affairs amounted to a perceived enhanced ability, and a more convenient time, to pay the remaining 25 per cent once the balance of the investor's money was received.
Of considerable import here, when analyzing the matter objectively, was the fact that the $100,000 had been advanced only in the form of an unsecured loan, that the investment deal was complex and that the agreements and share transfers, while believed to be prepared in draft form, had not been fully finalized and executed. It was admitted that the essential and substantive documents had not yet been done. These uncompleted aspects of the investment deal underscores the reality that, objectively, the expectation of eventual fulfilment was merely subjectively probable, and that the appellant had no real or reasonable control over the situation until all the essential matters had been fully completed and executed. I cannot consider the matters yet to be done as merely peripheral or subsidiary in nature.
Appellant's counsel urged the Court to find that the company's inability to pay the October's 25 per cent withholding, as planned, was inextricably interwoven with the consequences from its post-dated discovery of the enormous loss to be suffered on its largest contract followed by the investor withdrawal, both of which were unexpected and unforeseeable. If, it was urged, both events were indeed unexpected and unforeseeable, then the company's decision in mid-November regarding the October's remittances, being based on its then expectations, could realistically be viewed as contextually reasonable. Therefore, it was said, the risk assumed by the appellant in causing the corporate diversion and deferral of a part of these withholdings was minimal and, by implication, reasonable; the Act does not call for perfection nor does it impose an absolute liability.
In my view there may well be greater and more persuasive merit in this proposition if all of the documentation and other formalities of the investor transaction had been substantially completed. As I see it, and as a concomitant to the submission, there remains a serious reservation that it is reasonable for a director to expect definiteness in matters involving complex investment arrangements yet to be fully executed and finalized.
I return to the appellant's mid-November decision and observe there were no unexpected intervening circumstances precluding payment at that time of the whole amount of the October withholdings. I find that the conscious and deliberate appropriation and deferral of 25 per cent of this amount, under all of the factual circumstances, was not reasonable.
Conclusion
In conclusion the appeal is to be allowed in part and the matter referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the appellant, as a director of King Ornamental Iron Ltd., is liable for the unremitted employee source deductions only for the month of October 1986 pursuant to section 227.1 of the Income Tax Act.
The appellant, having in my view substantially succeeded in this appeal, will have his costs on a party-to-party basis.
Appeal allowed in part.