Director Liability: Madison v. Canada, 2012 FCA 80 & Canada v. Colitto, 2020 FCA 70
When a corporation fails to remit trust amounts such as payroll source deductions, the Canada Revenue Agency’s (“CRA”) recovery options do not end with the company itself. For example, according to section 227.1 of the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.) (“ITA”) the CRA may hold the corporation’s directors personally liable, and that exposure can cascade further still, reaching a spouse or child to whom a director has transferred property.
Two Federal Court of Appeal (“FCA”) decisions, Madison v. Canada, 2012 FCA 80 [Madison] and Canada v. Colitto, 2020 FCA 70 [Colitto], illustrate how this regime operates. Read together, they resolve two distinct questions: how the CRA may attach the corporate debt to a director, and when that liability arises.
The Statutory Framework
In Madison, at para. 2, the FCA outlined the framework under section 227.1 of the ITA as follows:
Pursuant to subsection 227.1(1) of the Income Tax Act, the directors of a corporation may be held liable for, among other things, the corporation’s unremitted employee source deductions…
Subsection 227.1(2) shields the directors of a corporation from liability until the Minister has met certain conditions that are intended to ensure that collection remedies against the corporation are exhausted before the directors are assessed…
A director may also avoid liability by establishing the due diligence defence set out in subsection 227.1(3), or by invoking subsection 227.1(4) which provides that a director cannot be assessed under subsection 227.1(1) more than two years after he or she last ceased to be a director…
A director who is assessed under subsection 227.1(1) may assert a claim against the corporation and its other directors for any amounts paid to satisfy the assessment (subsections 227.1(6) and (7))…
Madison v. Canada, 2012 FCA 80
In Madison, the corporation failed to remit employee source deductions for certain taxation years. The CRA assessed the Appellant for director’s liability under subsection 227.1(1) of the ITA. The issue was whether the CRA satisfied any preconditions set out in paragraphs 227.1(2)(a), (b) or (c) of the ITA.
Subsection 227.1 (2)
According to subsection 227.1 (2), a director is not liable under subsection 227.1(1), unless:
(a) a certificate for the amount of the corporation’s liability referred to in that subsection has been registered in the Federal Court under section 223 and execution for that amount has been returned unsatisfied in whole or in part;
(b) the corporation has commenced liquidation or dissolution proceedings or has been dissolved and a claim for the amount of the corporation’s liability referred to in that subsection has been proved within six months after the earlier of the date of commencement of the proceedings and the date of dissolution; or
(c) the corporation has made an assignment or a bankruptcy order has been made against it under the Bankruptcy and Insolvency Act and a claim for the amount of the corporation’s liability referred to in that subsection has been proved within six months after the date of the assignment or bankruptcy order.
The FCA confirmed that 227.1(2) is a precondition the CRA must satisfy before it can collect from a director, but which gateway fits depends entirely on how the company wound down. According to the FCA, at para. 18:
Subsection 227.1(2) is intended to ensure that a director is not held liable for a tax debt of the corporation unless the Crown has taken specified steps on a timely basis to satisfy the debt from the assets of the corporation. In this regard, there are three alternatives – paragraph 227.1(2)(a), (b) or (c). Only one of these can apply in a given case. Which one applies depends on the particular facts…
Paragraph 227.1(2)(b)
The Appellant in Madison argued that paragraph 227.1(2)(b) applied because the corporation was dissolved. A proof of claim was not filed within the permitted six month period for the corporation’s liability for unpaid source deductions therefore the requirements of paragraph 227.1(2)(b) had not been met. However, the FCA disagreed, stating at para. 20:
paragraph 227.1(2)(b) does not apply where a corporation is dissolved under a procedure that does not require the appointment of a liquidator or the submission of proofs of claim.
In this case, the corporation, of which the Appellant was the director, was dissolved for failure to file annual corporate returns. A liquidator is not appointed in respect of an involuntary dissolution for non-compliance including failing to file information returns with the respective business registry. Accordingly, the director’s argument that paragraph 227.1(2)(b) applied was unsuccessful.
Canada v. Colitto, 2020 FCA 70
Between February and August 2008, the corporation failed to remit source deductions to the CRA. While the corporation was in default of its obligation to remit the required source deductions, the Appellant transferred certain properties to his wife. The consideration for the transfer was for less than fair market value.
On October 10, 2008, CRA issued a Notice of Assessment to the corporation for the unremitted source deductions. On August 6, 2009, a certificate for the corporation’s tax debt in the amount of $794,286.98 was registered in the Federal Court. On January 4, 2011, a writ was executed against the corporation and returned unsatisfied.
As mentioned above, subsection 227.1(1) imposes joint and several liability on a director of a corporation that fails to remit tax which the ITA requires be withheld at source. The issue was whether the Appellant, the transferor, was liable under the ITA to pay an amount “in or in respect of” the taxation year in which the properties were transferred or any preceding taxation year.
The Tax Court of Canada
The Tax Court in Colitto v. The Queen, 2019 TCC 88 allowed the appeal on the ground that the Appellant’s personal liability under section 227.1 did not arise until January 4, 2011, when execution against the corporation’s tax debt was returned unsatisfied.
The Tax Court relied on the decision in Canada (Attorney General) v. McKinnon, [2001] 2 F.C. 203, 194 D.L.R. (4th) 164 (F.C.A.) [McKinnon] for the proposition that “a director is liable to pay to the Crown the amounts not remitted by the company only after all efforts to collect have been exhausted.”
The Federal Court of Appeal
The FCA rejected the Tax Court’s decision for two reasons. First, the FCA reasoned that the statement in McKinnon was obiter and therefore not binding. Second, the requirement that the Minister must exhaust collection efforts against the corporation is only a condition precedent to recovery from the director. It does not mean that the director’s liability arises only when those collection efforts have failed.
Additionally, the FCA considered the text, context and purpose of subsections (1) and (2) of section 227.1. With respect to the text, the FCA found that the provision was ambiguous when the director’s liability arises.
The FCA further examined the contextual factor in subsection 227.1(2) and found that it does not state that a director is not liable for the corporation’s default “unless and until” the specified actions take place. According to the FCA, at para. 22:
The Tax Court read subsection 227.1(2) to “strongly” suggest that a director’s liability does not “arise until the relevant preconditions set out in subsection 227.1(2)” are met (reasons, paragraph 48). Contrary to the Tax Court’s reading of the provision, subsection (2) makes clear that it is subsection (1) that imposes liability upon directors. Subsection (2) is a relieving provision that sets out specified circumstances when the liability otherwise imposed by subsection (1) may be avoided.
The FCA finally considered the purpose of the subsection 227.1(2), finding that the provision is intended to prevent double taxation. According to the FCA, at para. 24:
Properly understood, subsection 227.1(2) effects, among other things, a purpose that animates a number of provisions of the Act: the avoidance of double taxation. Thus, paragraph 227.1(2)(a) operates to avoid double taxation by prohibiting the Minister from recovering unremitted source deductions from a director otherwise liable for the deductions if the corporation has already paid all of the liability (see also subsection 227.1(5) to the extent the corporation has paid a portion of the liability). Similarly, subject to the potential application of section 166 of the Act, … the Minister may not collect an amount in excess of the amount proven to be owing by a corporation after liquidation, dissolution or bankruptcy proceedings have been commenced.
Having examined the text, the context and the purpose of subsection 227.1(1), the FCA concluded that the Appellant’s liability for unremitted source deductions arose in or in respect of the 2008 taxation year.
Conclusion
Taken together, the decisions in Madison and Colitto demonstrate that director’s liability under section 227.1 operates in two stages. First, director’s liability under s. 227.1(1) arises in the taxation year in which the corporation’s remittance failure occurs. Second, the Minister must satisfy one of the preconditions in subsection 227.1(2) before proceeding against the director. The distinction is important: subsection 227.1(2) limits recovery from the director, but it does not postpone the existence of the director’s liability.
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