Personal Liability Of Directors For Corporate Taxes

By Vern Krishna, Executive - Director of the CGA Tax Research Centre, University of Ottawa.
Reprinted with permission

The directors of a corporation must manage the business and affairs of the corporation.  Subject to a unanimous shareholders agreement, the obligation to manage the corporation is mandatory. In corporate law, the director’s obligation is to the corporation and not to its shareholders or creditors. In certain circumstances, however, the Income Tax Act looks through the corporate veil and makes a director vicariously and personally liable for corporate tax debts. Thus, directors who do not discharge their management duties can end up paying the corporate tax bill.

Obligation to Withhold and Remit

The Income Tax Act requires withholding of tax in various circumstances. There are severe financial consequences for failure to withhold taxes as required by the Act. Failure to withhold taxes can make the payer liable and expose the payee to penalties. The directors of a corporation or other entity that fails to withhold taxes can also be personally liable. 

Liability of Payer

Subsection 153(1) requires every person paying salary, wages or other remuneration to deduct a prescribed amount of tax. Remuneration includes all taxable benefits. The payer must remit amounts withheld to the Receiver General of Canada. Failure to withhold or remit taxes can trigger severe penalties. The penalties apply at two levels. The first tier penalty is 10 percent of the amount that the payer should have withheld in taxes. The penalty doubles to 20 percent for repeat offences if the payer was grossly negligent in its failure to withhold taxes as required.

 “Gross negligence” is knowing conduct or indifference to the consequences of one’s actions or inactions. Gross negligence involves greater neglect than simply a failure to use reasonable care. It involves a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not.

In addition, the payer is liable for interest at a prescribed rate on any amounts that it should have withheld in taxes. Such interest generally applies until the amount is paid. Interest is also chargeable on any penalties from the day of the mailing of the notice of original assessment of the penalty to the day of payment. The payer’s liability for withholding is strict. It is difficult to escape liability merely because the mistake was in good faith or that the payer acted in a reasonable manner.

Waiver of Penalties and Interest

The Minister has absolute discretion to waive penalties and interest in appropriate circumstances, but he does not have the power to waive taxes. The discretion generally applies to the 1985 and subsequent taxation years. Unfortunately, this remedy is not easily available to taxpayers. The so-called “Fairness Package” is not nearly as fair as its label implies.

Taxpayers must apply in writing to the taxation centre where they file their returns or to the district office serving their area. The application for waiver must set out the relevant information. In particular, the application must address the particular circumstances that triggered the interest and penalties and why those circumstances were beyond the taxpayer’s control.  The circumstances must truly be quite “extraordinary”, such as, natural or human-made disasters (floods, fires), civil disturbances or disruptions in services (postal strikes), serious illness or accidents, or serious emotional or mental distress (e.g. death in the immediate family).

The Revenue Agency also considers processing delays or errors, errors in material available to the public, incorrect advice, or delays in providing information necessary for the taxpayer to make a required payment as appropriate factors to consider in granting relief.

The inability to pay an amount owing is also a mitigating factor but only if the taxpayer acts reasonably and prudently. A small business entrepreneur who is unable to pay his taxes owing may not be able to arrange reasonable payments because a large part of each payment would go towards interest charges. The entrepreneur can discuss the matter with the Agency, which may consider waiving all or part of the interest for the period from when the payments begin until he pays the amount owing. The Agency waives interest only if as the entrepreneur makes the payments on time.

In determining whether it will waive interest or penalties, the Agency considers whether the taxpayer has:

·     A history of compliance with tax obligations;

·     Knowingly allowed a balance to exist upon which arrears interest has accrued;

·     Exercised a reasonable amount of care and has not been negligent or careless in conducting their affairs under the self-assessment system;

·     Acted quickly to remedy any delay or omission.

Personal Liability of Directors

A director is not liable if he can show that he acted in a reasonable and diligent manner. The due diligence defense determines the degree of responsibility that the director must shoulder for his or her mismanagement or non-management of the corporation’s affairs. A director must exercise the degree of care, diligence and skill to prevent the failure of the corporation to deduct, withhold or remit tax that a reasonably prudent person would have exercised in comparable circumstances. Due diligence is essentially a subjective test. Hence, one must take into account circumstances such as degree of education, business knowledge and general ability of the director.

The Act limits the liability to individuals who were directors at the time that the corporation was obliged to deduct, withhold, remit or pay the tax. Because the liability is joint and several, each director can be liable for the full amount of the liability. They may, however, claim contribution from their fellow directors. The liability of directors includes not only the amount that the corporation is liable to pay but also interest and penalties on such amounts.

Directors are obliged to manage their corporations. Some directors manage actively, others are more passive. Regardless of the degree of their involvement, all directors are obliged to tend to corporate affairs according to their personal skills and expertise. Of course, directors can always rely on professional advisors and corporate officers for technical expertise, but their reliance must be prudent. Directors who do not discharge their management duties in a prudent manner can are ultimately responsible for corporate tax debts.

Professor Vern Krishna, QC, FRSC, FCGA is the Executive Director of the CGA Tax Research Centre, University of Ottawa and Tax Counsel, Koskie Minsky, Barristers & Solicitors, Toronto. Web: counsel.ca

Prepared by, Vern Krishna.
June 19, 2000

Disclaimer

Please be aware that this information is not intended to be a substitute for competent professional advice. Please consult your CGA or other professional advisor before acting on any of the information or suggestions contained herein.