Director’s Liability: A Comprehensive Overview

Posted on by Tax Partners
30
Dec

Introduction:

Directors of corporations hold significant responsibilities, including overseeing financial, legal, and operational matters. Among these responsibilities is ensuring compliance with tax laws. Under Canadian tax legislation, directors can be held personally liable for specific tax obligations of their corporations, particularly for unremitted source deductions and GST/HST. 

This article delves into the nuances of director's liability, recent case law developments, and practical steps directors can take to protect themselves.

Director's Liability: Key Tax Obligations

Directors can be held jointly and severally liable for:

  1. Unremitted Source Deductions: Includes employee income tax, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums deducted at source but not remitted to the Canada Revenue Agency (CRA).
  2. Unpaid GST/HST: Amounts collected from customers but not remitted to the CRA.
  3. Part VIII Tax Liabilities: Historical liabilities tied to tax credit claims, though less common today.

Tax authorities, such as the CRA, have adopted aggressive measures in pursuing directors for unpaid tax liabilities, especially when businesses face financial struggles.

Conditions for Director’s Liability

Under the Income Tax Act and the Excise Tax Act, specific conditions must be met before the CRA can hold directors personally liable:

  1. Attempt to Collect from the Corporation: The CRA must attempt to collect the outstanding amounts from the corporation by filing a certificate in Federal Court and executing judgment against the corporation. If the execution is returned unsatisfied, the CRA can then pursue directors.
  2. Time Limitation: Directors can only be assessed for liabilities if they ceased to be a director within two years from the date of the CRA's assessment.
  3. Bankruptcy or Liquidation: If the corporation is bankrupt or liquidated, the CRA must file its claim within six months.

Defenses Available to Directors

Directors have several defenses to avoid personal liability:

  1. Due Diligence Defense: A director is not liable if they can demonstrate that they exercised the degree of care, diligence, and skill that a reasonably prudent person would have exercised under similar circumstances.

Factors Courts Consider for Due Diligence:

  • Actions taken to ensure proper remittance systems were in place.
  • Regular oversight of the company’s financial processes.
  • Efforts to rectify issues when financial challenges arose.
  1. Improper Appointment: A person cannot be held liable if they were not legally appointed as a director during the relevant period.
  2. Resignation: A valid resignation starts the two-year limitation period. However, a resignation must be properly documented and submitted in accordance with corporate law requirements.
  3. Lack of Control: Directors may argue they had no freedom to act as a director, such as in cases involving unanimous shareholder agreements or when a receiver is managing the business.

Recent Developments and Case Law

The application of the due diligence defense continues to evolve through case law. Recent decisions emphasize the proactive role directors must take to meet their obligations:

  1. Familiarity with Tax Obligations: Directors are expected to understand their remittance obligations and actively monitor compliance.
  2. Positive Duty of Action: Courts have underscored the importance of taking preventative measures, such as implementing robust financial controls and acting swiftly when remittance issues arise.
  3. Closing the Business: Courts have ruled that when a corporation is unable to meet its remittance obligations, it is the director's responsibility to wind up operations rather than allow the business to continue accruing liabilities.

Practical Steps for Directors

To mitigate risks and avoid personal liability, directors should:

  1. Understand Tax Obligations: Familiarize themselves with payroll and GST/HST remittance requirements.
  2. Implement Robust Systems: Ensure the corporation has systems in place to withhold and remit taxes accurately.
  3. Monitor Regularly: Request and review written reports confirming remittance compliance.
  4. Act Promptly in Financial Distress: If the corporation faces financial challenges, prioritize remittance obligations and seek professional advice immediately.
  5. Maintain Clear Documentation: Keep records of board discussions, financial reports, and steps taken to address compliance issues.

Conclusion

Director’s liability for unremitted taxes highlights the importance of understanding and fulfilling fiduciary duties. While tax authorities can aggressively pursue directors for unpaid tax obligations, defenses such as due diligence provide avenues for directors to protect themselves. 

If you are a director facing potential liability or need guidance on meeting your obligations, consult a qualified tax professional to ensure your compliance and safeguard your interests.

This article is written for educational purposes.

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at [email protected], or by visiting our website at www.taxpartners.ca.

Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.

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