Most director's liability claims are with respect to unremitted withholding taxes such as source deductions, GST and other related Federal and Provincial taxes. When the Corporation subsequently goes out of business, Revenue Canada has the statutory right to go after the directors of the Corporation. The directors are liable for the taxes collected from third parties and not remitted to Federal and Provincial governments.
The Rules for Liability
For Revenue Canada to successfully claim against a director there are three (3) basic rules they must do in order for the CRA Agency to attack a director of a corporation on a personal basis which are:
(a) the Agency must demonstrate its inability to recover the amounts directly from the corporation;
(b) the Agency must start proceedings to assess directors no later the two (2) years after they have ceased to be directors; and
(c) directors must be unable to show that they exercised the degree of care, diligence and skill ("due diligence") required to prevent the failure
The Agency's Obligation
The agency must demonstrate its inability to recover the amounts directly from the corporation, the Agency must
(a) show that its execution against the corporation was returned unsatisfied
(b) prove a claim against the corporation in dissolution or liquidation by doing an audit on the corporation
(c) prove a claim against the corporation in bankruptcy
Revenue Canada must prove its claim within a 6-month period of time for points (b) and (c).
In assessing whether an individual has potential liability for unremitted source deductions, it is important to determine as a matter of law whether the individual who Revenue Canada claims was a director of the Corporation was in fact a director in law at the time that the withholding deductions were not remitted. For example, the individual might never have properly been appointed as a director in accordance with the appropriate corporate statute, or might have resigned prior to the failure to remit.
Even if the person was a director at the relevant time, the Courts have held that if he had no freedom of choice or power to act as a director on the relevant date then he might not be liable. Such freedom of choice may not exist where, for example, there is a unanimous Shareholders Agreement removing the director's power to act, or in a situation where a receiver has been appointed by a creditor of the Corporation and the Receiver is actually running the business.
Finally, even if all of the above tests have been met, a director can still avoid liability by availing himself of the "due diligence" defense set out in the Tax Act.
The Tax Act provides that a director is not liable for a Corporation's failure to remit source deductions where he exercises the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.
Much of the recent case law has focused on the questions of the due diligence defense. The Courts tend to look at a variety of factors before deciding whether a director has acted diligently. The personal background of the director including general capability as a director, business knowledge and education have been examined. The Courts has also examined actions taken by the director to prevent the failure. The Courts have stated that there is a positive duty to take action to prevent these failures. Accordingly, every director should:
 | familiarize himself with the withholding
and remittance requirements; |
| ensure that an appropriate system to
withhold and remit has been implemented by the Corporation; and |
| require regular written reporting ensuring that the remittance procedures are functioning. |
For companies that are in a precarious financial position even more stringent steps may have to be taken.
The Courts have also said where a Corporation reaches the point where it cannot issue a remittance cheque for fear that it will not be honoured, it is time to lock the door and go out of business. Accordingly, the mere decision to try to keep the Corporation in business may result in the director's reducing his ability to rely on the due diligence defense.