Tax Remittances: Proactivity Key to Due Diligence Defence

Due diligence was a big topic at the Audit Defence Bootcamp this past week, as the burden of proof in establishing a due diligence defence rests with any appellant to a CRA challenge.

As per subsection 227.1(3) of the Income Tax Act, to succeed in pleading the due diligence defence, an appellant must convince the court that they exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances – in other words; it is an objective test.  

In a recent Tax Court of Canada case, the appellant in Roitelman v. The Queen (2014) TCC 139 was an experienced businessman and was familiar with remittance obligations. He placed an advertisement and hired a bookkeeper when his business took him out of town more often. The bookkeeper had taken a bookkeeping course and had a little experience, but he also personally provided training to her in respect to the duties for which she was hired. The appellant’s accountant also provided additional instructions to the new bookkeeper. The appellant continued to supervise the bookkeeper’s work, including the remittance obligations, until he had a level of comfort in her competence.

At one point, the appellant became aware of failed remittances and instructed the bookkeeper not to make such mistakes again and provided increased supervision over her work until he felt she was competent in her duties.  

The Hounourable Justice Diane Campbell found that the appellant’s actions constituted proactive steps to prevent future failures to remit and to ensure compliance but that the appellant’s efforts were frustrated by this bookkeeper’s fraudulent and deceitful behaviour. At paragraph 28 she stated:

“The (established) test does not dictate that the positive steps taken must be effective in ensuring future compliance but only that a director takes those steps and that those steps would be the proactive steps that a reasonably prudent person would have exercised in comparable circumstances.”

In the end, the appellant in Roitelman was availed of the director’s liability charges. Here is how the judge interpreted the established tests, relevant to practitioners advising on due diligence required by business owners and directors:

To defend a CRA challenge of negligence in the case, several precedents could be relied upon:

• In Peoples Department Stores Ltd v Wise [2004] SCC 68, the leading case on the issue, the Supreme Court replaced the objective/subjective test with a purely objective test as the appropriate standard in reviewing the due diligence defence. This purely objective standard has set aside the common law principle that a director’s management of a corporation is to be judged according to his own personal skills, knowledge, abilities and capacities. The rationale behind changing the standard was to improve the quality of board decisions through the establishment of good corporate governance rules; a person will not be able to avail themselves from malfeasance in the discharge of his or her duties by relying on his or her own inaction. 

• In The Queen v. Buckingham, 2011 FCA 142, the Federal Court of Appeal provided a concise summary of how a director may establish a due diligence defence at paragraph 52:

“Parliament did not require that directors be subject to an absolute liability for the remittances of their corporations. Consequently, Parliament has accepted that a corporation may, in certain circumstances, fail to effect remittances without its directors incurring liability. What is required is that the directors establish that they were specifically concerned with the tax remittances and that they exercised their duty of care, diligence and skill with a view to preventing a failure by the corporation to remit the concerned amounts.”
(Emphasis added)

The Court in Buckingham also stressed that for directors to successfully rely on a due diligence defence, they must have taken active steps to prevent a failure to remit and not merely to have taken steps to remedy the failure after its occurrence. The focus of analysis in subsequent cases has been on the degree of care, diligence and skill exercised in preventing a failure to remit.

Greer Jacks is updating jurisprudence in EverGreen Explanatory Notes, an online research library of assistance to tax and financial professionals in working with their clients.