Former director still involved in running company was not a “de facto” director
The recent Tax Court of Canada decision in Koskocan has potentially changed the law on de facto directors.
The question of “who is a director of a corporation?” is very important in tax disputes, when a corporation goes out of business owing either GST/HST net tax, or payroll deductions (income tax source withholdings), or both. In most cases, the directors of the corporation are fully liable for its unremitted payroll deductions and GST/HST.
Over the past 18 years, the CRA and Revenu Québec (RQ) have often assessed a person on the grounds that the person was a de facto director even if not legally a director. A 1999 Federal Court of Appeal decision (Wheeliker and Corsano) confirmed that someone who thought he was a director, but had not properly been appointed, was liable as a de facto director.
The concept of de facto director has gradually expanded over the years, to effectively include anyone who is managing a company.
In this case, Koskocan founded a company in 1997 that operated a pizzeria in Montreal. In 2003 he turned the business over to his son and resigned as director, but he continued to help out with the business in various ways, including being the person who signed its cheques. RQ decided the company had under-reported its revenues and assessed it for a large amount of GST and Quebec Sales Tax. When the company could not pay the debt, RQ assessed Koskocan for the debt as a de facto director.
Koskocan appealed his GST assessment to the Tax Court of Canada, which allowed his appeal and cancelled the assessment. The Court strongly rejected the recent trend of treating anyone involved in running a company as a de facto director.
The judge engaged in a lengthy review of the meaning of “director”, and explained that directors are supposed to provide direction to a company through board decisions, to pass resolutions and to take certain major actions. It is the officers of a corporation who run it on a day-to-day basis.
When a person takes actions such as signing cheques or routine contracts on behalf of a corporation, those are not the actions of a director but of an officer or manager. Koskocan’s actions were, if anything, those of a manager. He was not a de facto director and so he was not liable for the company’s GST debt.
For good measure, the Tax Court also ruled that RQ’s method of calculating the restaurant’s revenues, based on its use of utilities and industry averages, was unreliable, so there was no GST debt of the corporation for Koskocan to be liable for, even if he had been a director.
This decision is refreshing. If the other judges of the Tax Court follow it, it will greatly restrict the number of cases where a person can be assessed as a de facto director.
RQ did not appeal this decision to the Federal Court of Appeal, so as of now it stands as the latest word on de facto directors.
Lawyer liable for not giving tax advice
The Ontario Superior Court of Justice issued an interesting ruling in January 2017, in Ozerdinc Family Trust v. Gowling Lafleur Henderson LLP. A lawyer who set up a family trust was found liable for not advising about the tax consequences.
The parents in question were doing trust and estate planning, and retained S as their lawyer in 1990. S set up a trust for their children, with a final distribution date of all the trust assets once the youngest child turned 22. In 2007, the parents decided this meant the children would get their money too early (perhaps they thought the children would not yet be mature enough), and they came back to S for assistance. He created a new trust for them, to which the old trust transferred its assets tax-free. The trust assets included property with substantial accrued capital gains that had not yet been taxed.
Unfortunately, in 1990 S failed to tell the parents about a key rule that applies to trusts: every 21 years there is a “deemed disposition”, and the trust must recognize and pay tax on all accrued capital gains. Since a trust usually pays tax at the highest marginal tax rate, this is often much more expensive than if the gains were taxed in the beneficiaries’ hands.
S’s failure to tell the parents about the “21-year deemed disposition rule” continued in 2007 when he designed the new trust. While it was possible to transfer the old trust’s assets tax-free to the new trust, S did not realize that the Income Tax Act provides that the 21 years would still expire in 2011, on the 21st anniversary of the old trust. The new trust had to pay substantial tax on the deemed gains for its 2011 taxation year.
Had S warned the parents about this problem, there was a fairly simple tax solution: the assets could have been “rolled out” tax-free to the children in 2011, before the 21 years were up, and the tax on the capital gains could have been deferred further and likely reduced.
The Court ruled that S’s law firm was liable in negligence to the trust. However, determination of the amount of damages to be awarded was left for another day.
As can be seen, there are many income tax traps that can catch an unwary taxpayer who is planning their financial affairs.