When does director's liability arise to support section 160 assessment?

19 May 2020

The Queen v. Colitto

The Queen v Colitto[1] addressed the combined effect of two provisions that create third party liability for someone's tax debts, namely:

  1. subsection 160(1)[2] (joint and several liability in connection with a non-arm's length property transfer from the tax debtor for less than fair market value ("FMV"); and
  2. subsection 227.1(1) (director liability for corporate failure to deduct, withhold, remit or pay certain amounts).

Colitto is the first case decided by the Federal Court of Appeal ("FCA") to consider the timing for director liability arising under subsection 227.1(1) for purposes of subpara. 160(1)(e)(ii).[3] Paragraph 160(1)(e) is a key part of section 160 that sets out limiting factors that would reduce or eliminate liability: liability is limited to the lesser of:

(1) the amount by which the property's FMV, when it was transferred, exceeded the FMV of the consideration;[4] and

(2) the total of all amounts the transferor was liable to pay under the ITA in or in respect of the taxation year in which the property was transferred or any preceding year.

Obviously, if the transferor did not have a liability in or in respect of the year that the property was transferred (or leading up to that year), no liability can flow through to a transferee.

A review of the facts illustrates the timing question: Domenic Colitto was a director and shareholder of a corporation that failed to remit source deductions between February and August, 2008 and his failure to exercise due diligence was conceded. In May, 2008, while the corporation was in default of its remittance obligations, he transferred his 50% interest in each of two properties to his wife Caroline for nominal consideration. The total value of the property interests was approximately $228,750. In October, 2008, the Canada Revenue Agency ("CRA") assessed the corporation for its unremitted source deductions, plus interest and penalties totalling $631,554 and no notice of objection was filed. A certificate was registered in Federal Court and while the Sheriff was directed to enforce the debt, it remained unsatisfied. Consequently, in March, 2011, the CRA assessed Mr. Colitto personally as a director. Again, no notice of objection was filed. Much later, in January, 2016, the CRA assessed Mrs. Colitto in connection with the property transfer. She filed notices of objection and later appealed to the TCC.

The TCC allowed the appeal and vacated the assessments against Mrs. Colitto. The TCC's reasoning was based on timing. Mr. Colitto's liability as a corporate director did not coalesce until 2011. The property transfers in 2008 to Mrs. Colitto were therefore not caught. The Crown appealed to the FCA. The issue in the FCA concerned the wording of subpara. 160(1)(e)(ii) and whether Mr. Colitto, as property transferor, was in fact liable under the ITA to pay an amount "in or in respect of" the taxation year in which the property was transferred (i.e. 2008) or any prior taxation year. This determination depended on whether Mr. Colitto was liable under section 227.1 "in or in respect of" 2008, being the year of the property transfer to his wife for a nominal sum that was accordingly far less than FMV.

Under subsection 227.1(1), where a corporation fails to deduct, withhold, remit or pay, the directors at the time the corporation was required to do so are jointly and severally liable together with the corporation to pay the amount plus any interest or penalties.

The FCA concluded that subsection 227.1(1) is ambiguous. It might merely specify which directors are liable (namely, the directors at the time of the default). Alternatively, it might specify not only which directors, but also the point in time that their liability arose (namely, their liability accrues at the time of the corporation's failure). Because there is more than one possible interpretation, the FCA looked at the context of the provision, including subsection 227.1(2). Under subsection 227.1(2), the first criterion is that "a director is not liable under subsection 227.1(1), unless a certificate for the amount of the corporation's liability referred to in that subsection has been registered in the Federal Court under section 223 and execution for that amount has been returned unsatisfied in whole or in part". The TCC read this subsection as a precondition for a director to become liable in the first place. The FCA disagreed. Subsection 227.1(1) imposes a liability on directors and subsection (2) is merely a relieving provision that sets out circumstances in which a liability otherwise established under subsection (1) might be avoided. According to the FCA, the TCC imported into subsection 227.1(2) a timing requirement, that director liability does not accrue "unless and until" certain conditions are met. However, the words "and until" are not part of the provision and so subsection 227.1(2) does not delay the accrual of liability for a director until certain preconditions occur.

The FCA also held that subsection 227.1(2) functions to avoid double taxation. The CRA cannot recover from a director any unremitted source deductions if the underlying liability has been paid down. Further, while a director may be jointly and severally liable with the corporation, subsection 227.1(2) also establishes a sequencing rule to avoid double taxation. The first step in satisfying the debt is to pursue the corporation. Failing that, the equally liable director is next on the list. The FCA stated that subsection 227.1(1) enhances the CRA's ability to enforce remittance obligations and to deter corporations from using trust funds to pay other creditors. The FCA stated that the TCC's reasoning would undermine the purpose of the director liability provisions – allowing directors time to reorganize their affairs to duck liability (one cannot help but notice that in Colitto the default and property transfers were close in time) and that Parliament could not have intended that kind of outcome. Thus, the FCA held that Mr. Colitto was liable qua director for unremitted source deductions in or in respect of the 2008 taxation year. Therefore, the TCC was wrong. It logically followed that the section 160 assessments against Mrs. Colitto were valid.

Reasonable people may differ as to the proper interpretation of the words of statutory provisions. In my respectful view, the FCA's discussion of the TCC reasons could have gone in a different direction. The FCA said that the TCC read words into subsection 227.1(2), namely, the TCC added a temporal aspect "and until" following the word "unless". "Unless" versus "unless and until" might be a distinction without a difference. The provision states that "a director is not liable under subsection 227.1(1), unless" and then it lists three possible conditions. The text of the provision is not vague, and expressly states that a director is not liable unless one of the conditions is met. The "and until" read-in was a red herring. A textual interpretation of subsection (2), applied to resolve the alleged ambiguity of subsection (1), could have generated a different result. In addition, while the FCA's points regarding legislative purpose and practical future implications were fair, the Courts have been clear that those factors should not displace clear language. The FCA could have concluded that Parliament has the power to amend the ITA with clear language to effect the results it wants. Finally, there was probably an underlying practical reality at play here. The timing of events would lead a suspicious mind to think that there was a deliberate attempt to avoid liability by the respondent's spouse. When faced with what looked like a plan to circumvent the operation of the administration and enforcement provisions, a Court is likely not going to be motivated to find a way to uphold that outcome.

[1] 2020 FCA 70 ("Colitto").

[2] All statutory references are to the Income Tax Act (Canada) ("ITA").

[3] The Tax Court of Canada ("TCC") had considered these issues before, in cases including Filippazzo v R, 2000 DTC 2326 and Sheck v The Queen, 2018 TCC 125.

[4] This limitation isolates the gratuitous portion of the transaction, and if the transferee pays FMV there is no third party liability exposure for them.

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