With its decision in Barrett v. The Queen¹, the Federal Court of Appeal effectively shut down a potential technical defense for directors faced with joint and several liability for unpaid taxes.

Directors are jointly and severally liable with defaulting corporations for GST, deductions at source and withholding taxes. A due diligence defense is available where directors can persuade the courts that appropriate steps were taken to prevent the default, but this defense turns on its facts and the courts have been quite strict in its application.

Another avenue of defense, largely unexplored, is to argue that the Crown failed to meet the conditions required before a director could be assessed.

Sections 227.1 of the Income Tax Act ("ITA") and 323 of the Excise Tax Act ("ETA") establish the joint and several liability of directors for taxes not remitted². Subsection 2 of each of these sections provides that a director is not liable "unless" one of three conditions is met:

• A writ of execution must be returned unsatisfied (in whole or in part);
• The corporation is dissolved or has commenced liquidation or dissolution proceedings and a claim has been proved; or
• The corporation is bankrupt and a claim for the amount has been proved within six months of the bankruptcy.

Attempts to argue the insufficiency of the proof of claim were rejected in Matossian³, even though the decision in Port Chevrolet⁴ seemed to support the argument.

Now the Federal Court of Appeal has rejected the argument that returning a writ of execution unsatisfied requires reasonable efforts to collect on the part of the CRA. That thesis was accepted by the Tax Court but overturned by the Court of Appeal.

Mr Barrett had been a director of a corporation which ceased operations in 1995. The CRA’s efforts to collect moved slowly. The debt was certified in the Federal Court in October 1998. The sheriff was directed to execute the writ in October 2000 and the writ was returned unsatisfied in November 2000. The assessment was issued on September 8, 2003. Despite this pace, and the appellant’s testimony that there were ample assets to satisfy the debt in 1995, the Tax Court rejected the submission that the Minister could have recovered the taxes had it acted diligently:

[13] Whether or not the company had enough assets to cover the GST liability if the Minister had moved to seize corporate assets in 1998 does not affect the Appellant’s liability, nor does the fact that collection efforts were slow. It must be recalled that it is the company’s obligation to pay the liability and the Appellant’s obligation as director to see to it that the liability is paid. There is no doubt that the period in question was a very difficult one in the Appellant’s life but that does not change his responsibilities as director.⁵

The Tax Court then held that reasonable execution efforts, including a search for a bank account, had to be completed by the CRA before the writ of execution was returned. It relied on a passage from then Chief Justice Bowman in Miotto v. The Queen⁶, to conclude that the CRA, as creditor, had some obligation to take reasonable steps to collect.

The Federal Court of Appeal disagreed, noting that "nothing in the text of the provision imposes any requirement on the Minister to take reasonable steps to search for the assets of the corporate debtor". The same was said of the Federal Courts Act, Federal Courts Rules and the provincial rules of procedure. The court was fortified in its conclusion by the observation that if a corporation has assets, directors who are liable may claim against it and are entitled to any preference the Crown enjoyed (ETA ss. 323(7) & ITA ss 227.1(6)). Finally, the Court concluded that the decision Miotto did not establish an obligation on the CRA other than the public law duty of good faith.

In light of the Tax Court’s conclusions concerning collection efforts and the time between the failure to remit and the assessment, one might conclude that the CRA is poorly placed to evaluate the "due diligence" of directors.

It is well known that our tax system is based on self-assessment and therefore relies on the honesty of taxpayers. This also implies that it is to be expected that the tax authorities from time to time examine returns filed by taxpayers.

Quebec applies these rules since the adoption of its own system for taxation. It might be asked however if these are truly principals underpinning the system or only fancy words.

Many professionals and taxpayers (including the undersigned) believe we are distancing ourselves more and more from the principals inherent in a self-assessment system and see certain procedures followed by Revenue Quebec as evidence of this. To be blunt, it seems more often than not, that Revenue Quebec assumes that taxpayers are dishonest.

Many unlucky taxpayers have had the pleasure of facing what Revenue Quebec calls a “contrôle fiscale” and dealt with the feeling that they were presumed guilty. As an example, we will look at an example concerning producers of softwood lumber.

The difficulties faced by the softwood lumber industry are well known. As they can no longer be "subsidized" by means of low cutting fees or stumpage, governments have found a way to help with refundable tax credits for road construction. This credit is called "Tax Credit for the Construction of Public Access Roads and Bridges in Forest Areas".

The regime is fairly straightforward. The government reimburses (with tax credits) ninety percent (90%) of the direct costs associated with road construction in forestry zones. Maintenance expenses are not eligible.

If the work is contracted out, the entire cost of the contract is eligible. If it is done by the taxpayer, direct costs such as salaries and expenses for goods and services are eligible. The work should generally be found on a prescribed list of eligible activities, but even the list is not restrictive.

As a result, any project is eligible as long as it is approved in advance by the ministère des Ressources naturelles et de la Faune ("MRNF"). It issues an attestation of eligibility. In principal, the project should fall within the scope of the Annual Intervention Plan of the MRNF and the main components of the project should be submitted by the taxpayer together with an estimate of costs. The taxpayer is not bound by the estimate as the roads constructed are often more than 250 km from any inhabited area. For example, the plan may call for a culvert but a bridge becomes necessary and this might have to be located in a different place than originally foreseen. This kind of decision might only be taken on the site at the moment of construction by the engineers.

The program seems to have a dark side when it is administered by the audit department of Revenue Quebec.

First, any taxpayer who files a tax return, including the documents required by the law, generally receives a first assessment fairly quickly. The rules of the self-assessment system require the tax authorities to act diligently. We understand that taxpayers participating in the road-building credit system generally expect to receive 90% of the credit quickly as the cost of financing is extremely high.

The documentary requirements of the credit program are not onerous. Nor is the documentation complex or difficult to examine. However, the credit request (and tax return) can be reviewed.

It is at this moment that the self-assessment system breaks down as Revenue Quebec, according to some reports, begins to treat taxpayers claiming credits as fraud artists. In effect, the file can be transferred to a new team at Revenue Quebec, the role of which is to review and reduce the credits claimed and review the returns of the claimant.

This examination resembles an investigation during the course of which the taxpayer is questioned as though the mere fact of claiming the credit was an indication of the taxpayer’s intention to abuse the tax system. Where does this come from? Part of the cause is likely the fact that credits claimed for 2006 exceeded the original budgeted amount of $250 million by an additional $200 million. Clearly, the producers approved of the program.

Could it be the result of the decision of the Auditor General to include a complete chapter (Volume 2, chapter 5) in his annual report for 2010-2011, which questioned the administration of the program by Revenue Quebec and the MRNF. The report pointed out a number of shortcomings. The Auditor General asked, among other things, how it was that the actual costs claimed by the producers often significantly exceeded the expected costs submitted to the MRNF with requests for attestations.

It is up to the National Assembly to establish the rules for the program, and in this case, it chose a simple, streamlined process.

Is the credit program an open cookie jar with a "Take One" sign and if so, is that what the legislator intended? Revenue Quebec, the MRNF and the Auditor General, should give some thought to respecting the intentions of the legislator.

That said, softwood lumber producers who are claiming the tax credit for road building are far from profiting from the venture. Everything is reviewed with a fine tooth comb as if the dishonesty of the participants was presumed: construction costs, plans and even the profit margins of sub-contractors. The result is that checks are delayed and the producers are put into an ever tighter financial bind. When a taxpayer owes money to Revenue Quebec,the agency acts with awesome efficiency. It is not the same when the money is owed to the taxpayer.

What is the impact for the notion of a self-assessing system based on the honest and good faith of taxpayers?

The British Columbia case of Botham Holdings Ltd. (Trustee of) v. Braydon Investments Ltd. is a reminder that tax and estate plans must take non-tax issues and law into account. It can be extremely dangerous to let the tax tail wag the dog!

Mr. Botham and a family trust were the shareholders of Botham Holdings Ltd. ("Holdings"). In 2004 Holdings was fortunate enough to realize a large capital gain and, as a result, incurred a significant income tax liability.

In 2005, Holdings entered into a partnership to acquire a portfolio of leased automobiles from a failed business. Holdings wanted to take advantage of substantial tax deductions that the new business made possible and to apply these deductions against its 2004 tax liability. These deductions would, however, only be available if Holdings was a general partner and, therefore, responsible for the debts of the partnership. The partnership commenced its operations on September 1^st, 2005 with Holdings as its general partner.

Holdings took steps to avoid risking its substantial other assets in the partnership business. On October 31^st, 2005, Holdings, by means of a complex series of transactions, transferred its other assets to a sister corporation. This was accomplished by means of a "butterfly" reorganization that allowed the transfer of assets to occur on a tax-free basis. At the time of the butterfly, there were no outstanding creditor claims against Holdings and no creditor had relied on Holdings’ assets before dealing with the partnership.

Unfortunately, the new automobile leasing business did not go well. In 2007 the partnership and Holdings were assigned into bankruptcy with creditor claims exceeding $20,000,000. The trustee in bankruptcy brought an action against Holdings and its sister corporation seeking the assets that had been transferred by Holdings to its sister corporation in order to pay the partnership’s creditors.

The B.C. Trial Court and the B.C. Court of Appeal agreed with the trustee in bankruptcy. The sister corporation was forced to turn over the assets that it had received on the butterfly to satisfy the partnership's creditor's claims. The B.C. Courts held that bad faith or dishonest intent was not necessary for a finding that a "fraudulent conveyance" was not opposable to creditors. The Court stated that "A transaction which is the result of an honest intent to defeat ones creditors is properly one of the situations caught by the Fraudulent Conveyance Act". Holdings could have protected its assets by incorporating a new subsidiary to be the general partner of the partnership but this would have precluded Holdings from utilizing the partnership's tax deductions. The fact that Holdings could have structured its investment in the partnership in a fashion that would have protected its assets was not considered by the B.C. Courts to be relevant.

Given that the creditors' claims were not in existence at the time of the butterfly and that no "dishonest intent" or intent to "defraud" creditors existed, the case was a shock to many business persons and advisors. Although British Columbia law was applicable, it is not impossible that similar reasoning could be applied in other provinces.

In Quebec, the "Paulian Action" permits a creditor who suffers prejudice from a juridical act made by his debtor in fraud of his rights to apply to the Court to have the juridical act, usually some sort of transfer, set aside.

It is worth noting that article 1634 of the Civil Code of Quebec (reproduced below) contains language might permit a Quebec court to decide a "Botham" type case in a fashion similar to British Columbia.

"Art. 1634. The creditor may bring a claim only if it is certain at the time the action is instituted, and if it is liquid and exigible at the time the judgment is rendered.

He may bring the claim only if it existed prior to the juridical act which is attacked, unless that act was made for the purpose of defrauding a later ranking creditor."

The Bothman case demonstrates that a tax plan must first and above all of all function properly from a business and civil law perspective. Needless to say, a good tax plan should also take into account personal, family and other non-tax considerations.