Just as most newlyweds don’t expect their marriage to fail, most corporate directors don’t expect that they may be personally liable for their business' tax problems. Yet, directors' liability assessments are quite common, and failing to understand the warning signs can be costly.
When are Directors Liable for Corporation’s Taxes: The Law
Corporate directors are not personally liable for the corporation’s income taxes imposed by Part I of the Income Tax Act (Canada).
However, directors may be personally liable for the corporation’s failure to remit to the CRA taxes or similar payments it collected (or was required to collect) from third parties. These include employees' withholdings, harmonized sales tax (HST), Canada Pension Plan or Employment Insurance source deductions.
The CRA must first exhaust its collection efforts against the corporation before they can go after the directors personally.
Are You in the Risk Group? Here Are the Warning Signs
Bad things happen to good directors if they don’t hold their finger on the financial pulse of the corporation and/or don’t prioritize remittances due to the CRA over other debts.
Some directors knowingly or negligently disregard their corporation’s tax obligations.
Others, however, become innocent victims of someone else’s dishonesty or fraud. They are often offsite directors who rely on an on a co-director, a trusted employee, or a close family member for information about the corporation. Despite their best efforts, these directors may not find out about the CRA remittances problems until the corporation is bankrupt and it’s too late to fix anything.
The following categories of corporate directors are typically exposed to a higher risk of personal liability. If you think you belong to one of the categories, you should contact a tax lawyer immediately:
directors of a business that shows first signs of financial trouble;
directors who delegate the corporation’s financial affairs to other parties;
offsite directors who rely on third-party information about business performance;
"nominees" or people who are "doing a favour” for a friend or a relative by agreeing to be appointed as a director without knowing much about the business.
Note that a person who merely performs a director's role, a so-called “de facto” director, may be personally liable along with formally appointed “de jure” directors.
Defences Available to Directors
Directors’ liability is not absolute and there are three primary defences available to directors facing this kind of liability:
The corporate collection defence: A director is not liable unless, in general terms, the CRA has exhausted its collections efforts against the corporation.
The limitation period defence: There is a limitation period for bringing an action against a director. It precludes the Minister from commencing an action more than two years after the director resigned.
The due diligence defence: A director is not liable where the director exercised the degree of care, diligence, and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.
How Can Directors Protect Themselves from Liability?
When advising clients, I always inform directors of their potential personal liability for unremitted taxes, particularly when I work with unsophisticated “nominees” or outside directors.
Although the list of specific recommendations to corporate directors can be long, they can be grouped into three easy-to-remember categories:
Remember remittances: take regular active steps to confirm the financial wellbeing and proper remittances of the corporation.
Dangerous delegating: Delegating to trusted professionals can be proper if done with sufficient oversight. Complete and blind reliance on another person or a family member is not appropriate.
If a corporation needs help with remittances, the director needs legal help: Any indications of financial trouble should be treated as a red flag and actively and independently investigated. If a director becomes aware of the corporation’s past and potential failures to make remittances, which cannot be easily cured, he or she should seek advice from a tax lawyer immediately.
CONTACT US if you are a corporate director who is being audited, or were assessed personal liability for the tax debts of your corporation.