DIRECTORS' LIABILITY IN CANADIAN TAX LAW: CRITICALLY ANALYZING THE DUE DILIGENCE STANDARD.

• Author: Singer, Samuel

INTRODUCTION

The Canadian tax system requires corporations to withhold tax and payroll amounts and remit those funds to the government. When corporations do not fulfill these obligations, directors' liability acts as an important backstop to collect amounts owed but unpaid by the corporation. (1) To escape liability, directors can invoke the due diligence defence by demonstrating that they acted with the care, diligence, and skill of a "reasonably prudent person" in similar circumstances. (2) In 2011, Canada v Buckingham established that the due diligence defence in tax law is assessed as an objective standard, based on the Supreme Court of Canada's decision in Peoples Department Stores Inc (Trustee of) v Wise. (3) In 2020, in Penate v R, (4) the Tax Court of Canada explicitly named the racism and sexism faced by the sole director and owner of a corporation as relevant factors in assessing her due diligence.

This article studies directors' liability cases in Canadian tax law after Buckingham and identifies inconsistency and fairness concerns about the treatment of a director's personal and socioeconomic circumstances. The statutory due diligence test requires the consideration of a director's actions in reference to what a reasonable person would do in "comparable circumstances". Drawing from critical legal scholarship about the "reasonable person" and critical tax theory, the article argues that the due diligence inquiry requires a critical and contextual approach that accounts for the director's personal and socioeconomic context, including direct and systemic discrimination.

Critical legal scholars emphasize that the "reasonable person" in legal tests is not a neutral party; they carry race, gender, class, and other assumptions. (5) Similarly, critical tax scholarship shows that tax law is not neutral; tax policy reflects and even reinforces societal inequities. (6) This article contributes to critical legal scholarship and Canadian tax literature on directors' liability by critically analyzing the due diligence standard in Canadian tax law. Other articles have studied tax case law on the due diligence standard for directors, but this is the first to apply a critical tax lens. (7) At a time when the Canadian government is increasingly undertaking initiatives to address exclusion, including Gender-based Analysis Plus policy analysis, an anti-racism strategy, and an action plan for Canadians with disabilities, (8) this article also provides an example of how the application of the law without a critical lens can contribute to social and economic marginalization.

The article begins by outlining the legal sources for directors' liability under tax law in Part 1. In Part 2, it provides the history of the reasonably prudent person standard for directors' liability. In Part 3, the article looks to critical legal scholarship on the reasonable person and critical tax scholarship on the relationship between tax law and inequality. In Part 4, the article reports on a study of case law on directors' liability in tax post-Buckingham. It explores three themes: a director's level of knowledge and skills, a director's financial investment in the corporation, and a director's reliance on the actions or information provided by others, such as a business partner, an employee, or a spouse. In Part 5, a discussion of Penate supplies lessons on the importance of applying a critical lens when assessing whether a director exercised the care, diligence, and skill of a reasonably prudent person in comparable circumstances. The authors conclude by asserting the need for an equitable and consistent due diligence standard in Canadian tax law.

1. DIRECTORS' LIABILITY UNDER TAX LEGISLATION

   Under the Income Tax Act, a director of a corporation that failed to deduct, withhold, remit, or pay amounts can be held liable for those debts. (9) These amounts include taxes on salaries and amounts paid to non-residents of Canada, as well as penalties and interest. Directors can only be assessed after the Canada Revenue Agency has met certain statutory requirements in respect of the corporation's liability. (10) The Income Tax Act provides that a director can defend themselves from liability if they demonstrate 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" (the due diligence defence). (11)

   Directors can also be held liable under the Excise Tax Act, the Canada Pension Plan, and the Employment Insurance Act. (12) The same due diligence defence is available to directors under all three statutes. Under the Excise Tax Act, a corporation must charge and remit goods and services tax (GST) or harmonized sales tax (HST). (13) Under the Canada Pension Plan, corporate employers must deduct and remit pension amounts from payments to their employees, together with mandatory employer contributions. (14) The Employment Insurance Act requires each employer to deduct and remit employee contributions, along with the employer's premium. (15)

2. THE EVOLUTION OF THE DUE DILIGENCE STANDARD

   Directors serve a primary role in corporate governance as the "directing mind" of the corporation. (16) The obligation of directors to exercise care, diligence, and skill in carrying out their duties has long been recognized under the common law. (17) In Peoples Department Stores Inc (Trustee of) v Wise, the Supreme Court of Canada reviewed the history of the directors' duty of care. (18) It described the common law standard for a director's duty of care as "a reasonably relaxed, subjective standard" considered an individual's skill, knowledge, and experience and only required directors not to be "grossly negligent." (19)

   Canadian governments recognized the need for a more stringent duty of care for corporate directors in the late 1960s and early 1970s. In 1968, Ontario proposed corporate legislation that required directors to exercise the duty of care of a "reasonably prudent director". (20) Ivan R. Feltham and William R. Rauenbusch note that this proposed phrasing raised a director's duties to a professional director's level of care, skill, and diligence, creating a significantly higher standard. (21) In 1970, a revised version of the statute modified that language to require the level of care of a "reasonably prudent person", lowering the standard to a reasonably prudent individual rather than a professional director. (22)

   In 1971, a Federal Task Force recommended raising the duty of care requirements for directors under federal corporate law on the basis that the common law standard was too lenient. (23) It produced the "Dickerson Report", which advised that the standard should be that directors must exercise the care, diligence, and skill of a "reasonably prudent man." (24) The Dickerson Report asserted that this phrasing raised the standard to the duty of care imposed on professionals, such as lawyers and surgeons. (25)

   Both the Ontario and federal business corporate statutes ultimately included an additional phrase that modified the duty of care required of directors. A director must "exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances." (26) Robert Flannigan argued that the phrase "comparable circumstances" was politically artful, as it satisfied both those wanting to raise the standard for directors and those seeking to maintain subjectivity. (27) The revised wording produced the political solution of "interpretive ambiguity". (28) Rousseau and colleagues also discuss the varying interpretations of the statutory duty of care because of the inclusion of the expression "comparable circumstances". (29) They note that some commentators argued that the statutory duty of care did not significantly change the common law standard, while others asserted that the statutory duty elevated directors' duty of care by adding an objective component.

   The requirement that directors act as a reasonably prudent person in comparable circumstances is now included in tax and corporate statutes across Canada. (30) Yet "interpretative ambiguity" remains as to which comparable circumstances should be considered in applying the due diligence standard. (31)

   1. BEFORE PEOPLES: AN OBJECTIVE SUBJECTIVE STANDARD

      Prior to the Peoples decision in 2004, the due diligence defence in tax was generally assessed on an "objective subjective" standard. The Federal Court of Appeal decision in Soper v Canada served as the leading decision. (32) The Court relied on the common law history of the duty of care and the words "in comparable circumstances" to conclude that directors should be assessed differently depending on their knowledge, skill, and background, and the corporate context. (33)

      The Federal Court of Appeal in Soper stated that directors should not be treated as a "homogeneous group of professionals whose conduct is governed by a single, unchanging standard". (34) Rather, the Court asserted that the standard of care "embraces a subjective element which takes into account the personal knowledge and background of the director, as well as his or her corporate circumstances." (35) In other words, the capacity of the reasonably prudent person shifted based on the director's "comparable circumstances". (36) A person with greater skills or knowledge was evaluated at a higher level of expectation.

   2. PEOPLES: AN OBJECTIVE STANDARD

      In Peoples, the Supreme Court of Canada interpreted a director's duty of care under the Canada Business Corporations Act, (37) and described the due diligence standard as objective. It held that the words "in comparable circumstances" do not provide for a subjective component in assessing the director's competence. (38) Rather, the Court asserted that the standard allows courts to situate a director's decisions in their socioeconomic context. (39)

      The Peoples decision was hailed as a significant...