Understanding director liability for unremitted taxes

Serving on a corporate board comes with significant responsibilities, but few carry the direct personal financial risk of director liability for unremitted taxes. When a corporation fails to remit payroll source deductions or GST/HST, the Canada Revenue Agency (CRA) can look past the corporate veil and hold directors personally responsible for the debt. This framework is designed to ensure compliance by making the corporation's directing minds accountable for these trust funds.

The statutory basis for director liability (Income Tax Act, s. 227.1)

The foundation of director liability for unremitted taxes is found in federal law. Subsection 227.1(1) of the Income Tax Act (ITA) and the parallel provision in section 323(1) of the Excise Tax Act (ETA) for GST/HST are unequivocal. They state that directors of a corporation, at the time the corporation was required to deduct, withhold, or remit these amounts, are jointly and severally, or solidarily, liable, along with the corporation, to pay the outstanding amount, plus any related interest and penalties.

This liability covers a wide range of corporate tax debts, including:

• Employee source deductions for income tax, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums.
• Non-resident withholding tax on payments like dividends, interest, and royalties.
• Net GST/HST collected from customers but not remitted to the government.

The term "jointly and severally liable" means the CRA can pursue any single director for the full amount of the debt, leaving that director to seek contribution from their fellow board members (ITA, s. 227.1(7)). This personal liability applies to directors of all corporations, including not-for-profit organizations, a point the CRA has consistently affirmed.

The power of the deemed trust (Income Tax Act, s. 227(4))

A critical concept underpinning director liability is the "deemed trust." Under both the ITA and ETA, amounts withheld from employee pay or collected as GST/HST are deemed to be held in trust for the Crown, separate and apart from the corporation's own funds (ITA, s. 227(4)). This is not a mere accounting entry; it creates a super-priority for the Crown over the company's assets.

These trust funds are not the property of the corporation and should never be used as operating capital, even during periods of financial distress. The deemed trust attaches to all property of the taxpayer, including after-acquired property, and gives the CRA priority over almost all other creditors, including those with secured interests like a general security agreement. When a business fails, directors who allowed these trust funds to be used to pay other creditors will find themselves squarely in the CRA's crosshairs.
Planning Tip: Advise your corporate clients to establish a separate bank account for payroll deductions and GST/HST remittances. This physically segregates the trust funds, preventing their accidental use for operational expenses and providing clear evidence of due diligence.

When the CRA can pursue a director (Income Tax Act, s. 227.1(2))

Director liability is secondary to the corporation's. The CRA must first attempt to collect from the corporation itself. Before a director can be held personally liable, one of three conditions must be met:

1.  A certificate for the corporation’s debt has been registered in the Federal Court, and the execution for that amount has been returned unsatisfied.
2. The corporation has started liquidation or dissolution proceedings, and the CRA has proven its claim within six months.
3. The corporation has entered bankruptcy, and the CRA has proven its claim within six months of the assignment or bankruptcy order.

There is also a crucial limitation period: the CRA cannot commence an action to recover from a director more than two years after that individual has validly ceased to be a director (ITA, s. 227.1(4)). An effective resignation must be properly documented and delivered to the corporation in accordance with its governing statute. A director who continues to perform the functions of a director after a formal resignation may be considered a *de facto* director and remain exposed to liability.

The due diligence defence (Income Tax Act, s. 227.1(3))

The primary shield available to a director is the due diligence defence. A director will not be held liable if they can 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." This is the most litigated aspect of director liability, and the standard of care is high.

The courts have established that this is an objective standard, but one that is applied in the context of the director's specific circumstances. Key factors include:

Active Involvement: A director cannot be passive. The defence requires positive action to prevent a failure to remit. Simply relying on others, even competent officers or professionals, is not enough without a system of verification.

System of Control: A reasonably prudent director would implement and monitor a system to ensure remittances are made. This could involve requesting regular reports from financial officers, reviewing financial statements for red flags, and demanding confirmation that remittances have been made.

Responding to Financial Difficulty: The standard of care increases when a director knows or ought to know that the corporation is in financial trouble. At this point, a director has a positive duty to be more vigilant about remittances. Using trust funds to pay other creditors in the hope that the business will turn around is precisely the conduct the legislation seeks to prevent and will almost certainly defeat a due diligence defence.

Inside vs. Outside Directors: While the standard is objective, the courts have recognized a distinction. More is expected of an "inside director" who is involved in the day-to-day management of the company than an "outside director" with limited financial expertise. However, even an outside director must act once they become aware of a problem.

In Lagace v. The Queen (2012 TCC 117), directors were held liable for unremitted GST, and their defence that they relied on an external accountant failed. The court found the shortfall was caused by the company’s own failure to remit, and the directors had not established the necessary elements of due diligence. Conversely, in Rancourt v. The Queen (2008 TCC 285), a director of a non-profit with limited business experience was found to have met the standard of care by taking reasonable steps, such as appointing a new accountant, to address the corporation's financial situation.

Planning Tip: The importance of a paper trail cannot be overstated. Board minutes should reflect regular inquiries about the status of remittances. Directors should document their requests for compliance certificates from the CFO and any steps they take to address remittance issues.

The consequences of payment delays and the power of liens

Administrative delays within a company can have severe financial consequences. Internal delays at the CRA in transferring funds from corporate and GST accounts to the payroll account to cover remittances can result in significant penalties. Over a period of several months, transfers can be delayed up to a year in some cases. This can lead directly to the assessment of late-remitting and failure-to-remit penalties plus interest.

This illustrates how operational inefficiency can directly trigger the very liabilities that fall on directors. When the corporation cannot pay these amounts, the CRA can use powerful collection tools. Beyond assessing directors, the CRA can register a lien against the taxpayer’s property. For unremitted source deductions, the deemed trust gives the CRA a super-priority that attaches to all assets of the corporation, even those pledged to secured creditors. The CRA can also issue a Requirement to Pay, a form of enhanced garnishment, to third parties who owe money to the corporation, compelling them to pay the CRA directly.

Seeking relief from penalties and interest (Income Tax Act, s. 220(3.1))

When a director is assessed, they may have recourse under the taxpayer relief provisions, formerly known as the "fairness provisions." Subsection 220(3.1) of the ITA gives the Minister discretion to waive or cancel penalties and interest. According to the CRA's Information Circular IC07-1R1, relief may be granted in three main situations:

1. Extraordinary circumstances: Events beyond the taxpayer's control, such as a natural disaster, serious illness, or death in the immediate family.
2. Actions of the CRA: Errors or delays caused by the CRA, such as processing delays, providing incorrect information, or, significantly, "undue delays in resolving an objection or an appeal."
3. Inability to pay or financial hardship: Where payment of the interest would prevent the taxpayer from affording basic necessities.

The Federal Court case Maloney v. Canada (Attorney General) (2024 FC 1474) provides a stark example of CRA actions potentially justifying relief. In Maloney, the taxpayer's Notice of Objection took over seven and a half years to be resolved. The court found the CRA's decision to deny interest relief was unreasonable, in part because it failed to properly consider this "undue delay" as a basis for relief under its own guidelines. The court emphasized that it is a breach of procedural fairness for the CRA to fail to provide a taxpayer with the documents and information it relied on, as the taxpayer cannot know the case they have to meet.

Planning Tip: If an audit or objection is dragging on and the 10-year limitation period for requesting relief is approaching, a director should file a "protective request for relief" with the CRA. This preserves their right to have penalties and interest reviewed once the underlying tax matter is finally resolved.

TAKEAWAYS

For directors and the professionals who advise them, managing the risk of personal liability for corporate taxes requires proactive and diligent governance.

Liability is Personal and Real: The provisions in the ITA and ETA are robust. Directors cannot hide behind the corporate veil for unremitted payroll taxes and GST/HST.

Due Diligence is an Active Defence: The only reliable defence is a proactive, documented system of oversight. Directors must ask questions, demand reports, and act decisively when they detect problems.

Trust Funds are Not Working Capital: Remittances are held in trust for the Crown. Using them to pay other creditors, even with the best intentions, is a direct path to personal liability.

Process Matters: Ensure resignations are legally effective to start the two-year limitation period. Understand the grounds for taxpayer relief and use protective requests to preserve rights during long disputes with the CRA.

THIS ARTICLE PROVIDES GENERAL INFORMATION ONLY AND DOES NOT CONSTITUTE LEGAL, TAX, OR OTHER PROFESSIONAL ADVICE. READERS SHOULD CONSULT QUALIFIED PROFESSIONALS REGARDING THEIR SPECIFIC CIRCUMSTANCES. TAX LAWS AND INTERPRETATIONS CHANGE FREQUENTLY, AND THE APPLICATION OF LAWS DEPENDS ON INDIVIDUAL FACTS.