If you’re a corporate director in Canada, you could face personal liability for certain unpaid tax debts of your company. The Canada Revenue Agency (CRA) can assess directors personally for unremitted GST/HST and payroll source deductions (income tax, CPP, EI) under section 227.1 of the Income Tax Act (Canada) (ITA) and section 323 of the Excise Tax Act (Canada) (ETA). However, there is an important safeguard for responsible directors: the due diligence defence. This article explains what a CRA director’s liability assessment is, how the due diligence defence works under Canadian law, and practical strategies for proving due diligence.
What Is a CRA Director Liability Assessment?
A director’s liability assessment is a tool the CRA uses to collect certain corporate tax debts from a company’s directors personally. If a corporation fails to remit trust funds like employee withholdings or GST/HST collected, the CRA becomes an “involuntary creditor” and can pursue directors for the unpaid amounts. Typically, this happens with unpaid payroll deductions (income tax, CPP, EI that were deducted from employees’ pay) or unremitted GST/HST that was collected from customers. Before the CRA can tap directors, though, three conditions generally must be met:
- Corporate Default & Execution: The company has failed to pay the amounts, and the CRA has tried to collect from the company (e.g. by seizing assets or in bankruptcy) without success.
- Two-Year Limit: The CRA must issue the director assessment within two years of the person ceasing to be a director.
- Lack of Due Diligence: The director is unable to demonstrate “due diligence,” meaning they did not exercise the degree of care, diligence, and skill to prevent the failure that a reasonably prudent person would have in similar circumstances.
Understanding the Due Diligence Defence
The due diligence defence is a statutory protection codified by subsection 227.1(3) ITA and subsection 323(3) of the ETA. The defence generally provides that if every reasonable measure was taken to avoid the failure to remit, a director should not be personally liable. But this defence has limits and has been interpreted strictly by the courts. Key points to understand:
Objective Standard of Care:
The standard for due diligence is largely objective. In the leading case, Canada v. Buckingham (FCA 2011), the Federal Court of Appeal held that the director’s conduct is measured against what a “reasonably prudent person” in similar circumstances would have done.
Timing – Prevention, Not Cure:
Due diligence is about preventing the failure to remit, not fixing it afterward. Courts draw a line at the moment when things start to go wrong. The clock starts when a director knew or ought to have known the company was in financial trouble. From that point on, a prudent director would actively try to avert a remittance failure. If you only took action after the taxes went unremitted (for example, negotiating a payment plan with CRA once arrears piled up), that’s considered “curative” rather than preventive and usually won’t satisfy the due diligence test.
No Using CRA as a Bank:
A common scenario is a company in a cash crunch that uses the withheld taxes to pay suppliers or keep the lights on, intending to catch up later. Courts have repeatedly rejected due diligence claims in this scenario. The law was designed precisely to prevent directors from financing operations with money owed to the Crown.
Active Oversight is Required:
Being a passive director is dangerous. The ITA and CRA guidance make clear that all directors – even volunteers or nominal directors – are expected to actively ensure tax compliance. You cannot hide behind “I left it to my accountant” or “I was just an outside director”. The law does not distinguish between hands-on and absentee directors. In fact, if you delegate bookkeeping or tax duties, you still must monitor and verify that withholdings and remittances are being made. Failing to ask questions or to implement basic controls can sink a due diligence defence. For example, in Newhook v. The Queen, a director who relied on an accountant was still found liable because he did not oversee or review the accountant’s work.
Experience and Skill Level:
While the standard is objective, courts do consider the context and the director’s role. A more experienced businessperson may be expected to foresee and address issues that a novice might not. In Hall v. The King, the Tax Court noted the director was an experienced entrepreneur and held him to a higher standard of diligence than a brand-new director. Similarly, if you have an accounting or legal background, you might be held to knowing more about compliance. Conversely, genuine incapacity might be a factor: recent cases suggest that serious mental or physical illness could excuse a director’s inaction, but only if it truly made them incapable of understanding or performing their duties. This is a high bar – generally, partial impairment or stress is not enough to succeed with due diligence on that basis.
Practical Strategies to Prove Due Diligence
If you are a director and want to protect yourself (or if you’re facing a director’s liability assessment and need to build a defence), here are practical steps and proof strategies:
1. Implement Clear Internal Controls:
From day one, set up a system to ensure tax remittances are made. For example, maintain a separate account for payroll withholdings and GST collections. Treat that money as untouchable for other expenses. Regularly check that payments to the CRA are scheduled and executed. Document these procedures in board meeting minutes or internal memos. Showing that you established a reasonable system is strong evidence of diligence.
2. Monitor and Document Compliance:
Don’t just trust – verify. Require that your CFO, bookkeeper or payroll service provide you with monthly reports on all source deduction and GST remittances. Follow up on any anomalies immediately. Keep emails or signed reports that confirm remittances have been made each period. If you’re a non-active director, make inquiries periodically in writing. CRA expects directors to maintain effective communication and be aware of what’s happening in the company.
4. Plan for Financial Stress:
If the business hits a rough patch, prioritize tax remittances in your cash flow. It can be tempting to pay suppliers or wages first, but remember that Crown debts are special. Consider speaking with your bank about a bridge loan or line of credit that covers making CRA remittances on time.
5. Don’t Delay Difficult Decisions:
If it becomes clear the company cannot meet its tax obligations, exercise your duty by taking decisive action. That might mean cost-cutting, temporarily holding back other payments to make the remittance, or even ceasing operations if continuing would rack up unremittable tax debts. The courts praise directors who act quickly to address tax arrears. Conversely, the longer you let a tax debt slide, the more it looks like you were using CRA as an unofficial line of credit.
6. Keep Evidence of Your Diligence:
In a dispute, you’ll need to prove what you did. Keep copies of relevant documents: bank statements showing separate tax accounts, correspondence with accountants or CRA, meeting minutes where tax compliance was discussed, emails where you urged timely remittances or raised concerns about cash flow, etc. If you ever directed someone to make a payment or raised a red flag about falling behind, record it. Also log any professional advice you sought – for example, if you consulted a tax lawyer or advisor when trouble started, that shows proactiveness.
7. Use Professional Help Strategically:
Engaging a tax lawyer early can bolster your due diligence story. Not only can a lawyer advise on how to manage or dispute a director’s liability, but the fact that you sought expert help is evidence that you took the issue seriously. If a director’s liability assessment is proposed, respond to the CRA’s pre-assessment letter. This is often a last chance to persuade CRA officials that you exercised due diligence, potentially avoiding the assessment. A lawyer can help frame your response effectively, citing the evidence of your actions.
Consider Resignation if Necessary:
As a last resort, if you realize you cannot prevent further tax arrears and the business is failing, you might choose to resign as director. Resignation won’t absolve you of liability for amounts that became due while you were a director, but as noted, if you’re no longer a director for 2 years, the CRA cannot assess you for new amounts.
Conclusion
Facing a CRA director’s liability assessment is stressful, but knowing about the due diligence defence gives you a fighting chance if you truly acted responsibly. The courts have set a high bar for this defence – it’s not enough to show you were well-intentioned or busy with other matters. You need to demonstrate concrete actions and vigilance, especially once your company started struggling financially. Many honest directors have fallen short of this standard simply by delaying tough choices or failing to document their efforts. The key lessons are: be proactive, stay informed, document everything, and never assume CRA will wait while you sort things out.
