Skipping Payroll Remittances Can Cost You Personally

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Director liability for unremitted source deductions is one of the few places where the corporate veil gives a business owner no protection at all. A company can fail, wind up, and disappear, and the payroll remittance debt can still land on the person who signed the cheques. The Tax Court of Canada worked through exactly that situation in Jafarnia v. The King, 2023 TCC 171.

The facts are sympathetic, which is what makes the decision useful. A director kept a struggling steel foundry running while its financing fell apart. Workers received their net pay. Money went into maintaining the plant. The income tax, Canada Pension Plan contributions, and Employment Insurance premiums withheld from those paycheques stayed in the business. The Canada Revenue Agency assessed the director personally for roughly $400,000 in source deductions relating to 2011 and 2012.

He appealed, argued due diligence, and lost.

Prefer to watch instead of read? The full walkthrough is here: https://youtu.be/2Wht64kxZlk

How the liability attaches

Under subsection 227.1(1) of the Income Tax Act, a director who holds office at the time a corporation fails to deduct, withhold, or remit required amounts becomes jointly and severally liable with the corporation for that amount, together with the related interest and penalties.

Two points about that wording matter in practice.

First, the liability is joint and several. The Crown does not have to choose between the corporation and the director; it can pursue both for the same debt.

Second, the amounts in question were never the corporation’s property. Source deductions are withheld from employee wages and held in trust for the Crown from that moment forward. When a corporation pays net wages and operating costs while holding the deductions back, it is funding its operations with money belonging to someone else.

The courts have described the Crown in this setting as an involuntary creditor. A supplier can demand cash in advance or stop shipping. The Crown cannot. Its exposure grows every pay period that a corporation keeps operating on withheld funds, which is the policy reason Parliament attached personal liability to the directors.

The conditions that have to be met first

Director liability is not automatic. Subsection 227.1(2) requires the Crown to have run out of collection options against the corporation before it can assess a director. In general terms, one of the following has to have happened: a certificate for the corporation’s debt has been registered in the Federal Court and execution has been returned unsatisfied; the corporation has started liquidation or dissolution proceedings and the claim has been proved; or the corporation has made an assignment or a bankruptcy receiving order has issued and the claim has been proved.

Subsection 227.1(4) adds a limitation period. An assessment cannot be made more than two years after a person last ceased to be a director of the corporation. Resignation therefore starts a clock, though only if it is real and properly documented in the corporate registry.

On the amounts themselves, penalties for failing to remit come from subsection 227(9): 10% of the amount not remitted, rising to 20% where the corporation has already been penalized for the same failure in the same calendar year and the second failure was made knowingly or in circumstances amounting to gross negligence. Subsection 227(9.1) limits the penalty to the amount by which the total unremitted for the period exceeds $500, unless the knowing or grossly negligent standard applies. Interest on amounts deducted and not remitted runs under subsection 227(9.2).

The due diligence defence, and why it failed

Subsection 227.1(3) gives a director a 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.

That sentence reads as though it makes room for the director’s own situation. It does not, and this is the part directors most often misjudge.

The standard is objective. Following the Federal Court of Appeal in Buckingham v. Canada, 2011 FCA 142, the Court in Jafarnia applied the standard objectively. The director’s education, business experience, financial training, and language ability were treated as beside the point. The comparison is to a reasonably prudent person in comparable circumstances, and “circumstances” means the situation facing the corporation, rather than the personal attributes of the individual sitting on the board.

The defence is about prevention, not rescue. The statutory language asks what the director did to prevent the failure. The Court held that steps taken after arrears have built up do not answer that question. A director who notices the problem once the CRA calls is already outside the defence.

Cash flow pressure is not an answer. The corporation’s financing had been disrupted by international sanctions that restricted the banking transactions its investors depended on. The Court accepted that the pressure was real and still found the director liable. Where a corporation cannot fund both net pay and the corresponding remittances, continuing to operate and paying the net pay is a choice. The Court treated it as a decision to finance the business with trust funds.

Relying on someone else is not oversight. The director pointed to a co-director who had authorized payments once new financing arrived, and to the people handling the corporation’s finances. The Court found that he remained the central voice of the corporation, never gave specific instructions about remittances, and never sought confirmation that they had been paid. Leaving the file to someone else and never asking about it was treated as abdication of the duty rather than discharge of it.

What this means for owner-managed corporations

The practical lesson is that the defence has to be built before there is a problem, and it has to be documented.

Treat source deductions as a first claim on cash. They rank ahead of rent, suppliers, and net pay, because they are not the corporation’s money.

Size the workforce to what the corporation can fund on a fully remitted basis. The relevant figure is net pay plus the deductions plus the employer portions, rather than net pay alone.

Release the remittance in the same payment run as payroll. Where the remittance is a separate step taken later, it becomes the step that gets skipped in a tight month.

Record the remittance status for each pay period in the board minutes. A contemporaneous record of directors asking the question is evidence; a recollection of having assumed it was handled is not.

Get written confirmation of payment where day-to-day finance sits with another person or at another location. Jafarnia is clear that a director cannot rely on a general impression that someone competent is on it.

Decide in advance at what point the corporation stops rather than continuing on unremitted funds. That decision is uncomfortable to make and considerably more uncomfortable to explain in hindsight.

Directors who are already behind on remittances are in a different conversation, and the sooner it happens the more options remain. Voluntary disclosure, payment arrangements, and the timing of a resignation all interact with the two-year limitation in subsection 227.1(4).

Sources

Video

Watch the full case walkthrough: https://youtu.be/2Wht64kxZlk

Disclaimer

This article provides general information for educational purposes only. It does not constitute legal, accounting, or tax advice, and it does not create a professional relationship between the reader and Cloudiverse CPAs Inc. Tax legislation, administrative positions, and case law change over time, and the application of any provision discussed here depends on the specific facts of a given situation. Readers should obtain advice from a qualified professional regarding their own circumstances before acting on anything in this article. Descriptions of court decisions reflect the findings of the court in question and are summarized for general readership.

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