Source deductions two quarters in arrears

The situation

A buyer was acquiring the shares of a small trucking and logistics company. Diligence found the corporation was two full quarters behind on remitting payroll source deductions — income tax, CPP and EI withheld from employee paycheques — to the CRA: $46,000 per quarter, $92,000 in total, plus $3,100 the CRA had already assessed in interest.

The problem

Because it was a share deal, the buyer’s acquisition vehicle would take over a corporation that still owed the CRA $95,100 the moment the shares changed hands. Treadstonelaw’s comparison of the two deal structures is the general version of the point: “the buyer buys the shares of the corporation, and the corporation keeps its…every obligation it ever took on — including the ones nobody has found yet.” This one, at least, had been found.

The numbers

ITA s.227.1(1) — marginal note Liability of directors for failure to deduct — makes the corporation’s failure to remit a personal problem too. Where a corporation fails to deduct, withhold or remit an amount required by s.153 (among others), “the directors of the corporation at the time the corporation was required to deduct, withhold, remit or pay the amount are jointly and severally, or solidarily, liable, together with the corporation, to pay that amount and any interest or penalties relating to it.” That liability attaches to the directors in office when the remittance was due, not to whoever holds the office afterward. The founder and his spouse, the only two directors throughout the arrears period, were the ones exposed; the buyer’s incoming appointees never would be, regardless of when they took over.

One correction the deal team had to make to its own summary, because it changes which statute you look up when a number is disputed. The commonly-stated version — that “directors are personally liable for unremitted source deductions, CPP, and EI under the Income Tax Act” — is right about the outcome and wrong about the source. Section 227.1 reaches income tax withheld under s.153; it says nothing about Canada Pension Plan contributions or Employment Insurance premiums. Those come from their own Acts: Canada Pension Plan s.21.1(1) and Employment Insurance Act s.83(1), each imposing the same joint-and-several liability in near-identical words, and each then applying “subsections 227.1(2) to (7) of the Income Tax Act…with such modifications as the circumstances require.” The defences and the limitation period travel across; the charging provision does not. Three statutes, one arrears figure.

The rule that decided it

“Together with the corporation” is the phrase that mattered to the buyer. Director liability under s.227.1 is additive, not a substitute for the corporation’s own debt — the company the buyer was about to own remained liable for the full $95,100 regardless of whose name carried personal exposure alongside it. It is also, on its own, no comfort to a buyer. Section 227.1(2) provides that a director “is not liable…unless” a certificate has been registered in the Federal Court under s.223 and execution returned unsatisfied, or the corporation has entered liquidation, dissolution or bankruptcy and a claim has been proved within six months. Those are conditions precedent, and each of them presupposes that CRA has already failed to collect from the corporation. Personal liability is a remedy of last resort against directors, not a parallel debt the buyer can point CRA toward. Closing was made conditional on the corporation remitting the full $95,100 to CRA before closing, evidenced by a statement of account showing a nil balance dated within five business days of closing — curing the corporate liability entirely, rather than leaving it as something the buyer’s own subsidiary would have to chase.

The outcome

The founder and his spouse remained exposed — their position under s.227.1 is fixed by who held office when the remittances fell due, and a share sale does not move it, even though the liability only crystallizes if s.227.1(2)’s conditions are ever met and is defeasible under s.227.1(3), which excuses a director who “exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.” They resigned as directors effective at closing rather than earlier, which preserved rather than shortened the two-year window under s.227.1(4) during which any residual CRA claim against them personally would have to be brought: that clock runs from when a director “last ceased to be a director,” and an earlier resignation date would simply have started it sooner. Because CPP s.21.1(2) and EI Act s.83(2) both import s.227.1(2) to (7), the same two-year window and the same due-diligence defence govern the CPP and EI portions of the arrears. A separate, personal indemnity from the founder — outside the deal’s ordinary basket and cap — covered any further interest or penalty CRA assessed on the cleared arrears in the following 24 months.

What it would have cost otherwise

Had the buyer accepted the founder’s initial proposal — a general indemnity for “any pre-closing tax liabilities,” sitting inside the ordinary basket and cap, rather than a pre-closing cure — the corporation the buyer was purchasing would have carried a $95,100 CRA payable on its books at closing, understating what the buyer actually received for the purchase price by that amount, and competing for recovery against every other ordinary claim on a capped indemnity pool instead of being confirmed as fixed before any money changed hands.

The tell

The tell showed up in the bank statements before anyone pulled a CRA account summary: two consecutive quarters where the corporation’s payroll remittance dates drifted later each month, visible in ordinary cash-flow diligence. Tracking remittance timing against payroll dates in the bank records — not just checking whether a CRA balance-owing letter exists in the data room — is what actually catches this early.

Takeaways

• • ITA s.227.1(1) attaches director liability to whoever was a director “at the time” the remittance was required — not to a buyer’s newly appointed directors — but only for income tax withheld. CPP s.21.1 and EI Act s.83 carry the CPP and EI portions, importing s.227.1(2) to (7) as they go.
• • Director liability is not immediate: s.227.1(2) requires a registered certificate and unsatisfied execution, or a proved claim in liquidation, dissolution or bankruptcy, before a director owes anything — and s.227.1(3) supplies a due-diligence defence.
• • Director liability is “together with the corporation,” not instead of it — the corporation’s own CRA debt survives a share sale regardless of who is personally liable alongside it.
• • The s.227.1(4) two-year limitation runs from when a director last ceased to hold office — resignation timing at closing, not before, protects the window rather than shortening it.
• • Curing an arrears before closing, evidenced by a nil-balance CRA statement, is cleaner than folding a known liability into the general indemnity basket and cap.

Sources

• • Income Tax Act s.227.1(1)–(4) — marginal notes Liability of directors for failure to deduct, Limitations on liability, the due-diligence defence, and Limitation period. Note the charging provision reaches only amounts required to be deducted, withheld, remitted or paid under s.135(3), s.135.1(7), s.153, s.215 or Parts VII and VIII — income tax withholdings, not CPP or EI.
• • Canada Pension Plan s.21.1 — marginal notes Liability and Application of Income Tax Act provisions: directors are liable for unremitted CPP contributions under this section, and “subsections 227.1(2) to (7) of the Income Tax Act apply, with such modifications as the circumstances require.”
• • Employment Insurance Act s.83 — marginal note Liability of directors: the parallel provision for EI premiums, which likewise imports ITA s.227.1(2) to (7).
• • Treadstone Law — Director liability for source deductions — quoted above, and accurate on the practical outcome. It attributes the CPP and EI liability to the Income Tax Act; the charging provisions are in fact CPP s.21.1 and EI Act s.83, which is the correction this file makes.
• • Treadstone Law — The due diligence defence — on point for s.227.1(3) in practice: an inside director “is held to a higher standard than an outside director,” and “simply being a passive director or trusting others without any oversight mechanism rarely satisfies the defence.”
• • Treadstone Law — Do unpaid source deductions and HST follow a share purchase? — on point for the corporate side: “In a share purchase, you’re buying the same corporation that owes the money. The debt to the CRA doesn’t ask who owns the shares.”
• • Treadstone Law — Asset vs share purchase (Ontario) — the source of the quoted description of a share purchase: the corporation keeps “its name, its bank account, its HST number, its contracts, its employees and every obligation it ever took on — including the ones nobody has found yet.”