Buy the shares and you buy the corporation, including its remittance history. Then you appoint yourself a director, and the Income Tax Act attaches personal liability for amounts the company failed to withhold or remit. The defence is real but it is a standard of conduct, not a formality — and the person who sold you the company is not off the hook either.
Key takeaways
SECTION 01 OF 08
Income Tax Act s. 227.1(1), marginal note Liability of directors for failure to deduct, applies where a corporation “has failed to deduct or withhold an amount as required by subsection 135(3) or 135.1(7) or section 153 or 215, has failed to remit such an amount or has failed to pay an amount of tax” under Part VII or VIII.
The consequence is direct: “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.”
Two features matter for a buyer. The liability attaches to whoever was a director at the time of the failure, and it extends to interest and penalties, which on an old remittance shortfall can exceed the original amount.
SECTION 02 OF 08
On an asset purchase, the buyer takes assets and leaves the corporation behind with its history. On a share purchase, the corporation comes with everything it has ever done, and the buyer then typically becomes its director.
Treadstone Law makes the same distinction in checking CRA debts before buying a business, which sets out a comparison of the two structures — share purchases inherit the corporation’s full tax history, while an arm’s-length asset purchase at fair value carries lower risk. Worth noting that page deals with source deductions as a diligence item but does not address director liability, which is the additional layer this article is about.
The wider structural trade-off is in asset purchase versus share purchase. Director liability is one more entry on the share-purchase side of that ledger.
SECTION 03 OF 08
Section 227.1(3) provides that 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 is a conduct test measured against what the director actually did. It is not satisfied by having been new, by having relied on a bookkeeper without checking, or by having been a director in name while someone else ran the payroll.
For an incoming buyer the practical reading is that the defence protects a director who put controls in place and monitored them. It does not protect one who assumed the previous regime was fine.
SECTION 04 OF 08
Section 227.1(2) sets conditions before a director can be pursued. The principal one is that “a certificate for the amount of the corporation’s liability… has been registered in the Federal Court under section 223 and execution for that amount has been returned unsatisfied in whole or in part”.
The other routes involve the corporation having commenced liquidation or dissolution proceedings or been dissolved, or an assignment or bankruptcy order, with the claim proved within six months.
The consequence is that this liability tends to appear when the company is already in trouble, long after the transaction. A buyer who inherits a shortfall and keeps trading may not hear about it for years, and by then it is attached to them.
SECTION 05 OF 08
Section 227.1(4) sets the limitation: “No action or proceedings to recover any amount payable by a director of a corporation under subsection 227.1(1) shall be commenced more than two years after the director last ceased to be a director of that corporation.”
So a departing owner-director carries exposure for two years after resignation for failures during their tenure. That is a live issue in negotiation, because it means the seller has a genuine interest in the historical position being clean and in the buyer not creating problems that get characterised as theirs.
It also means the seller has a reason to cooperate with diligence on this point rather than resist it, which is a more productive framing than treating it purely as buyer protection. Treadstone Law covers the exposure itself in director liability for source deductions and director liability for unremitted payroll.
SECTION 06 OF 08
Remittance history, not just a balance. A nil balance today says nothing about whether amounts were withheld and remitted correctly across the periods that are still open.
Treadstone Law’s diligence list includes exactly this — “Payroll source deduction remittance history, if the business has employees” — and it is the document that answers the question rather than the account summary.
Then check who the directors were during those periods, because that determines who is exposed and therefore who has an interest in the answer.
SECTION 07 OF 08
A specific representation about withholding and remittance, separate from the general tax representation, because a general tax rep tends to be negotiated down to what is disclosed while this exposure is personal to individuals rather than to the company.
An indemnity that survives long enough to be useful. Given the two-year tail on directors and the gating conditions that delay enforcement, a twelve-month survival period on tax representations is unlikely to cover the period in which this actually surfaces.
And consider a holdback rather than a bare covenant, since the counterparty on this exposure is an individual whose ability to pay in three years is not something the agreement can guarantee. Treadstone Law addresses the general problem in hidden liabilities in an Ontario share purchase and undisclosed liabilities after buying a business.
SECTION 08 OF 08
Treating this as a tax issue for the accountants. It is a personal liability question for the individuals who will sit on the board, and the person most exposed is usually the buyer themselves, who has just taken on a directorship of a company whose history they did not live through.
The cheapest protection is the earliest: know the remittance history before closing, and know it from the records rather than from an assurance.
Sources
