Two Franchise Directors Avoid Liability for a Payroll Shortfall

The situation

Ramon drove for the local transit system on a rotating shift schedule. Pratheep spent most weeks on the road as a long-haul truck driver. Neither of them had any background in running a business, but three years earlier they had pooled their savings to buy a small franchise outlet together, incorporating a company to hold the location and hiring a manager to run day-to-day operations. The corporation brought in somewhere between $250,000 and $1 million a year in revenue, employed about eight staff, and was structured the way a lot of side-investment franchises are: two directors who kept their full-time jobs, a hired manager on site, and a part-time bookkeeper, Tharshini, who handled payroll and remittances on a contract basis.

For most of those three years, the arrangement worked. Tharshini processed payroll every two weeks, deducted income tax, Canada Pension Plan contributions and Employment Insurance premiums from each employee's pay the way every employer in Canada is required to, and reported to Ramon and Pratheep periodically that remittances were up to date. Neither director reviewed the underlying CRA remittance records directly — they trusted the bookkeeper they had hired specifically because neither of them had the time or the expertise to do that work themselves.

The problem surfaced when the corporation's bank flagged an unusual pattern of transfers, and the new accountant the corporation had just brought on for its year-end filing found the same thing: roughly $52,000 in source deductions withheld from employee paycheques over the previous eight months had never actually reached the CRA. Tharshini had continued deducting the correct amounts from every paycheque, but had stopped forwarding them, instead using the corporation's operating account to cover a widening gap caused by rising food costs and a slow season. By the time anyone noticed, she had left the contract, and the shortfall was sitting on the corporation's books as an unpaid liability to the CRA.

The personal exposure

Under the Income Tax Act, an employer is required to withhold income tax, CPP and EI from every employee's pay and remit those amounts to the CRA on a set schedule. Failing to remit is treated seriously because the money was never the employer's to begin with — it belongs to the employee and to the government the moment it is withheld. When a corporation fails to remit, the CRA can assess the corporation for the shortfall plus penalties and interest. That much was expected once the gap was discovered, and the corporation acknowledged the debt.

What worried Ramon and Pratheep far more was a letter that arrived a few weeks later, addressed to each of them personally rather than to the corporation. The Income Tax Act allows the CRA to look past the corporate structure and assess the directors of a corporation personally for unremitted source deductions, on the theory that directors are ultimately responsible for ensuring a corporation meets its remittance obligations. A corporation can go bankrupt or simply have no assets left to collect from; the personal director assessment exists so that unremitted trust-like payroll money is not simply written off when that happens. For Ramon and Pratheep, that meant the CRA was proposing to hold each of them personally on the hook for the full $52,000, on top of whatever the corporation itself could pay.

Neither of them had touched the payroll software once in three years. Both had full-time jobs that had nothing to do with running the franchise day to day. And both were now staring down a personal debt that could reach into savings, home equity and future income — for money that had been stolen from the business by someone they had hired precisely to handle it correctly. The corporation had no assets beyond leasehold equipment and a lease that was itself now in question, which made the personal assessments the CRA's realistic path to collecting anything close to the full amount.

What we did

1. Explained the due diligence defence and what it actually requires. The Income Tax Act allows a director to avoid personal liability for a corporation's failure to remit if the director can show they exercised the degree of care, diligence and skill a reasonably prudent person would have exercised in comparable circumstances to prevent the failure. This is not a defence of ignorance — simply not knowing is not enough. It requires evidence of active, ongoing oversight, even if that oversight was reasonably delegated to someone else.
2. Gathered the paper trail that showed real oversight, not passive trust. We worked with Ramon and Pratheep to assemble everything that documented their involvement: monthly financial summaries the bookkeeper had sent them, emails where they had asked pointed questions about cash flow during the slow season, and records showing they had periodically requested confirmation that remittances were current. The volume of this material mattered less than what it showed — a pattern of a director asking, not simply assuming.
3. Documented how quickly they acted once the problem was found. The moment the new accountant flagged the discrepancy, Ramon and Pratheep terminated the bookkeeping contract, engaged a bookkeeper directly supervised by their new accountant, and arranged for the corporation to begin catching up on the outstanding amount from ongoing revenue. Swift, decisive action after discovery is one of the strongest pieces of evidence in a due diligence defence, because it shows the directors' prior trust in the bookkeeper was reasonable right up until the point they had reason to doubt it — and that once they had reason to doubt it, they did not look away.
4. Responded to the CRA's proposed assessment directly, before it became final. Rather than waiting for a formal assessment and objecting afterward, we made written submissions to the CRA collections officer handling the file while the assessment was still proposed, laying out the due diligence evidence and requesting the personal assessments be reconsidered before they were issued. Engaging early, while a decision is still open rather than already made, generally gives a stronger chance of resolution without a formal dispute.
5. Kept the corporation's own repayment on track in parallel. A due diligence defence for the directors works better alongside a corporation that is visibly dealing with its own debt, not ignoring it. We helped the corporation set up a payment arrangement with the CRA for the underlying $52,000, which reinforced that this was a story about a bookkeeper's failure being addressed responsibly, not directors trying to walk away from an obligation.

The outcome

After reviewing the submissions, the CRA collections officer withdrew the proposed personal assessments against both Ramon and Pratheep. The finding was that the evidence supported a due diligence defence — the directors had exercised reasonable oversight of a function they had properly delegated to a bookkeeper with no prior history of problems, and had acted immediately once irregularities came to light. The $52,000 debt remained with the corporation, which continued paying it down under the arrangement already in place, funded from ongoing revenue rather than the directors' personal assets.

It was a clean result, but not a lucky one. The defence worked because Ramon and Pratheep, without any legal advice at the time, had still behaved the way careful directors are expected to behave — asking questions periodically, keeping records of those questions, and reacting immediately rather than defensively once a problem surfaced. Directors who instead ignore payroll entirely, keep no records of any oversight, and only react once the CRA comes calling face a much harder version of this same argument, because there is nothing in the file to show diligence beyond hindsight.

Ramon and Pratheep kept the franchise outlet running, kept their personal finances untouched by a debt they did not create, and put a formal reporting routine in place with their new accountant so that remittance status is now confirmed to them in writing every month — not because the law requires that level of detail, but because they never want to be surprised by a letter like that again.

What you can learn from this