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← Curriculum /Payroll and source deductions /Level 3

Amounts held in trust and director's liability

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Source deductions withheld from an employee's pay were never the employer's money. The law treats them as held in trust for the Crown, separate from the employer's own property, and that single characterisation is why this area behaves unlike every other tax debt: the amounts are traced into the employer's assets ahead of secured creditors, the corporate veil does not reliably stand between the debt and the people who ran the business, and an employer who used the money to make payroll or pay a supplier has not made a difficult commercial choice but has spent funds belonging to someone else. This tutorial covers the deemed trust, director's liability and the defence against it, and what an agent can properly say to someone in the middle of it.

How to work through this tutorial

This explains why unremitted deductions are unlike other tax debts: 1. Understand what it means that the amounts are held in trust. 2. Learn what the deemed trust reaches, and where it sits against other creditors. 3. Learn how liability extends to the directors of a corporation. 4. Learn the conditions that must be met before a director is assessed. 5. Learn the due diligence defence, and what does not amount to one. 6. Understand who counts as a director, including someone who never held the title. 7. Work through an example of a business that used the money to survive. 8. Check your work against the common errors. 9. Verify every specific against CRA's published guidance before relying on it.

Whose money it is

When an employer withholds income tax, CPP contributions and EI premiums from an employee's pay, the employer has taken money that belongs to the employee and is destined for the Crown. The employer is a conduit. The legislation makes that explicit: the amounts are deemed to be held in trust, separate and apart from the employer's own property. The employer's own share of CPP and EI is a genuine debt of the employer's, but the amounts withheld from employees are not. This is worth stating carefully on a call, because it changes what kind of conversation is happening. An employer who is behind on corporate tax has a debt and can talk about payment arrangements in the ordinary way. An employer who is behind on source deductions has spent money that was held in trust, and the same tone does not apply. It also answers the question employers ask most often here, which is some version of "I had to choose between remitting and making payroll." The honest answer is that the money withheld was not available for either choice, and that an employer who reaches that point should be talking to CRA about it before the remittance is missed rather than afterwards.

What the deemed trust reaches

The consequence of the trust characterisation is that the amounts are not merely owed — they are traced. Where an employer has failed to remit, property of the employer, and property held by a secured creditor that would but for the security interest be the employer's, is deemed to be held in trust for the Crown to the extent of the unremitted amount. In practical terms the Crown's claim reaches assets that a lender believed it had security over. This priority survives events that ordinarily reorder creditors, and it is the reason lenders to small businesses ask about source deduction arrears specifically. A business seeking financing with unremitted deductions on its account has a problem it may not have connected to the financing. The interaction with insolvency is genuinely technical and differs between a bankruptcy and a proposal or arrangement. It is not an area to reason through on a call. Where a caller mentions insolvency proceedings, an agent's job is to route rather than to explain — but knowing that source deductions sit differently from other Crown claims is what tells you the routing matters.

Reaching the individuals

A corporation is ordinarily a shield: its debts are its own, and the people who ran it are not liable for them. Source deductions are one of the places that shield does not hold. Where a corporation has failed to deduct or to remit, its directors can be held jointly and severally liable for the amount, together with the interest and penalties on it. The same applies to unremitted GST/HST, which is why an agent seeing one often finds the other. Two conditions gate an assessment, and both matter because they are frequently misunderstood as formalities. First, CRA must generally have exhausted collection against the corporation itself — a certificate registered and execution returned unsatisfied, or the corporation into liquidation, dissolution or bankruptcy with a claim filed. Director's liability is not a first resort. Second, there is a **time limit**: a director cannot be assessed more than two years after they last ceased to be a director of that corporation. Resigning does not extinguish liability, but it does start a clock. A director assessed in this way has the ordinary objection and appeal rights, and can dispute both the underlying amount and their liability for it.

The due diligence defence

A director is not liable where they exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. The crucial word is **prevent**. The defence is about steps taken to stop the failure from happening, not about efforts to fix it afterwards or about how hard the director tried to save the business. Things that do not, on their own, establish the defence: being a passive or inactive director; having delegated payroll to a bookkeeper or an accountant and assumed it was handled; not knowing the remittances were being missed; being outvoted; or having personally funded the business from savings. The last one in particular feels to the person involved like the strongest possible evidence of diligence, and it is directed at the wrong thing — it shows commitment to the company, not steps to ensure the trust amounts were remitted. What tends to support the defence is evidence of a system: the director put controls in place, monitored that remittances were actually made rather than assumed, and acted when they were not. An agent should not assess whether a caller has the defence. It is fact-specific, it is decided on objection or appeal, and telling someone they probably qualify is a serious thing to be wrong about.

Who counts as a director

The title is not the test, which by now should sound like a recurring theme in this line. A person formally appointed and registered is plainly a director. But someone who has never been appointed can be treated as a **de facto** director if they perform the functions of one — directing the business, making the decisions a director makes, holding themselves out as running the company. The reverse also arises. A person named as a director because a corporation needed a second name on the registration, who has never had anything to do with the business, is nonetheless a director on the record and is exposed. This is a real and unhappy category: family members added to incorporation documents years earlier who learn of it when the assessment arrives. Resignation is the other place people go wrong. A resignation must be effective under the governing corporate law; a person who stopped attending, or who believed themselves to have left, may still be a director, and the two-year clock never started. Where the resignation was effective, the date matters greatly, because it determines whether the assessment is in time. None of this is something an agent determines. It is something an agent recognises as the question, so that a caller saying "I resigned years ago" gets pointed at what actually decides it rather than reassured.

A worked example: the money that kept the doors open

Teaching example. The figures below are invented to show the method. They are not CRA figures, and no amount here should be used for a real taxpayer.

The figures and details in this example are invented for teaching. Nothing here should be quoted as CRA's position, and any real case turns on its own facts. Suppose Tamsin and her brother incorporate a printing business. Tamsin runs it. Her brother is named as the second director on the incorporation papers and has never worked a day in it. A large customer fails to pay. Facing a choice between paying suppliers and remitting, Tamsin remits nothing for eight months while continuing to deduct from her four employees' pay. Suppose the unremitted amount reaches $52,000. She also puts $30,000 of her own savings into the company over the same period. What she believes: she has been keeping people employed at personal cost and will catch up when the customer pays. What actually happened: $52,000 that belonged to her employees and the Crown was used to pay the company's suppliers. Her $30,000 went to the business, not to the trust amounts. The company eventually fails. CRA's collection against it is unsatisfied. Both Tamsin and her brother are assessed as directors for the amount, with interest and penalties. Tamsin's personal investment does not establish due diligence, because the defence looks at steps taken to prevent the failure to remit and her decisions caused it. Her brother's position is different in substance — he did nothing at all — but doing nothing is not obviously diligence either; a passive director has generally not taken preventive steps. Whether he has a defence is exactly the kind of fact-specific question that is decided on objection, not on a call. The lesson for the call: when an employer describes using the deductions to stay afloat, they are describing the situation this liability was designed for, and the useful thing to convey — early, plainly, without a lecture — is that the money was never theirs and that the exposure reaches them personally.

Common errors

Treating unremitted source deductions as an ordinary tax debt. They are held in trust. Accepting "I had to choose between remitting and making payroll" as a description of a legitimate choice. The withheld money was not available for either. Forgetting that the employer's own share of CPP and EI is a debt of the employer's, while the employee's withheld amounts are not. Assuming incorporation protects the individuals. Directors can be assessed personally. Assuming director's liability is a first resort. Collection against the corporation must generally have been exhausted first. Telling a caller that resigning ends the exposure. It starts a two-year clock and only if the resignation was effective under the governing corporate law. Assuming only registered directors are exposed. A person acting as a director can be treated as one. Assuming a person named on the papers but uninvolved is safe. They are on the record. Treating personal investment in the company, or effort to save it, as due diligence. The defence concerns steps to prevent the failure. Treating delegation to a bookkeeper as due diligence without monitoring that remittances were actually made. Assessing on a call whether someone has the defence. It is fact-specific and decided on objection or appeal. Reasoning through the insolvency interaction on a call. It is technical and it differs between proceedings.

What to verify this tutorial against

This was drafted without a source document. The trust provision, the conditions for a director's assessment and the two-year limit are statutory, and the statutory wording is what governs. CRA's guidance on the deemed trust for source deductions is the reference for what the trust covers, what property it reaches, and its position against secured creditors. Confirm the current page and its statement of priority. The Income Tax Act's trust and director's liability provisions, and the corresponding provisions in the Canada Pension Plan, the Employment Insurance Act and the Excise Tax Act, are the operative law. Confirm the section numbers before citing any of them — this tutorial deliberately cites none. CRA's guidance on director's liability sets out the conditions that must be satisfied before a director is assessed, the two-year limit from ceasing to be a director, and the objection and appeal rights. CRA's guidance on the due diligence defence describes what the defence requires. Confirm how it is expressed, particularly the emphasis on preventing the failure. CRA's employers' guide to payroll deductions and remittances is the narrative reference for the consequences of not remitting. Guidance on the treatment of source deductions in bankruptcy, proposals and other insolvency proceedings should be taken from CRA's insolvency material rather than inferred from the trust rule. This tutorial deliberately does not describe it. This line's tutorial on failing to deduct or remit is the reference for the penalties and relief routes, and the two should be kept consistent.

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