Limits of the deemed trust created under provincial tax legislation

December 1, 2011

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In its judgment in the case of Banque Nationale du Canada v. Agence du Revenu du Québec, 2011 QCCA 1943, issued on October 21, 2011, the Court of Appeal of Quebec discussed two grounds of dispute that might be of interest to the hypothecary creditors of tax debtors when the tax authorities rely on provincial statutory provisions pertaining to deemed trusts, namely :

the limits of the scope of the deemed trust; and
the estoppel.

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Written by

Jean Legault
Partner, Lawyer

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October 19, 2020

Tax Aspects of Insolvency and Bankruptcy

The current crisis caused by the COVID-19 pandemic has already caused, and will continue to cause, significant liquidity problems for some businesses. Companies whose financial difficulties threaten their very existence will have to restructure in order to avoid bankruptcy, either by availing themselves of the protection of the Companies' Creditors Arrangement Act1 (the "CCAA") or by using the proposal mechanism of the Bankruptcy and Insolvency Act2 (the "BIA"). Tax considerations related to an arrangement or a proposal accepted by creditors Making use of the provisions of the CCAA or the BIA entails tax considerations for the debtor corporation that directors and owner-operators need to consider. Some of these tax considerations are discussed below. In the context of the restructuring of a debtor company, creditors may accept a partial settlement of their claim or a conversion of their claim into shares in the debtor company. If a corporation is not bankrupt within the meaning of the Bankruptcy and Insolvency Act, the settlement of a debt for an amount less than its principal will have tax consequences for the debtor corporation. For example, certain tax attributes of the debtor corporation such as the balance of loss carryforwards, the undepreciated portion of the capital cost of depreciable property or the adjusted cost base of capital assets will be reduced by the amount of the reduction in the receivable, if any. In certain cases, if the tax attributes of the debtor corporation are insufficient to absorb the amount of debt forgiven, inclusion in the calculation of its taxable income may occur, creating a tax liability. Several strategies can be adopted to limit undesirable consequences in the context of a restructuring under the Companies' Creditors Arrangement Act. As mentioned, it may be possible, among other things, to convert the debt into shares of the debtor company without causing adverse consequences, if the fair market value of the shares issued upon conversion of the debt is equal to the principal of the debt. In some cases, a debt held by a shareholder of the debtor company could be written off without consideration and without the need to issue shares. Finally, it may be possible, in certain situations, to avoid inclusion in the income of the debtor corporation through the use of certain reserve mechanisms or through tax deductions. Insolvency is a delicate situation for any business. Proper tax planning will allow the debtor company to maximize the effectiveness of the restructuring process offered by the CCAA. Our taxation team can help you set up effective planning in this context. R.S.C. 1985, c. C-36 and amendments R.S.C. 1985, c. B-3 and amendments

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Farmers, drivers and debtors: The Supreme Court considers the conflicts between the Bankruptcy and Insolvency Act and several provincial statutes

On November 14, 2015, the Supreme Court of Canada rendered three decisions on the application of the the Bankruptcy and Insolvency Act, RSC 1985, c. B-3 (BIA) and its interaction with certain provincial statutes. OVERVIEW OF THE FACTS In Saskatchewan (Attorney General) v. Lemare Lake Logging Ltd. Ltd., 2015 SCC 53 (Lemare), the Court, sitting as a bench of seven judges, considered the conflict between a provincial statute, which imposes a 150-day notice period before instituting any action relating to farm land, and the BIA, which permits a secured creditor to apply for the appointment of a receiver for the property of a debtor upon the expiry of a 10-day notice period under section 244 BIA. In Alberta (Attorney General) v. Moloney, , 2015 SCC 51 (Moloney), and 407 ETR Concession Co. v. 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APPLICATION In Lemare, the review was limited to the purposes which underlie the existence of the 150-day notice period in favour of the debtor/ owner of farm land under the provincial statute, which protects farms and farming operations, and to the purposes of the 10-day notice period provided in section 244 BIA before the appointment of a receiver can be required under section 243 BIA. For the majority of the Court, the time period in the provincial statute constitutes a grace period, whereas the purpose of the 10-day notice period in section 244 BIA is to avoid the multiplication of proceedings. The BIA does not require the appointment of a receiver upon the expiry of the 10 days. Moreover, this time period can be extended or abridged, depending on the circumstances. The creditor’s right to obtain the appointment of a receiver is in all cases subject to court authorization. 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The interim receiver: A “Trustee in Bankruptcy” dispensed from obtaining a clearance certificate

In a judgment rendered in the case of 9210-6905 Québec Inc. (proposal of),1 the Superior Court of Québec held that an interim receiver is not required to obtain a clearance certificate from the tax authorities before proceeding with the distribution of a debtor's property, and is not subject to personal liability for this reason. Indeed, the Court stated that an interim receiver appointed under the Bankruptcy and Insolvency Act2 is a "trustee in bankruptcy" within the meaning of subsection 159(2) of the Income Tax Act3 ("BIA") is a "trustee in bankruptcy" within the meaning of subsection 159(2) of the Income Tax Act ("ITA"). Therefore, the interim receiver benefits from the exception dispensing the "trustee in bankruptcy" from obtaining a certificate ("clearance certificate") attesting that all amounts due under the ITA have been paid. CONTEXT On March 24, 2014, the debtor 9210-6905 Québec Inc. (“Debtor”) filed a notice of intention to make a proposal and Richter Advisory Group Inc. (“Richter”) was appointed to act as trustee under the notice of intention. On March 27, 2014, the Court rendered an order appointing Richter to act as interim receiver under the BIA. The Debtor, with Richter’s help, then undertook a process aimed at soliciting offers from potential purchasers for its assets. On July 17, 2014, the Court rendered an order authorizing the sale of the majority of the Debtor’s assets and ordering that the proceeds of sale be remitted to Richter for distribution to the Debtor’s creditors. DISTRIBUTION OF THE AMOUNTS COLLECTED BY RICHTER Following the sale of the assets and the collection of the Debtor’s claims, Richter wished to distribute a net amount of more than $500,000 to the creditors, according to their respective rights. As part of this distribution, Richter proposed to pay first the amounts that were owed to the tax authorities in respect of source deductions made by the Debtor which were subject to deemed trusts within the meaning of the tax statutes or certain other statutes. The amounts owed by the Debtor to the tax authorities which were not source deductions subject to deemed trusts were however not paid under the proposed distribution. Indeed, the Debtor’s secured creditors ranked ahead of the tax authorities in respect of these amounts, and the balance of the net amount to be distributed by Richter was clearly insufficient to allow for the full payment of the amounts owed to the secured creditors. QUESTION IN ISSUE Richter presented a Motion for directions to the Court for authorization to proceed with the proposed distribution and asked the Court to declare that it was not required to obtain a clearance certificate under the relevant federal and Quebec statutory provisions (i.e. section 159(2) ITA and section 14 of the Tax Administration Act4 (the “TAA”)). Revenu Québec did not contest Richter’s motion, as opposed to the Canada Revenue Agency (the “CRA”), which essentially alleged that the exception provided for in section 159(2) ITA did not apply to Richter acting as an interim receiver, so that Richter would be bound to obtain a clearance certificate. Section 159(2) ITA states that “[e]very legal representative (other than a trustee in bankruptcy) of a taxpayer shall, before distributing to one or more persons any property in the possession or control of the legal representative acting in that capacity, obtain a [clearance] certificate from the Minister”. Under section 159(3) ITA, where a legal representative fails to obtain a clearance certificate before proceeding with a distribution, such representative is personally liable for the amounts owed to the tax authorities to the extent of the value of the property distributed. It should be noted that section 14 TAA contains provisions to the same effect. DECISION Analyzing the practical effects of the terms of sections 159(2) and 159(3) ITA in light of the position put forward by the CRA, the Court stated as follows: [Translation] [11] However, the trustee will not be able to get a clearance certificate because, as we saw above, an amount of $29,640 remains due to the CRA. [12] The trustee is therefore caught in this predicament in which it has fulfilled the Court’s order, but must retain the proceeds of sale due to the lack of a clearance certificate which it will never be able to obtain, whereas in the case of a bankruptcy, the issue would not arise. The Court rejected the position taken by the CRA that the expression “trustee in bankruptcy” used in section 159(2) ITA excludes an interim receiver appointed under the BIA. Firstly, the Court noted that only a “trustee” can act as an interim receiver within the meaning of the BIA. Next, the Court explained that the expression “in bankruptcy” was added after the word “trustee” in section 159(2) ITA because it was the federal legislator’s intention [translation] “to distinguish the trustee acting under the Bankruptcy Act from, for example, the syndic of a professional corporation or an agent chosen by the co-owners of a building.”5. The Court held as follows: [Translation] [23] Since only a licensed trustee, commonly referred to as a trustee in bankruptcy, is authorized to act under section 47 BIA, what the legislator had in mind was that the immunity in section 159(2) ITA applied to a trustee appointed under the BIA to act as an interim receiver. This interpretation is also consistent with the spirit of section 215 BIA which provides that the interim receiver, like the trustee, benefits from relative immunity when carrying out any duty under the law.6. Finally, the Court rejected the CRA’s argument to the effect that it could not grant the conclusion sought by Richter without exceeding its jurisdiction on the grounds that only the Tax Court of Canada could dispense Richter from the requirement to obtain a clearance certificate. Indeed, the judge held that the Superior Court has jurisdiction to interpret the meaning of the expression “trustee in bankruptcy” and to declare that an interim receiver appointed under the BIA is included in this expression. CONCLUSION Therefore, the Court declared that Richter, acting as interim receiver, was a “trustee in bankruptcy” within the meaning of section 159(2) ITA. Given the similar terminology used in the Quebec statute,7 in our view, the Court’s holding applies both to the federal statute and the provincial statute. As well, we are of the opinion that the Court’s holding also applies to a trustee under a notice of intention, a trustee under a proposal, a receiver appointed under section 243 BIA, a monitor appointed under the Companies’ Creditors Arrangement Act,8 and a liquidator appointed under the Winding-up and Restructuring Act.9 This judgment is important in practice because it permits any person licensed as a trustee and acting in any of the aforementioned functions to benefit from the “trustee in bankruptcy” exception and to be dispensed from the requirement to obtain a clearance certificate when such person distributes the property of an insolvent person. 1 S.C.M. 500-11-046426-140, Revised transcript of the reasons for judgment rendered from the bench on June 25, 2015 by the Honourable Danielle Turcotte, J.S.C. 2 R.S.C. (1985), c. B-3. 3 R.S.C. (1985), c. 1 (5th Supp.). 4 CQLR, c. A-6.002. 5 Paragraph 19 of the judgment. 6 Paragraph 22 of the judgment. 7 See s. 14 TAA. 8 R.S.C. (1985), c. C-¬36. 9 R.S.C. (1985), c. W-11.

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