Canada: GST/QST - A Tax Debtor's Bankruptcy Or Arrangement Does Not Extinguish The Obligation To Obtain A Clearance Certificate From A Tax Authority

On September 4, 2014, the Supreme Court of Canada dismissed a taxpayer's application for leave to appeal in the matter of Rita Congiu et autre c. Agence du revenu du Québec et autre (35830/35833). In practice, this decision upholds the position of the Québec Court of Appeal (in QST matters) and of the Federal Court of Appeal (in GST matters) to the effect that a director who distributes the property of a corporation under his or her control, even where the corporation is under the protection of the Bankruptcy and Insolvency Act (the "BIA"), is still obliged to obtain a clearance certificate from the relevant tax authority. Where the director fails to obtain such a certificate, he or she may become an additional debtor for any GST- or QST-related debt of the corporation, despite the fact that this very debt may not be legally recoverable from the corporation itself. However, note that the director's liability is not normally incurred while the trustee has control and possession of the corporation's property, in connection with its bankruptcy, since in theory the trustee alone has the power to dispose of the property.

From another perspective, the Congiu case consolidated the principles of abuse of process and judicial comity where Quebec courts have already ruled on similar issues pursuant to Quebec tax legislation. As this single topic could, in and of itself, be the subject matter of a separate article, we will not deal with it in this bulletin.

Background

In 2001, further to an audit, the Agence du revenu du Québec (the "ARQ") issued a notice of assessment against 3279227 Canada Inc. (the "Corporation") for GST pursuant to the Excise Tax Act (the "ETA") and for QST pursuant to the Act respecting the Québec Sales Tax. As the Corporation did not have the requisite resources to pay the assessed amounts, it sought protection under the BIA on October 10, 2001 by filing a notice of intention to make a proposal. The creditors then agreed to the proposal, which was ratified by the court on January 25, 2002 (the "Proposal"). The Proposal provided, in particular, for payments to be made on a regular basis in the twelve months following the Proposal's approval.

On October 28, 2002, Ms. Rita Congiu ("Congiu") acquired the shares of the Corporation for the sum of $1 and also became its director. On November 4, 2002, the Corporation transferred all of its assets to Congiu for $1,625,000. The Corporation then used a portion of this sum to pay off its hypothecary loan and, instead of using this amount to pay the last instalment provided for under the Proposal, transferred the balance, i.e. $406,000, to 9100-7146 Québec Inc., an affiliate. The Corporation thus breached its obligations under the Proposal and was legally deemed to have made an assignment of its property on May 26, 2005. Concurrently with the claim sent to the trustee, the ARQ also assessed Congiu for an amount equal to the GST and QST claimed from the Corporation. The ARQ based its assessment on the application of sections 14 and 14.4 of the Act respecting the ministère du Revenu, now the Tax Administration Act (the "TAA"), for QST matters (as well as on the equivalent GST provisions, that is, subsections 270(4) and 325(2) of the ETA). Basically, section 14 of the TAA, like the corresponding subsection 270(4) of the ETA, obliges a person who distributes the property of another person to notify the minister so that the latter can, where required, collect from such distribution the amounts which the assignor owes him and subsequently issue a clearance certificate. Any person who makes the distribution without having obtained the clearance certificate becomes personally liable for the amount of the assignor's debt pursuant to a fiscal law up to the amount of the value of the distributed property. If the assignee is a corporation, the directors may be held personally liable where they agreed to the distribution. As for section 14.4 of the TAA (like the corresponding subsection 325(2) of the ETA), it also allows the tax authority to recover from a third person certain sums that are owed by a tax debtor where he/she transfers property to a person with whom he/she is not dealing at arm's length for consideration less than that property's fair market value.

Court of Québec decision¹

Referring, in particular, to the Montmagny² and Century Services Inc.³ rulings by the Supreme Court of Canada (see our earlier Tax Law Update, " GST/HST deemed trust loses priority in CCAA reorganization"), Congiu argued that the only way the ARQ could recover the amount of her debt was by means of a claim to the trustee, as unsecured creditor, owing to the loss of the deemed trust benefit. In addition, she argued that the extinguishment of the tax debt in the course of a tax debtor's bankruptcy barred any recourse against a third person.

Judge Lareau strongly disagreed with the taxpayer's position in this matter, citing the Federal Court of Appeal decision in Heavyside⁴ with respect to sections 159 and 160 of the Income Tax Act (the "ITA"). The scope of those sections is roughly the same as sections 14 and 14.4 of the TAA. In Heavyside, the Federal Court of Appeal had ruled that a third person's liability under ITA sections 159 and 160 arose upon the transfer and that constituted an obligation independent of the principal debt, whether or not there is a subsequent bankruptcy.

Thus, Judge Lareau ruled that Congiu's position was unfounded in law on the ground that it confused the principal debtor's obligations with those of the third person who agreed to the transfer, liability for which stems from the transfer without obtaining a clearance certificate in advance.

Québec Court of Appeal decision⁵

According to the Québec Court of Appeal, the situation of the principal debtor was resolved by operation of the BIA, and section 14 of the TAA entitles the ARQ to turn to Congiu as secondary debtor, the goal of the provision being clear: to give the tax authority an additional debtor if the obligation to notify the minister of any distribution of the original tax debtor's property has been breached.

However, the Court noted that had Congiu paid the aggregate claim, the trustee would not have had to honour the ARQ's claim. Also, had the trustee paid a portion of the claim to the ARQ, this amount would have had to be deducted from Congiu's assessment. However, assuming that the Corporation had paid the last instalment under the Proposal on a timely basis and that it would thereby have been released from its debt to the ARQ, would this have also had the effect of releasing Congiu from her liability? The Court decided that it did not have to rule on this question.

Conclusion

Tax authorities have a vast arsenal of tools to recover a taxpayer's GST/QST debt. Whether under the ETA or the TAA, they can, in particular, turn to a third person who incurs his or her liability either by distributing property without a clearance certificate or by accepting the transfer of property from a related person for a consideration less than the property's fair market value, even in the context of a bankruptcy. In fact, as the Federal Court of Appeal indicated in Heavyside, a debtor's release under the BIA does not necessarily release persons who are liable for the same debt. Following this line of thought, a debtor's release further to an arrangement would not end the obligations of the third person, but they would be reduced by the sums paid by the principal debtor pursuant to the proposal. However, in practice, in the case of a director, the director could be relieved of any liability by operation of subsection 50(13) of the BIA where it is expressly provided in a proposal made in respect of a corporation that it constitutes a compromise with regard to any statutory claim against the directors.

Furthermore, it is important not to confuse a director's liability under section 14 of the TAA (equivalent to subsection 325(2) of the ETA) with the liability covered by subsection 24.0.1 of the TAA (equivalent to section 323 of the ETA). In fact, in the latter case, the director's liability ensues from the corporation's failure to remit certain collected or withheld amounts to the tax authority; however, the law provides that the director may avoid this liability if he/she is able to show, in particular, that he/she acted with due diligence. In the former case, a director does not have the same leeway and cannot avail him/herself of this type of defence. Thus, by analogy with criminal law, the regime of section 14 of the TAA would correspond to an absolute liability offence with extremely limited grounds of defence, giving greater manoeuvrability to the tax authority, whereas the regime under section 24.0.1 of the TAA would be equivalent to a strict liability offence that enables the director to exonerate him/herself under certain circumstances.

Foonotes

1. Congiu c. Québec (Agence du revenu), 2012 QCCQ 4869 (CQ).

2.Quebec (Revenue) v. Caisse Populaire Desjardins de Montmagny, [2009] 3 S.C.R. 286.

3.Century Services Inc. v. Canada (AG), [2010] 3 S.C.R. 379.

4.Canada v. Heavyside, [1997] 2 CTC 1 (FCA).

5.Congiu c. Québec (Agence du revenu), 2014 QCCA 242 (Québec Court of Appeal).

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