The Supreme Court of Canada ruled that bankruptcy trustees, receivers and secured creditors can continue to collect the full amount of accounts receivable of a bankrupt supplier, including the Goods and Services Tax (GST) component, even if an amount remains owing by the supplier to the Canada Revenue Agency (CRA).
In a decision released today, the Supreme Court of Canada settled the ongoing controversy concerning the duty of a bankruptcy trustee, a receiver or a financial institution holding a security interest to remit to the tax authorities the GST and Québec Sales Tax (QST) included in the total amount of the accounts receivable of a bankrupt supplier, when the supplier is indebted to the tax authorities for unremitted GST or QST.
The Federal CRA and Minister of Revenue of Québec (MRQ) have a first-ranking deemed trust in all the property of a supplier for an amount equal to the amounts owing to them by a supplier for GST and QST, respectively, which deemed trust arises upon failure of the supplier to remit same to the tax authorities. However, that deemed trust ceases to have effect upon the bankruptcy of the supplier, and the tax authorities then rank only as ordinary unsecured creditors.
The question submitted to the Court was whether the tax authorities could claim a real trust or a right of ownership in the taxes included in an unpaid account receivable owing to the supplier on the date of its bankruptcy. The MRQ argued that it could collect the GST and QST directly from the customers of the bankrupt supplier if the account was unpaid at the date of bankruptcy. The MRQ also argued that it could identify and claim the GST and QST in the hands of the bankruptcy trustee, the receiver or the financial institution who collected accounts from the customers after the supplier’s bankruptcy.
In the three cases decided today, the Québec Court of Appeal had overturned the decisions of the Québec Superior Court, all favourable to the MRQ. In each case, unpaid accounts receivable of a bankrupt supplier had been collected after bankruptcy, either by the trustee, the receiver, the financial institution under its security interest, or even by the MRQ. The uncertainty about the rights of the CRA and MRQ on the retail tax portion of the accounts receivable had resulted in multiple competing demands being made upon the customers of the bankrupt supplier.
The Québec Court of Appeal had determined that it was Parliament’s intent to have the GST and QST claims rank as unsecured claims upon bankruptcy of a supplier. The Court further considered that no real trust could exist on the GST and QST component of accounts receivable, as the input tax credit system did not permit tracing of the unpaid taxes.
2. Summary of the Supreme Court of Canada's Decision
In Sous-Ministre du Revenu du Québec v. Caisse Populaire Desjardins de Montmagny and the two related cases, the Supreme Court of Canada unanimously maintained the decision rendered by the Québec Court of Appeal against the tax authorities, for the same reasons. For the Court, the GST collection system and bankruptcy law are not compatible with a trust claim, as the taxes that need to be remitted are not the taxes actually collected, but the net amount resulting from set-off of amounts between the tax authorities and the supplier.
Therefore, the rights of the tax authorities do not have priority over the rights of the bankruptcy trustee, the receiver or the secured creditor to collect the full amount of an account receivable of a bankrupt supplier. The GST and QST remain unsecured claims in bankruptcy.
Because retail sales tax claims are usually larger when a borrower is in default, today’s ruling will provide an additional incentive for financial institutions to realize their security after bankruptcy of the borrower, to avoid a potential liability to the tax authorities under the deemed trust provisions.
A detailed paper on this subject, has been published in the September 2009 issue 25.1 of Banking and Finance Law Review, and is also available on the Fraser Milner Casgrain LLP website. Please click on this link to read the article.