It is not often that the Supreme Court of Canada grants leave to appeal a decision relating to the Income Tax Act (ITA) or the law relating to how cheques are processed and paid. It is even less common when both the trial and appellate courts were in agreement. Canada Trustco Mortgage Co. v. Canada is one of those rare cases and should be of interest to financial institutions that are involved with the processing and payment of cheques.
In Canada Trustco Mortgage Co. v. Canada, the specific issue before the Court was whether the act of delivering a cheque drawn by a tax debtor for deposit into a joint account constitutes a demand for payment of the cheque sufficient to require the appellant, Canada Trustco Mortgage Co. (Bank), to remit the proceeds of the cheque to the Canada Revenue Agency (CRA) pursuant to section 224(1) of the ITA. Section 224(1) of the ITA is a summary procedure that gives the CRA extraordinary power to garnish funds payable to a tax debtor without first obtaining a court order or judgment.
The facts underlying the decision involved the activities of a tax debtor, (a lawyer), who held two accounts with the Bank: a lawyer’s trust account and a joint personal account that he held with another lawyer. Over a period of several months:
- the tax debtor wrote a number of cheques on the trust account identifying himself as the payee;
- on each occasion, the cheques were delivered to the Bank for deposit into the joint account;
- these deposits, and the related credits to the joint account, were subject to the terms and conditions of the joint account agreement;
- when the Bank accepted the cheques for deposit, it provisionally credited the joint account an amount equal to the face value of the cheques;
- the Bank then sent the cheques through the standard third party clearing process; and
- after clearing, the cheques were presented for payment and the trust account was debited for the amounts of the cheques.
The arguments accepted by the Tax Court of Canada and the Federal Court of Appeal conflated the act of delivering a cheque for deposit with the act of presenting a cheque for payment. By doing so, the courts below disregarded the legal significance of each step that was undertaken between the time the cheque was drawn, and the moment the funds were debited from the trust account.
Justice Deschamps, writing for the majority, noted that important as electronic transactions have become in an increasingly paperless world, cheques are still popular bills of exchange that are processed daily in a multitude of transactions across Canada based on recognized mechanisms. In setting aside the decisions of the courts below, Justice Deschamps took the opportunity to review over 150 years of case law relating to the processing of cheques and to carefully explain why the law applicable to these recognized mechanisms must be understood and applied consistently. Justice Deschamps carefully distinguished the legal significance of each step in the life of a cheque, from the time it is created, to the time it is paid and in particular, carefully reviewed the different ramifications for the Bank and its customers when a cheque is deposited, compared to when a cheque is presented for payment.
This decision is important for two reasons. The first relates to the role of cheques in commercial transactions. The second relates to the scope of CRA’s power to garnish funds on deposit with financial institutions pursuant to section 224(1) of the ITA.
a) Cheques in Commercial Transactions
Parliament, in conjunction with the courts of this country, and throughout the Commonwealth, have developed a coherent set of principles to govern the relationship between and a bank and its customer, and the use of cheques as a convenient means to access the funds on deposit for a wide variety of commercial transactions. All financial institutions, and the clearing agencies they use, rely on these legal principles for the efficient operation of the clearing system that facilitates millions of commercial transactions each day.
In the interest of commercial efficacy and certainty, these principles must be applied consistently in all legal contexts including in the application of section 224(1) of the ITA. However, an inconsistent application of these legal principles, as was done by the Tax Court and Federal Court of Appeal, would have created risks for financial institutions and affected the commercial efficacy and certainty of the clearing system.
Although the CRA may have been simply trying to facilitate the collection of unpaid taxes from a very small and limited class of tax debtors, namely lawyers, the Tax Court and Federal Court of Appeal took what was intended to be a straightforward and summary procedure for the collection of tax debts under the ITA, and applied it in a manner that was based upon a fundamental misunderstanding of the law that applied to collection, presentment and payment of cheques and other negotiable instruments in a commercially efficient and predictable ways.
Justice Deschamps recognized the importance of the legal principles applicable to these transactions and was not prepared to disregard, contort or change principles, that have been established over such a long period of time, and which are essential for commercial efficacy in order to deal with a narrow category of tax debtor.
b) The Application of Section 224(1) of the ITA
CRA has the discretion to rely on the summary garnishment procedures in section 224(1) of the ITA only if two conditions precedent exist: (a) funds are or will be "payable" to the tax debtor; and (b) a person, such as the Bank, is or will become "liable to make a payment" of the funds. What the Court’s decision in Canada Trustco Mortgage Co. v. Canada demonstrates is that upon receiving a Requirement to Pay, financial institutions should carefully consider their various legal relationships with their customers who are tax debtors before remitting funds to the Receiver General.