The Supreme Court of Canada, in a judgment written by the Honourable Justice Lebel, rendered an important decision with respect to taxes on consumption and bankruptcy.[1]  The appeals of three related cases were before the Court, which was required to decide a controversial issue in Quebec related to the treatment of tax amounts in the context of the bankruptcy of a supplier.  More particularly, the Court had to determine the nature of the rights of the tax authorities, the trustee in bankruptcy and the secured creditors to GST and QST amounts that have been collected but not remitted or are collectible at the time of the bankruptcy of a supplier of goods or services.

On the one hand, the tax authorities submitted that they were the owners of the taxes collected or collectible and that therefore these amounts did not enter the bankrupts’ patrimonies.  The trustees in bankruptcy and the secured creditors, on the other hand, argued that these taxes are part of the estate of the bankrupt and that the Crown does not benefit from any priority over them in the context of bankruptcy.

The Supreme Court first analyzed the legal framework for taxes on consumption, specifically the GST and the QST, noting the particular situation of Quebec where the government is responsible for collecting both taxes.  The Court noted that the taxes collected or collectible are different at every stage of manufacturing and marketing where they are imposed and that furthermore, the claims of the Crown may be offset by those of the supplier through a system of input credits.  The result is that these claims are "fungible", such that the supplier is not a mere mandatory of the Crown who collects and remits specific property.

The Court also considered certain sections of the Bankruptcy and Insolvency Act as well as the amendments made to the Act in the 1990s that were intended to abolish the Crown priority system and reduce the Crown to the rank of an ordinary creditor in the bankruptcy.  Moreover, the provisions of the Bankruptcy and Insolvency Act provide that all the bankrupt’s property is part of the estate of the bankrupt unless a legislative provision creates a deemed trust.  Although some taxation legislation provide for the creation of such trusts intended to secure the amounts collected, they also provide that these trusts do not apply in bankruptcy situations (with some exceptions).  The Supreme Court noted, however, that the Quebec legislation does not provide that such trusts are ineffective in respect of the QST, which is incompatible with the Bankruptcy and Insolvency Act.  The Court concluded that although the Quebec legislation is silent with respect to the treatment of the deemed trust following bankruptcy, Canadian tax authorities remain bound by the provisions of the Bankruptcy and Insolvency Act on the order of priority of creditors to the bankruptcy.  The Court rejected the tax authorities' arguments, concluding that they did not respect the intention of the legislator.

The Supreme Court of Canada thus confirmed the judgments of the Quebec Court of Appeal that held that the Crown is not the owner of the claims related to amounts collected or collectible by suppliers in respect of the GST and QST.

Directors will not therefore see any reduction in claims against them for their statutory liability pursuant to taxation legislation.  We note, however, that directors can invoke the due diligence defence in response to such claims.

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