In the Matter of the Proposal of Alan Gregory Jones

[Indexed as: Jones (Re)]

66 O.R. (3d) 674

2003 72357 (ON CA), [2003] O.J. No. 3258

Docket No. C38961

Court of Appeal for Ontario

Carthy, Charron and Sharpe JJ.A.

August 20, 2003

*Vous trouverez la traduction française de la décision ci-dessous à 2003 72357 (ON CA), 66 O.R. (3d) 683.

Bankruptcy and insolvency -- Proposal -- Self-employed taxpayer filing proposal to creditors under Bankruptcy and Insolvency Act in April 1999 -- Creditors accepting proposal -- Canada Customs and Revenue Agency having unsecured claim against taxpayer for unpaid income tax -- Taxpayer making series of installment payments to CCRA starting in June 1999 to meet his current tax obligations -- CCRA not having right to apply post-proposal installment payments to reduce taxpayer's pre-proposal tax liability for 1999 -- Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3. [page675]

Income tax -- Bankruptcy -- Self-employed taxpayer filing proposal to creditors under Bankruptcy and Insolvency Act in April 1999 -- Creditors accepting proposal -- Canada Customs and Revenue Agency having unsecured claim against taxpayer for unpaid income tax -- Taxpayer making series of installment payments to CCRA starting in June 1999 to meet his current tax obligations -- CCRA not having right to apply post-proposal installment payments to reduce taxpayer's pre-proposal tax liability for 1999 -- Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3.

The taxpayer, a self-employed lawyer, became insolvent and filed a proposal to creditors under the Bankruptcy and Insolvency Act ("BIA") in April 1999. The proposal was subsequently accepted by the creditors and approved by the court. The Canada Customs and Revenue Agency (the "CCRA") was one of the ordinary unsecured creditors governed by the proposal. Beginning in June 1999, the taxpayer made a series of payments to the CCRA, through his trustee, in fulfilment of his continuing obligation to make installment payments under the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.). When the taxpayer filed his income tax return for 1999, he claimed a refund. The CCRA prorated the taxpayer's 1999 installment payments over the whole year notwithstanding the fact that the payments had all been made in the post-proposal period. The result was a shortfall for the post-proposal period rather than a refund. The taxpayer brought a motion in Bankruptcy Court for an order directing the CCRA to pay him the refund. The motion judge found that if the liability for taxes was determined on a pro rata basis as between the pre- and post-proposal periods, there was no reason why the requirement to pay should not be determined in the same way.

Held, the appeal should be allowed.

Section 62(1.1) of the BIA provides that where a proposal is made in respect of an insolvent person, the time with respect to which the claims of creditors shall be determined is the time of the filing of the notice of intention or, if no notice of intention was filed, the proposal. In this case, a notice of intention was filed in March 1999 and the proposal was filed on April 12, 1999. Sections 69 and 69.1 provide for a stay of proceedings by any creditor against the insolvent person on the filing of either a notice of intention or a proposal. Section 62(2) provides that a proposal accepted by the creditors and approved by the court is binding on, among others, all unsecured creditors. The proposal in this case was, in effect, a contract between the taxpayer and his creditors and bound all of his creditors. Under the terms of the proposal, the ordinary creditors' claims were to be satisfied by the pro rata distribution of the proposal amount payable by the taxpayer during the 48-month term of the proposal. The CCRA's claim for income tax owing as of the date of the proposal fell in the category of claims covered by those terms. The taxpayer's additional duty to meet his current tax obligations during the term of the proposal by making installment payments and filing returns did not add to or detract from this distribution scheme. The approach taken by the CCRA in assessing the taxpayer was contrary to this scheme of distribution because it would permit the CCRA to satisfy part of his pre-proposal debt at the post-proposal rate of 100 cents on the dollar. The CCRA had no basis for having its claim for pre-proposal debt satisfied in a different manner than the debt of any other ordinary unsecured creditor. The taxpayer's post-proposal installment payments for 1999 could not be used to reduce his pre-proposal tax liability for that year.

Sabey (Re), [1996] B.C.J. No. 2820 (QL) (S.C.); Vachon (André) v. Canada (Employment and Immigration Commission and Attorney General of Canada), 1985 12 (SCC), [1985] 2 S.C.R. 417, 23 D.L.R. (4th) 641, 63 N.R. 81, 57 C.B.R. (N.S.) 113, [1985] S.C.J. No. 68 (QL), consd [page676]

APPEAL by a taxpayer from an order of Platana J. (2002), 2002 49594 (ON SC), 34 C.B.R. (4th) 51 (S.C.J.) dismissing a motion for an order directing the Canada Customs and Revenue Agency to pay an income tax refund to the taxpayer.

The judgment of the court was delivered by

Other cases referred to 728835 Ontario Ltd. (Re) (1998), 1998 2019 (ON CA), 3 C.B.R. (4th) 214 (Ont. C.A.), affg (1998), 3 C.B.R. (4th) 211 (Ont. Gen. Div.); Agard v. Canada (1994), 94 D.T.C. 1232, [1994] T.C.J. No. 40 (QL), [1994] 1 C.T.C. 2407 (T.C.C.); Canada v. Simard-Beaudry Inc. (1971), 71 D.T.C. 5511, [1971] F.C. 396 (T.D.); Employers' Liability Assurance Corp. v. Ideal Petroleum (1959) Ltd. (1976), 1976 142 (SCC), [1978] 1 S.C.R. 230, 75 D.L.R. (3d) 63, 14 N.R. 503, 26 C.B.R. (N.S.) 84; Wesbrook Management Ltd. v. Canada (1996), 206 N.R. 23, 96 D.T.C. 6590, [1996] F.C.J. No. 1466 (QL), [1997] C.T.C. 124 (F.C.A.), affg (1995), 96 D.T.C. 1841, [1996] C.T.C. 2516, [1995] T.C.J. No. 1390 (QL) (T.C.C.) Statutes referred to Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, ss. 4.1, 60(1.1), 62(1.1), (2), 69, 69.1 Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), ss. 128(1)(d), (2)(d), 224(1.2)

Gavin Tighe, for appellant Alan Gregory Jones. Tracey Telford, for respondent Her Majesty the Queen in Right of Ontario as represented by the Department of Justice.

Analysis

[1] CHARRON J.A.: -- The question raised on this appeal is whether income tax payments made by a debtor, after the date of his proposal to creditors under bankruptcy legislation, can be applied to reduce his pre-proposal tax liability for that year. In my view, this question turns on the interpretation of the relevant statutory provisions and the terms of the proposal, and the answer is no. I would therefore allow Alan Jones' appeal from the dismissal of his motion for an order directing the Canada Customs and Revenue Agency ("CCRA") to pay him the refund he claimed in respect of his post-proposal payments to his tax account for the year 1999.

[2] Jones, a self-employed lawyer, became insolvent and filed a proposal to creditors under the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 ("BIA") on April 13, 1999. The proposal was subsequently accepted by the creditors and approved by the court. The CCRA (then known as Revenue Canada) was one of the ordinary unsecured creditors governed by the proposal. The CCRA's unsecured claim against Jones for unpaid income tax was in the amount of $203,000, out of the total indebtedness under the proposal of $288,376.41. [page677]

[3] Under the terms of the proposal, Jones was required to make, as full payment of his unsecured creditors' accounts, an initial lump sum payment of $40,000 followed by 48 monthly payments of $2,854, for a total of $176,992. These payments were to be made to the trustee, BDO Dunwoody Limited ("BDO"). Out of these funds (less BDO's administration fees and expenses), dividends would be paid firstly to any preferred creditors. Thereafter, the remaining funds would be distributed on a pro rata basis to the ordinary creditors. Jones was also obligated during the course of the proposal to adhere to a number of additional provisions, including making installment payments under the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) ("ITA") and filing all tax returns on time. Jones' failure to adhere to any of these provisions would be a deemed default under the proposal.

[4] Prior to the date of proposal, Jones had not made any payments into his tax installment account for the year 1999. Beginning in June 1999, he made a series of payments of varying amounts to the CCRA, through BDO, in fulfilment of his continuing obligation to make installment payments as provided under the ITA. In each case, BDO indicated that the payment was to be applied to Jones' 1999 post-proposal installment account. By the end of the year, a total of $79,065.96 had been remitted into Jones' installment account for 1999.

[5] The following April, Jones filed his income tax return for 1999, claiming a refund of $15,674.85. Accompanying the return was a letter to the CCRA from BDO explaining that this claim for a refund had been calculated in accordance with the CCRA's policy in respect of proposals. The policy in question is set out in a letter dated March 2, 1999, sent by Revenue Canada to the Canadian Insolvency Practitioners Association. In that letter, the CCRA recognized that with the advent of bankruptcy reform in 1992, a proposal providing for a payment of less than 100 cents on the dollar, once approved by the court, is binding on the Crown. The letter described the CCRA's approach to handling proposals by installment payers under this regime as follows:

[T]he Department relies on the instalment requirements of the Act to approximate the current-year debt . . . . If, then, a taxpayer has not remitted any current-year payments, and has filed a proposal, those unremitted payments would comprise the current-year debt which will be added to that person's assessed arrears. Assuming that the taxpayer has filed all required returns, the current-year debt and the assessed arrears would be the taxpayer's debt at the date of the proposal.

The Department computes the actual debt for the proposal, after the assessment of the current-year return in the following year. We prorate the assessed amount between the pre-proposal period and the post-proposal period. The amount for the former is payable in accordance with the terms [page678] set out in the proposal, while the amount in respect of the latter is payable at 100 cents on the dollar.

[6] In accordance with that policy, BDO first calculated the amount of Jones' 1999 income that fell in each of the pre- and post-proposal periods on a pro rata basis, according to the number of days in each period, regardless of when the income was actually earned. No issue is raised in this case with respect to this pro rata allocation of Jones' 1999 income as between the pre- and post-proposal parts of the taxation year.

[7] On the basis of this allocation, BDO determined that Jones' 1999 tax liability was $24,920.93 in respect of the pre- proposal period (payable at a rate less than 100 cents on the dollar as per the terms of the proposal), and $63,391.12 for the post-proposal period (payable at 100 cents on the dollar). BDO then applied the $79,065.96 credit in the installment account, all of which was accumulated during the post-proposal period, to the post-proposal tax liability only, resulting in a surplus, or refund, of $15,674.85. It is this allocation of the credit in the installment account, to the post-proposal tax liability only, that is in issue in this case.

[8] The CCRA took a different approach in assessing Jones for the 1999 taxation year. In the CCRA's view, it was appropriate in the circumstances not only to pro-rate Jones' 1999 tax liability as BDO had done, but also to pro-rate the 1999 installment payments over the whole year notwithstanding the fact that the payments had all been made in the post-proposal period. By this method, of the $79,065.96 in the installment account, $23,432.07 was applied to the pre-proposal tax liability, leaving a shortfall of only $1,488.86 for the pre- proposal period to be paid in accordance with the terms of the proposal. The remaining $59,603.89 was applied towards the post-proposal tax liability of $63,391.12, resulting in a shortfall of $3,787.23 for the post-proposal period rather than a refund.

[9] Jones moved before the motions judge in Bankruptcy Court for an order directing the CCRA to pay him the refund he claimed. The CCRA responded that Jones was not entitled to any refund. It submitted that its approach was an appropriate way to deal with a proposal by an installment payer. The CCRA illustrated the logic behind its approach by comparing the situation of an installment payer to that of a person whose tax is paid by way of deductions from his or her income at the source. In the latter case, any tax liability arising in a proposal year before the date of the proposal would be satisfied in whole or in part through those payments, which would be made at the same time that the tax [page679] liability arises. The CCRA's argument was effectively that, in the case of an installment payer, the installments take the place of source deductions. Therefore, just as the tax liability is pro- rated over the course of [a] year, regardless of when the income is earned, so should the installment payments, regardless of when they are made. By this logic, it argued that the pro-rated portion of the installment funds corresponding to the pre-proposal period should be applied towards the satisfaction of the pre-proposal debt.

[10] The motions judge agreed with the approach taken by the CCRA. He concluded that if the liability for taxes is determined on a pro rata basis as between the pre- and post- proposal periods, there is no reason why the requirement to pay should not be determined in the same way. He held that otherwise, there would be an unfair difference between the effect on taxpayers who remit payments by installment and the effect on those whose taxes are deducted at the source.

[11] It is common ground between the parties that the liability for income tax comes into existence at the moment income is earned, and not at the time the assessment is made: see Canada v. Simard-Beaudry Inc. (1971), 71 D.T.C. 5511, [1971] F.C. 396 (F.C.T.D.), approved in Wesbrook Management Ltd. v. Canada (1996), 96 D.T.C. 6590, 206 N.R. 23 (F.C.A.). The parties agree, however, that it is reasonable and convenient to pro-rate the taxpayer's income, and consequent tax liability, for the proposal year throughout the year, regardless of when the income is actually earned. Indeed, when a person has been working throughout the year, this approach is administratively efficient and makes eminent good sense. As indicated earlier, the dispute between the parties in this case centres rather on whether it is also appropriate to pro-rate installment payments made during that year, regardless of whether such payments are made before or after the date of proposal.

[12] I would pause to note parenthetically that in the case of a bankruptcy, a new taxation year is deemed to begin on the day the taxpayer becomes a bankrupt (see ss. 128(1) (d) and (2) (d) of the ITA). That option is not available, however, where the taxpayer is not a bankrupt: Agard v. Canada (1994), 94 D.T.C. 1232, [1994] T.C.J. No. 40 (QL) (T.C.C.). As there is no specific legislative provision deeming that a new taxation year begins at the date of the proposal by an insolvent person, the question raised on this appeal falls to be determined on the basis of the general provisions of the BIA relating to proposals and the terms of the proposal. [page680]

[13] Section 62(1.1) of the BIA provides that where a proposal is made in respect of an insolvent person, the time with respect to which the claims of creditors shall be determined is the time of the filing of the notice of intention, or, if no notice of intention was filed, the proposal. In this case, a notice of intention was filed on March 19, 1999, and the proposal was filed on April 13, 1999. The proposal itself defines the date of proposal as being April 12, 1999. The parties appear to be using April 13, 1999 as the relevant date in their respective facta and no issue was raised on this point. Regardless of the correct date, the parties do not dispute that the creditors' claims, for the purposes of the proposal, must be determined as of the time of the relevant filing, not after.

[14] Sections 69 and 69.1 provide for a stay of proceedings by any creditor against the insolvent person on the filing of either a notice of intention or a proposal, respectively. In Vachon (André) v. Canada (Employment and Immigration Commission), 1985 12 (SCC), [1985] 2 S.C.R. 417, 23 D.L.R. (4th) 641, the Supreme Court of Canada interpreted the equivalent provision found in a predecessor statute very broadly and held that its effect was to prevent a creditor's right of set off for debts owing by an insolvent person in the pre-bankruptcy or pre- proposal period against an amount owing the debtor by the creditor in the post-bankruptcy or post-proposal period. Conversely, the right to set-off may be exercised in respect of mutual debts existing at the date of bankruptcy: see Re 728835 Ontario Ltd. (1998), 1998 2019 (ON CA), 3 C.B.R. (4th) 214 (Ont. C.A.). The facts in Vachon are apposite to the situation in this case. A bankrupt owed the Employment and Immigration Commission the sum of $922 at the time of his assignment in bankruptcy. The claim was provable in bankruptcy and the Commission filed its proof of claim. After the day of bankruptcy and before his discharge, unemployment insurance benefits became payable to the bankrupt. The Commission withheld the sum of $922 from those benefits. The Supreme Court of Canada examined s. 49(1) of the Bankruptcy Act, R.S.C. 1970, c. B-3 [predecessor to s. 69(1)(a) of the BIA] of the legislation and held that the stay provision applied to this recovery by retention from subsequent benefits. The court therefore held that the Commission was not entitled to withhold the payment of $922.

[15] Section 62(2) provides that a proposal accepted by the creditors and approved by the court is binding on, among others, all unsecured creditors. Section 4.1 provides that the BIA is binding on Her Majesty in right of Canada. There is no dispute in this case about the binding effect of the proposal. The proposal is, in effect, a contract between the debtor and his creditors. When it is [page681] made in accordance with the provisions of the BIA, it binds all the creditors, even any dissenting minority: Employers' Liability Assurance Corp. v. Ideal Petroleum (1959) Ltd. (1976), 1976 142 (SCC), [1978] 1 S.C.R. 230, 75 D.L.R. (3d) 63, at p. 239 S.C.R.

[16] It is clear under the terms of the proposal that the ordinary creditors' claims are to be satisfied by the pro rata distribution of the proposal amount of $176,992 payable by Jones during the 48-month term of the proposal (less administrative expenses and preferred claims). It is also clear that the CCRA's claim for income tax owing as of the date of the proposal falls in the category of claims covered by those terms. Jones' additional duty to meet his current tax obligations during the term of the proposal by making installment payments and filing returns does not add to or detract from this distribution scheme. The approach taken by the CCRA in assessing Jones is, in my view, contrary to this scheme of distribution because it would permit the CCRA to satisfy part of his pre-proposal debt at the post-proposal rate of 100 cents on the dollar.

[17] It would have been possible to include a term in the proposal expressly allowing the CCRA to satisfy its claim for unpaid taxes as of the date of the proposal out of the funds paid into the installment account after the date of the proposal. If accepted by the creditors and approved by the court under the BIA, such a term would be binding on all parties. Because there is no such provision in this proposal, however, the CCRA has no basis for having its claim for pre- proposal debt satisfied in a different manner than the debt of any other ordinary unsecured creditor. It is noteworthy that the CCRA does not contend that it could apply the payments made by Jones after the date of the proposal to the pre-proposal debt arising prior to the year of the proposal. In my view, there is no principled basis to treat the pre-proposal debt arising in the year of the proposal differently. To do otherwise, as noted above, would permit the CCRA to receive more than anticipated by the terms of the proposal. This result could undermine Jones' ability to meet his obligations under the proposal and result in prejudice to the other creditors.

[18] The British Columbia Supreme Court reached a similar conclusion in Sabey (Re), [1996] B.C.J. No. 2820 (QL) (S.C.). In that case, the debtor filed a notice of intention to file a proposal on March 20, 1995. His proposal was later accepted by the creditors, including Revenue Canada, and approved by the court. In March 1995, Sabey commenced employment and his employer deducted and remitted from his wages amounts for income tax. The reported decision does not specify on what precise date the [page682] employment commenced, but it would appear that the source deductions were made in respect to the period of time after the notice of intention was filed. The deductions exceeded Sabey's tax liability for 1995 and, consequently, he was entitled to a refund. Revenue Canada withheld the refund and applied it to the pre-proposal debt. The motion judge held that there was no legislative or other legal basis for Revenue Canada to do so.

[19] The motions judge in this case distinguished the decision in Sabey on the basis that Jones, unlike Sabey, still owed taxes and was not entitled to a refund at the end of the year in question. With respect, it is my view that this distinction begs the question and, further, is irrelevant. The pertinent similarity between Sabey and this case lies in the fact that, in both cases, Revenue Canada purported to apply a surplus resulting from post-proposal payments to the pre- proposal debt. The court in Sabey held that it had no legal basis to do so. As noted earlier, I agree with that conclusion.

[20] I also disagree with the motions judge's conclusion that the CCRA was justified in adopting its position because otherwise there would be "a significant element of unfairness between tax payers who remit quarterly, and those whose taxes are deducted at source". Whatever the logical force of the CCRA's analogy of the situation of an installment payer to the situation of the taxpayer whose tax is paid by way of deductions at source, it does not have a statutory foundation. Section 60(1.1) of the BIA expressly provides that, unless the Crown consents, no proposal shall be approved by the court if it does not provide for the payment in full of amounts that could be subject to a demand for garnishment, for example by way of payroll deductions, under s. 224(1.2) of the ITA or similar provisions. In my view, absent any similar express provision regarding payment in full of the pre-proposal tax debt of an installment payer, the CCRA is not automatically entitled to such payment in full, and cannot justify the approach used in this case on that basis.

[21] For these reasons, I conclude that there is no legal basis for the CCRA's refusal to pay Jones the refund he claimed. I would allow the appeal, set aside the order of the motions judge and order the CCRA to pay Jones the amount of $15,674.85, together with costs on the motion and on the appeal fixed at $10,000 all inclusive.

Appeal allowed. [page683]