Legal compensation under Québec Law: A shield against claims by government relating to taxes

4 minute read
30 March 2016

In light of a recent decision rendered by the Federal Court of Appeal, financial institutions can now set up grounds against government authorities serving them with a requirement to pay the tax owing by an insolvent tax debtor, when that said tax debtor is also indebted towards the financial institution being served.

On Nov. 27, 2014, the Federal Court of Appeal (the Court) upheld a decision of the Tax Court of Canada allowing the appeal from Caisse Desjardins de Québec (the Caisse) from an assessment made under subsection 317(3) of the Excise Tax Act (the Act)1. The assessment arose from the Caisse’s failure to comply with a requirement to pay relating to the goods and services tax owing by a tax debtor.

The Caisse had consented a line of credit of $100,000 to Café de la paix (1980) inc. (the Tax Debtor) payable in increments of $10,000 in accordance with the terms and conditions set out in the credit contract (the Contract). Under the Contract, the Caisse reserved the right to demand at any time immediate repayment of any balance owed. The Contract also stipulated that if the borrower became insolvent, any balance then owing would become immediately payable. On Jan. 25, 2011, the Tax Debtor filed a notice of intention to make a proposal in bankruptcy and on March 25, 2011 the Tax Debtor went bankrupt.

Prior to the Tax Debtor filing said notice, Revenu Québec sent to the Caisse under subsection 317(3) of the Act a requirement to pay (Requirement) relating to the goods and services tax owed by the Tax Debtor. The Caisse refused to comply with the Requirement on the grounds that there was legal compensation of the amount seized in the Tax Debtor’s savings account. According to the Caisse, the internal statements indicating a balance of slightly over $10,000 in the tax debtor’s account only represented accounting entries that did not reflect the legal compensation provided for by applicable provincial legislation.

In fact, the Caisse argued that there was a situation of insolvency of the Tax Debtor before the Caisse received the Requirement. This situation of insolvency had led to the forfeiture of the term set out in the Contract and as a result, the Tax Debtor’s debt to the Caisse, namely the balance due on the line of credit, had become immediately payable. In other words, legal compensation had been effected between the amounts payable by the Caisse to the Tax Debtor and those payable by the Tax Debtor to the Caisse. Consequently, there was nothing to be seized and the Requirement was moot.

The Crown on the other hand argued that there was no payment through legal compensation, because the amount advanced on the line of credit was not payable at the time of the seizure.

The Court agreed with the Caisse’s position that the Tax Debtor became insolvent before the service of the Requirement, thus making the debt to the Caisse payable before said date. As a result, legal compensation had in fact been effected and the Requirement was deemed moot.

In sum, financial institutions shall consider whether any amounts owed to them by a tax debtor have become payable prior to the receipt of any requirement to pay. Should financial institutions successfully prove legal compensation, they can shield themselves from claims made by government authorities relating to taxes owed by an insolvent tax debtor.

1 R. v. Caisse Desjardins de Québec, 2014 FCA 279, appeal dismissed; Caisse populaire Desjardins de Québec v. The Queen, 2013 TCC 376.

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