1074022 B.C. Ltd. v. Li: The need for legislative reform

The Legal Background & CRA's Section 116 Collection Powers

In the case of Muir v The Queen, the Tax Court of Canada allowed the appeal, says David J. Rotfleisch, CPA, JD, of Rotfleisch & Samulovitch P.C.

The CRA is obligated to apply Canada's tax act and its regulations fairly and uniformly. This includes ensuring that all taxpayers pay their tax liability owing to the Crown. Where a taxpayer refuses to pay his or her tax liability, Canada's tax act protects the CRA's ability to recover money owed to the Crown. In particular, section 116 of Canada's tax act protects the CRA's ability to collect tax on capital gains earned on the disposition of real estate property by non-resident vendors. Since the Canadian government does not have direct jurisdiction over non-resident vendors, this provision was enacted to protect the CRA's abilities to collect money, that the Crown is entitled to, prior to it leaving Canada's jurisdiction.

Under section 116 of the Income Tax Act, non-resident taxpayers who dispose of certain taxable Canadian property must notify the Minister of the disposition either "anytime" before, or not later than 10 days after the disposition of the property. As a result, the Minister would issue a "clearance certificate" in conjunction with the appropriate amount of tax to be remitted as a tax consequence from the disposition of the taxable Canadian property by the non-resident vendor. However, where the non-resident vendor does not notify the Minister of the disposition, subsection 116(5) of Canada's tax act imposes an obligation on the purchaser who acquires the property, from the non-resident vendor, to withhold and remit to the Receiver General 25% of the amount paid by the purchaser for the property. A purchaser who fails to withhold and remit such amount to the Receiver General may be held liable for any, and or all, unpaid taxes of the non-resident vendor arising as a result of the disposition of the property.

In 1074022 B.C. Ltd. v. Li, 2020 BCSC 65, the Supreme Court of British Columbia was asked to determine the status of the sale proceeds on the sale of real property by a non-resident after the section 116 remittance was made to the Receiver General, and the non-resident vendor's tax liability.

On the one hand, understanding the CRA's collection abilities and powers is of great significance for individuals and corporations that owe money to the Crown, particularly non-residents earning income from a source in Canada. On the other hand, this case raises the alarm about the complexities associated with interpreting section 116 of Canada's tax act and the CRA's collection abilities specifically in the context of non-resident vendors. Furthermore, this case sheds light on the provisions of Canada's tax act associated with cross border transactions and why this is a complex area of law that requires detailed analysis and advice from an experienced Canadian tax lawyer.

Factual Background

In 1074022 B.C. Ltd. v. Li, the respondent mortgagor, Mr. Li, owned property in Victoria, British Columbia (the Property). Mr. Li was not a Canadian resident; he lived in Hong Kong during the time of the proceeding. In an order dated June 21, 2018, a court approved the sale of Mr. Li's property (the "order approving sale"). The order approving sale set out the amount that Mr. Li owed to the mortgagees and the priorities for payment of the net sale proceeds. As a result of the order approving sale, the relevant property was conveyed to and vested in the purchaser.

The Petitioner, 1074022 B.C. Ltd., held a second mortgage over the property owned by Mr. Li and was only partly paid out of the sale proceeds. The Petitioner was still owed $130,000 at the time of this decision. Bank of Montreal held a first mortgage over the property and was paid out of the net sale proceeds almost in full. A third mortgagee is mentioned in the reasons for judgment, yet he did not participate in the application and was not paid anything out of the sale proceeds.

The respondent Mortgagor, Mr. Li, did not give the Minister the required notice pertaining to the disposition of the property pursuant to section 116 of the Income Tax Act. As a result, the CRA did not issue Mr. Li a clearance certificate. In compliance with section 116 of Canada's tax act, $200,000 was remitted to the CRA (that being 25% of the purchase price which was approximately $800,000) to secure payment for Mr. Li's tax liability arising from the disposition of the property. Although the CRA did not finalize Mr. Li's tax liability at the time of this proceeding, the Supreme Court of British Columbia stated that "it is clear that he only owes $46,000, leaving $154,000 (the excess funds)". Mr. Li provided the CRA with a written irrevocable "direction to pay" the funds to his lawyer in trust. The court clarified that it is common ground that if funds are paid in this such manner, they will be dealt with in accordance with the priorities set out in the order approving sale.

The Application

In the Application before the Supreme Court of British Columbia, the Petitioner, 1074022 B.C. Ltd., requested an order authorizing that the excess funds be paid to the petitioner's lawyer in trust or into court to be "held and paid out according to the terms of the order approving sale".

The Application Respondent, Attorney General of Canada on behalf of Her Majesty the Queen, argued was that there is no legislative authority requiring or permitting it to return the funds to the secured parties, pay the funds into court to credit the proceeding, or even to comply with Mr. Li's direction to pay. Instead, the Respondent's position was that it is compelled by law, particularly section 164 of the Income Tax Act and section 67 of the Financial Administration Act, to pay the excess funds to Mr. Li as a tax refund.

Master Harper disagreed with the respondent. He explained that if the court concedes to the Respondent's position, Mr. Li would receive money which he owes to his secured creditors and the priorities set out in the order approving sales "will be defeated".

Agreeing with Bank of Montreal and the Petitioner's argument, Master Harper affirmed that the Respondent's position "ignores the statutory and common law principles that apply to foreclosures and that if the court accepts Canada's position, a commercial absurdity would result".

This demonstrates how the court is not willing to defeat its previous decisions in the order approving sale and the priorities set out in it. As well, the court is upholding statutory and common law principles applicable to foreclosures and it not willing to ignore them. This also illustrates how the court is shying away from going against its long-standing legal principles which could create unreasonable or unjust results.

The Issues

The issues under the application were:

• Is the Respondent obligated to comply with the direction to pay?
• If the answer is "no", is the Respondent required to pay the excess funds into court to the credit of the proceeding, or into a lawyer's trust account, to be dealt with in accordance with the priorities set out by the order approving sale?

Analysis

1) Is the Respondent obligated to comply with the direction to pay?

The Respondent argued that unless permitted by legislation "the Crown is immune from orders that are coercive in nature" and as such there was no legal basis to order the Crown to pay the tax refund to a third party. In support of this argument, the Respondent relied on the following legislation and reasonings:

• Because the 25% of the proceeds was remitted to the CRA on behalf of Mr. Li, as a result of his status as a non-resident, the excess funds can only be remitted to Mr. Li, pursuant to section 116 of the Income Tax Act;
• Relying on section 67 of the Financial Administration Act, the Respondent argued that the "assignment" of an income tax refund is prohibited by law; and
• Pursuant to section 164 of the Income Tax Act, a refund is to be paid to the taxpayer.

Master Harper of the Supreme Court of British Columbia disagreed with the Respondent's argument. He stated that the Respondent's argument is "misplaced" and that its interpretation of the aforementioned statutes is "overly narrow". He further explained that paying the excess funds to Mr. Li's lawyer in trust does not constitute an assignment, nor does it benefit anyone other than Mr. Li. As a result, "the funds remain Mr. Li's to be dealt with in accordance with the trust conditions agreed upon between him, his lawyer and the secured creditors." Master Harper took a broad approach and interpreted the statute in context of the facts as a whole, while upholding the non-resident taxpayer's trust conditions and arrangement to pay his secured creditors.

Master Harper accepted the Petitioner's request to the CRA to comply with Mr. Li's direction to pay. He stated that the CRA "could have, and should have, simply complied with the request". Master Harper explained that nothing in the Income Tax Act prevents the CRA from complying with the direction to pay and that Mr. Li's direction to pay "is not a violation of CRA's governing legislation". As a result, Master Harper imposed an obligation on the Respondent to act in accordance with Mr. Li' direction to pay. Interestingly, in finding that the Income Tax Act did not prevent the Respondent from acting on the Petitioner's request, the court declared an obligation on the CRA to act in accordance with Mr. Li's direction to pay. This demonstrates how the court interpreted the statue broadly in context of what is not in Canada's tax act, while interpreting the CRA's abilities and obligations.

2) If the answer is "no", is the CRA required to pay the excess funds into court to the credit of the proceeding, or into a lawyer's trust account, to be dealt with in accordance with the priorities set out by the order approving sale?

The parties agreed that section 116 of Canada's Income Tax Act requires 25% of the sale proceeds to be remitted to the CRA and that Mr. Li's tax liability will be fully paid from the $200,000 remitted to the Receiver General to pay his tax liability arising from the disposition of the relevant property. However, this second issue turned on whether (or not) the sale proceeds remain subject to the prior mortgage security that charged that land to which the sale proceeds related.

a) A Summary of the Law Applicable to Foreclosures and Vesting Orders

A mortgage effects the conveyance of title to the purchaser. Pursuant to the Supreme Court Civil Rules, Rules 21-7(7)(f) and 21-7(9) a person having engaged in a sale may apply to court for an order confirming the sale, directing the disposition of proceeds and vesting title in the purchaser. Under section 231(2) of the Land Transfer Act a mortgagor and a mortgagee are entitled to all legal rights that would be available to them if the mortgagor transferred the mortgagor's interest in the land to the mortgagee. In this case, the order approving sale was made pursuant to section 15 of the Law and Equity Act and the priorities for distribution was set out in accordance with section 20 of the Land Transfer Act

b) The Effect of Sale by Vesting Order

Master Harper affirmed the court's order which held that the sale proceeds were to be distributed in accordance with their existing priorities. He pointed to the distinctions between a court-ordered sale and a private sale. In a court-ordered sale, "title is transferred to the purchaser free and clear of all interests after the petitioning mortgagee with the sale proceeds standing in the place of the lands and subject to the same priorities." Master Harper relied on a previous decision of Supreme Court of British Columbia, Canada Permanent Mortgage Corp. v. Kerr (1984), which explained that in a court-ordered sale, the remaining funds (after the payment of property taxes), stand in place and stead of the land and are subject to the same priorities as the land. In this context, the court is demonstrating the effect of the court-ordered sale of Mr. Li's property and that addressing the priorities to which the land is subjected is necessary for a free and clear title transfer.

c) The Effect of s. 116 of the ITA on Proceeds of a Court-Ordered Sale in a Foreclosure

Master Harper rejected the Respondent's interpretation of section 116 of the Income Tax Act. He presented the following factors which are not included in Canada's tax act, nor in section 116 in particular:

• Contemplating a sale by a court order rather than by a private sale;
• Giving the crown priority for tax obligations over a mortgagee;
• Providing any mechanism by which sales proceeds paid to the CRA under section 116 which are encumbered by mortgage security can be effectively "cleansed" of those security interests; or
• Changing the nature of the mortgage itself, being a transfer of title of the property to the mortgagee subject to the right of redemption.

Master Harper explained that the purpose of section 116 of the Income Tax Act "is to ensure that funds owing for tax on capital gains arising on a disposition of property go to CRA, rather than to a tax debtor who is out of the reach of CRA collections procedures." Once again, this demonstrates how the court took a broad, purposive approach to interpreting the statue, in relation to the facts and circumstance of the proceeding. Particularly, the court is looking at what is not in Canada's tax act as a whole and the relevant provisions that would prevent the respondent from acting in accordance with the petitioner's request and Mr. Li's direction to pay.

Master Harper stated that "section 116 of the Income Tax Act presupposes that the sale is a voluntary sale by the registered owner who is required to clear title upon disposition". Interestingly, section 116 of the Income Tax Act does not discuss whether (or not) a disposition of property ought to be a court-order sale and or a voluntary sale. It is also unclear whether the Income Tax Act imposes more restrictions on one mechanism of sale versus the other (a court-order sale versus a voluntary sale), specifically in the context of disposition of a taxable Canadian property by a non-resident vendor.

d) Paramountcy

Master Harper also rejected the Respondent's interpretation of the principle of paramountcy. He explained that the principle of paramountcy only applies where there is conflict between federal and provincial legislation. He held that in this case, there is no conflict because the Income Tax Act does not grant the CRA priority to an amount remitted under section 116. Master Harper affirmed that the court has jurisdiction over its own order including the herein order approving sale and its established priorities and pointed to the Income Tax Act's failure to contemplate a court-ordered sale and that the proceeds of sale stand "in place and stead of the land".

On the one hand, Master Harper acknowledged the court's jurisdiction over its order approving sale and abilities to uphold such order. This illustrates that the court is setting precedent to its obligations and is attempting to avoid ambiguity relating to its past decisions. This could also be the Court's way of setting precedent for future applications arising from foreclosure proceedings and orders authorizing the sale of a taxable Canadian property. On the other hand, Master Harper again, explained what is not in Canada's tax act by outlining its failure to contemplate facts and circumstances as the ones appearing in this case. Perhaps, this is the court's way of calling out law makers to address legislative gaps and complexities, especially with regards to tax law. In setting out the intention of section 116 "is to ensure that the tax debts of non-resident property owners are paid so that funds that would go to paying those debts do not leave the country", Master Harper is showing that the courts are attempting to comply with this legislative intentions. Further, this could also be Master Harper's way of saying that it cannot have been the intention of parliament to allow funds to leave that country that could be distributed to existing creditors.

e) Is a Petition into Bankruptcy a Viable Solution to the Problem?

Master Harper rejected the Respondent's suggestion that one of the mortgagees should petition Mr. Li into bankruptcy and pursue payment of their judgments through the bankruptcy process based on the following reasons:

• It is not clear whether excess funds would lose their character as funds "in place and stead of the land" once paid to a trustee in bankruptcy;
• A trustee in bankruptcy has to be paid. It is unclear who would pay the trustee's fees and if such fees are deducted from the proceeds than the recovery will further be reduced;
• The bankruptcy process is cumbersome, expensive and unsatisfactory;
• There is no evidence before the court that the bankruptcy process would achieve recovery for the creditors.

Recognizing that the aforementioned list is inconclusive with respect to the impediments associated with the bankruptcy process, Master Harper explained that bankruptcy process is not a viable solution to the Respondent's narrow interpretation of section 116 of the Income Tax Act.

Conclusion

Master Harper decided in favor of the Petitioner and held that the CRA shall pay the excess funds to Mr. Li's lawyer in trust, into the Court to the credit of the proceeding or to the Petitioner's lawyer in trust. He explained that a legislation could have been put in place to resolve the Respondent's narrow interpretation of section 116 of the Income Tax Act. Although the Respondent did not see its role in making recommendations pertaining to legislative report, Master Harper held that there are no signs that the complexity of interpreting section 116 appears to be on the legislative reform.

This case appears to call on legislatures to address the complexity associated with interpreting tax law, particularly section 116 of the Income Tax Act. The case reveals that such complexities could be resolved by a "simple legislative amendment". The Court even goes as far as providing an example for such amendment by stating "For instance, legislation could provide that CRA pay excess funds into court to the credit of the foreclosure proceeding." Perhaps this is the court's way of providing law makers with recommendation and direction pertaining to legislative reform.

This case illustrates how the court took a broad, purposive approach and interpreted section 116 of the Income Tax Act in context of what is not in the provision specifically, nor in the Income Tax Act as a whole, while addressing the facts and circumstances in this case. On the one hand, this broad approach could be criticized in context against judicial restraint. On the other hand, proponents for this broad approach may emphasize its ability to provide balance and clarity to individuals and corporations who owe money to the Crown as well as to the CRA with respect to its collection abilities and powers.

David J Rotfleisch, CPA, JD, is the founding tax lawyer of Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law firm. With over 30 years of experience as both a lawyer and chartered professional accountant, he has helped start-up businesses, resident and non-resident business owners and corporations with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax litigation. Visit www.Taxpage.com and email David at david@taxpage.com.