CRA permitted to set-off post-bankruptcy credits against pre-filing debt?

Kidd (Re), 2023 ABKB 469
Can CRA set off post-bankruptcy credits against pre-bankruptcy debt after the trustee has been discharged?

Overview: In this case, the Court ruled on whether a tax provision in a compelling order in a bankruptcy was a s 68(13) order which continued to be binding on the Crown even after the Trustee’s discharge, such that the Crown would be required to continue to forward the debtor’s tax refunds directly to the Trustee. The Court ruled that the Crown was entitled to retain the bankrupt’s post-bankruptcy tax returns and set them off against the bankrupt’s tax debt, ruling that the discharge of the trustee restored the right of the Crown to use its set-off powers in s 164(2) of the Income Tax Act to set-off post-bankruptcy credits against pre-bankruptcy debt.

The bankrupt, Mr. Kidd, assigned himself into bankruptcy on November 28, 2011. The proved unsecured claims approached $300,000.00. Of that, $52,720.35 was tax debt for outstanding income taxes, penalties, and interest to the date of bankruptcy. Mr. Kidd did not perform his duties under the BIA. On October 1, 2015, the Court granted a Compelling Order which provided, in part, that:

1. notwithstanding the discharge of the Trustee, CRA shall forward Mr. Kidd’s income tax refunds directly to the Trustee, where they shall remain until further order of the Court or Mr. Kidd is granted an absolute discharge; and

2. if Mr. Kidd fails to comply with any of the terms of the Compelling Order, the Trustee has leave to proceed to its discharge and creditors’ rights to enforce payment will be reinstated upon the discharge of the Trustee.

Mr. Kidd filed his return for the 2013 tax year in May of 2014, resulting in a tax credit of $5,395.77. The Minister remitted this sum to the Trustee pursuant to the tax clause. Three years later, the Court ordered this amount to be paid into the estate to be allocated to Mr. Kidd’s outstanding surplus obligation.

Mr. Kidd did not comply with the Compelling Order. On April 17, 2018, the Trustee obtained its discharge. This had the effect of lifting the stay pursuant to s 69.3(1.1) of the BIA, restoring the rights of creditors.

In 2020, Mr. Kidd filed returns for the 2014 to 2019 taxation years and, in 2021 and 2022, for the 2020 and 2021 taxation years. This resulted in refunds totaling $31,681.54. The Minister sought to use her right under s 164(2) of the Income Tax Act (ITA) to set-off the tax refund credit against its proved unsecured claim of $52,720.35. The Trustee, for its part, sought to be reappointed and to distribute the funds as follows: (a) $4,500.00 to the Trustee for a file reactivation fee, (b) $10,830.72 for the balance of Mr. Kidd’s surplus obligation pursuant to the Compelling Order, (c) a 2,500.00 penalty for the benefit of the estate, and; (d) the balance, $14,150.82, to be paid to Mr. Kidd.

The Trustee argued that the tax clause in the Compelling Order amounted to a s 68(13) order which was binding on the Crown. Section 68(13) requires a person who owes money to the bankrupt to pay the amount fixed by the order to the bankrupt’s estate. The Trustee further argued that the tax clause had the effect of an after-acquired property clause in a GSA, and that the Crown was bound to provide the refunds to the Trustee notwithstanding the discharge of the Trustee and the restoration of the rights of creditors. In effect, the Trustee’s argument was that the Compelling Order overrode the statutory right of set-off in the ITA, and cited the general prohibition against setting-off a post-bankruptcy credit against a pre-bankruptcy debit.

The Crown argued that the tax clause could not have the effect described by the Trustee. Among other things, the Crown took the position that the Compelling Order was not competent to bind the Crown, especially since the Trustee had been discharged. The Crown relied on s 69.3(1) and (1.1) of the BIA which provide:

Stays of proceedings — bankruptcies

69.3 (1) Subject to subsections (1.1) and (2) and sections 69.4 and 69.5, on the bankruptcy of any debtor, no creditor has any remedy against the debtor or the debtor’s property, or shall commence or continue any action, execution or other proceedings, for the recovery of a claim provable in bankruptcy.

End of stay

(1.1) Subsection (1) ceases to apply in respect of a creditor on the day on which the trustee is discharged.

As a result, the Crown argued that the Trustee’s discharge had the effect of restoring the Crown’s rights pursuant to section 69.3 of the BIA.

The Court refused the Trustee’s application and ruled that the Crown could retain the funds and set them off against Mr. Kidd’s tax debt. The Court found that the tax clause in question did not operate as a s 68(13) order would in other circumstances because it did not name an amount and simply purported to intercept the refunds subject to further order of the Court. A further order of the Court was discretionary and not a fait accompli.

The Court also found that the rights and responsibilities of the parties were affected by the discharge of the Trustee and the effect of s 69.3(1.1). The Court did not interpret the first part of the tax clause ‘notwithstanding the discharge of the trustee’ as overriding this subsection.

A trustee is free to obtain a discharge in circumstances described by the Compelling Order. A trustee can also apply to be discharged at the end of the bankruptcy, after the bankrupt is discharged, the FSRD is taxed and the accounts cleared. The two discharges are not the same. In the former situation, the trustee is discharged, but its obligations are neither extinguished nor released. Rather, the removal of the stay exposes the bankrupt to further proceedings, but the bankrupt continues in bankruptcy and the administration of the bankrupt’s estate continues to be governed by the BIA. This is demonstrated by section 41(10), which provides that ‘notwithstanding his discharge, the trustee remains the trustee of the estate for the performance of such duties as may be incidental to the full administration of the estate’”.

The tax clause was reminiscent of this. It meant that the Trustee remained the receptacle for the tax refunds and was the proper payee rather than the bankrupt; potentially intercepting them to the extent of the bankrupt’s obligations to the estate. The Trustee did not wholly exit the stage on an interim discharge. The words ‘notwithstanding the discharge of the trustee’ were simply a reminder of the effect of s 41(10) and could not be read (without more) as overriding s 69.3(1.1). There was no reason to read these words as putting the CRA in a different, disadvantaged position from all of the other creditors following the Trustee’s interim discharge.

When a creditor’s rights are restored as a consequence of the lifting of the stay, it usually means that a creditor can resume or initiate proceedings for the very amounts proved in the bankruptcy. What the Crown asked was essentially no more than the right to combine and settle, setting off proved claims against post-bankruptcy credits. Otherwise, s 69.3(1.1) would have little meaning or consequences.

The Court did not direct otherwise here. The latter part of the tax clause required consideration of the rights and obligations of the parties and a direction. The funds did not automatically go into the estate. Accordingly, it was the Court’s opinion that the discharge of the Trustee restored the Crown’s rights to use its set-off powers in s 164(2) of the ITA to set-off the post-bankruptcy credits against the pre-bankruptcy debt proved by the Crown.

Judge: W.S. Schlosser, Registrar in Bankruptcy

Counsel: George Bódy, Department of Justice Canada, for the Attorney General of Canada on behalf of the Canada Revenue Agency

Bryan Maruyama of Parlee McLaws LLP for the Trustee, Dan Faber of Faber Inc.