Her Majesty the Queen v. American Express Bank Ltd., [1995] 2 CTC 469

Rowles J.

Background

American Express Bank Ltd. (’’the bank") is the holder of debentures and general security agreements which cover three hotels and their contents. 1873 Holdings Ltd. ("1873 Ltd.") is the registered owner of the hotel properties and holds title to them on behalf of Pacific Imperial Hotel Limited Partnership ("Pacific"). Pacific’s sole limited partner is A.E.B. Holdings Ltd. ("A.E.B."), which holds a 99 per cent interest in Pacific. A.E.B. is a Nevada company.

As of November, 12 1993, Pacific and 1873 Ltd. were deemed to have made assignments under the Bankruptcy and Insolvency Act, R.S.C. 1985,

c. B-3, as amended S.C. 1992, c. 1. and S.C. 1992, c. 27 (the "BIA"), by orders made in the Supreme Court of British Columbia. Price Waterhouse was appointed the trustee in bankruptcy. On 3 December 1993, Price Waterhouse was also appointed the receiver-manager of Pacific pursuant to the bank’s debentures and general security agreements. The hotels have been offered for sale by the receiver, but are as yet unsold.

As of June 22, 1994, the aggregate amount owing by Pacific and 1873 Ltd. to the bank was $58,645,784.12 (US) and interest was accruing at a rate of about $12,500 (US) per day. The bank is likely to suffer a shortfall when the hotels are eventually sold. The bank expects that when the properties are sold there may be significant capital gain and recapture tax consequences because the hotels were purchased by the present owners several years ago.

As the "owner" of the hotel properties is a non-resident within the Income Tax Act ("ITA"), certain provisions of the ITA will apply with respect to collection of capital gains tax. A summary of those provisions, which appears in the appellant’s factum and about which there is no dispute, is set out below:

Non-residents of Canada are required to include in computing taxable income earned in Canada for a taxation year its income from business carried on in Canada and its Taxable Capital Gains for dispositions of "Taxable Canadian Property".

Income Tax Act, 2(3)(c), 115(1)(a)(2), and 115(l)(b):

Taxable Canadian Property includes real property situated in Canada and any capital property used by the non-resident in carrying on business in Canada.

Income Tax Act, 115(l)(b)(2):

A non-resident who is a member of a partnership is required to include, in computing his taxable income earned in Canada, his share of the partnership income from the business carried on by the partnership or a Taxable Capital Gain realized by the partnership on the disposition of Taxable Canadian Property.

Income Tax Act, 96(1.1 )(a), 96(1 )(f), and 2(3)(c):

A partner that is a corporation must file its income tax return for the particular taxation year six months after the end of that taxation year.

Income Tax Act, 150(1)(a):

Through the operation of section 116, where a non-resident vendor proposes to dispose of taxable Canadian property, there are three possibilities:

(1) prior to sale, the vendor may obtain a clearance certificate by paying 33 1/3 per cent of the estimated capital gains on the sale proceeds of disposition less the adjusted cost base to the Minister, or by posting security acceptable to the Minister (subsection 116(2));

(2) within 10 days after the sale, the vendor may obtain a clearance certificate by paying 33 1/3 per cent of the actual capital gains from proceeds of disposition less the adjusted cost base to the Minister, or by posting security acceptable to the Minister (subsections 116(3),(4)); or

(3) if neither option above is exercised, after the sale the purchaser becomes liable to pay 33 1/3 per cent of the purchase price to Her Majesty on behalf of the non-resident vendor.

In April, 1994 the bank commenced an action against Pacific and 1873 Ltd. seeking, among other things, a declaration that the bank, by virtue of its debentures, is entitled to a fixed and specific mortgage against all the undertaking, property and assets of Pacific and 1873 Ltd., including the real property on which the hotels are located.

On June 22, 1994 the bank obtained an ex parte order adding Her Majesty the Queen in Right of Canada as represented by the Minister of Finance as a defendant in its debentureholder’s action. (Counsel for the respondent acknowledged the misdescription of the party added.) In seeking that order, the Bank contended that "Her Majesty’s involvement was necessary to determine the issue of priority of entitlement to a portion of the proceeds of sale of the hotels”. The only amendment made to the statement of claim after the ex parte order had been granted was the addition of paragraph 17:

17. Her Majesty the Queen in Right of Canada as represented by the Minister of Finance is joined as a defendant due to the fact that the plaintiff seeks a declaration that the plaintiff is entitled to the proceeds of sale of the hotels pursuant to the debentures in priority to the said defendant, and for other related relief.

The bank then brought a motion, "pursuant to Rules 43 and 44 of the Rules of Court, section 86 of the Bankruptcy and Insolvency Act, the inherent jurisdiction of the Court and section 116 of the Income Tax Act" for the following orders:

A. a declaration that American Express Bank Ltd. is entitled to the proceeds of sale on any sale by Price Waterhouse Limited (the "Receiver-Manager"), Receiver-Manager of Pacific Imperial Hotel Limited Partnership ("Pacific") and 1873 Holdings Ltd. ("1873"), of the assets of Pacific and/or 1873 in priority to Her Majesty the Queen in Right of Canada;

B. an order that the Minister of Revenue shall issue a clearance certificate in form T2068 pursuant to subsections 116(4) or (5.2) of the ITA in respect of any sale by the Receiver-Manager of the assets of Pacific and/or 1873, fixing a certificate limit in the amount found by this Honourable Court to be owing by Pacific and 1873 to American Express Bank Ltd. and to be subject to the security held by American Express Bank Ltd.;

C. an order that the said order shall constitute security acceptable to the Minister of Revenue pursuant to subsection 116(4) or (5.2) of the ITA in respect of the disposition by the Receiver-Manager of the assets of Pacific or 1873, for such clearance certificate.

In the alternative, for an order:

D. that any money received by the Minister of Revenue by any purchaser of the assets of Pacific or 1873 shall be received by the Minister of Revenue on behalf of, for the benefit of and in trust for American Express Bank Ltd. and Price Waterhouse Limited, Trustee of the estates of Pacific Imperial Hotel Limited Partnership and 1873 Holdings Ltd., both bankrupts; and

E. that the Minister of Revenue shall remit to Price Waterhouse Limited, Trustee of the Estates of Pacific Imperial Hotel Limited Partnership and 1873 Holdings Ltd., any and all proceeds of sale paid to the Minister of Revenue by any purchaser of the assets of Pacific or 1873 pursuant to section 116 of the Income Tax Act.

The orders granted by the chambers judge, and from which this appeal is brought, provide:

THIS COURT ORDERS that section 116 of the Income Tax Act does not interfere with the entitlement of American Express Bank Ltd. to the proceeds of a sale of the assets of Pacific Imperial Hotel Limited Partnership and 1873 Holdings Ltd. up to an amount sufficient to discharge the liabilities of Pacific Imperial Hotel Limited Partnership and 1873 Holdings Ltd. to American Express Bank Ltd. pursuant to debenture and general security agreements entered into between them.

THIS COURT FURTHER ORDERS that in the event that the equity in the assets of Pacific Imperial Hotel Limited Partnership and 1873 Holdings Ltd. should exceed the amount sufficient to discharge the liabilities of Pacific Imperial Hotel Limited Partnership and 1873 Holdings Ltd. to American Express Bank Ltd., such excess amount be paid to Price Waterhouse Limited, trustee of the estates of Pacific Imperial Hotel Limited Partnership and 1873 Holdings Ltd. for the benefit of their other creditors.

Reasons for Judgment of the Chambers Judge

After setting out the background and after making reference to the expectation of the bank that it would suffer a shortfall on the sale of the hotels, the chambers judge said:

Enter the Minister of National Revenue. Counsel for the Crown claims that pursuant to section 116 of the Income Tax Act any capital gain or recapture identified at the time of sale will result in taxes owing to the Minister of National Revenue....

Because the hotels were purchased by the present owners several years ago, capital gain and recapture tax consequences may be significant.

American Express, therefore, has brought this proceeding. They seek a declaration that American Express is entitled to the proceeds of a sale, or in the alternative an order that any money received by the Minister of Revenue will be held in trust for American Express and that the Minister should remit such funds to the Trustee in Bankruptcy.

Counsel for the applicant says the Court should make the declaration sought because section 116 cannot provide Revenue Canada with priority over secured creditors. Although he can find no authority dealing with section 116, he says that other sections of the Income Tax Act, notably 224(1) and (1.2) have been found ineffective in achieving that result because it would amount to confiscation of secured creditors assets without compensation. Counsel for the Crown says those authorities are of no help to Revenue Canada [sic] because the property with which we are concerned does not belong to the secured creditor. Therefore, he argues, the effect of a section cannot be to confiscate secured creditors’ assets without compensation.

These submission [sic] require a consideration of the relationship between the Bankruptcy and Insolvency Act and the Income Tax Act.

Section 86 of the BIA states:

86(1) In relation to a bankruptcy proposal, all provable claims, including secured ones, of Her Majesty in right of Canada or a province rank as unsecured claims...

Counsel for the applicant says that as section 116 of the Income Tax Act does not say that it operates notwithstanding the BIA, the latter pravails. Any claim, he says, that Revenue Canada has pursuant to section 116 in the circumstances of this case is a claim "in relation to a bankcruptcy" and as a result, Revenue Canada has an unsecured claim which must be subject to the fixed secured claim of American Express.

American Express relies on a number of cases which counsel argues stand for the proposition that to deprive a properly secured creditor of all or part of a security without compensation the statute must be express and absolutely clear. Among the cases he cites are Lloyds Bank Canada v. International Warranty Co., [1989] 1 C.T.C. 401, 89 D.T.C. 5279 (Alta. Q.B.)

In the circumstances of this case, counsel for the applicant says that from May of 1991, the date the applicant obtained the "fixed and specific charge", the assets were no longer the property of Pacific and 1873 (the debtors) except subject to that charge. Therefore, he argues, the Crown can only succeed if section 116 provides specifically that the Crown would take despite the applicant’s secured position.

Thus, from May of 1991, the applicants had a specific and fixed charge against the proceeds of the conversion or sale of the property with which we are concerned. Nowhere in section 116 are clearly and precisely expressed words which would violate a third party’s property rights where those rights pre-exist the claim of the Crown.

[Emphasis added. I

Discussion

During oral argument, we were told that the bank has the choice of proceeding through a sale of the hotels within the debentureholder’s action or through foreclosure and taking title to the hotels. Counsel for the bank stated that while proceedings through foreclosure would probably avoid the problem created by section 116 of the ITA, it would have other disadvantages, one of which was that the guarantees the bank holds would become unenforceable. The bank also has the option of having the hotels sold by the trustee in bankruptcy but, in that event, respondent’s counsel stated, the sales would be subject to the trustee’s levy. One of the bank’s other concerns, we were told, is that if the limited partner, A.E.B., which is not in bankruptcy, has losses against which it can write-off the capital gain and recapture on the sale of the hotels, the Minister of National Revenue may have to direct any funds paid to the Minister to obtain a section 116 clearance certificate to A.E.B.

It is clear that the bank’s purpose in seeking a declaratory order was to determine how best to proceed, that is, to sell the hotels or to take title through foreclosure. As I understand it, the bank is now awaiting the outcome of this appeal before taking any further steps in relation to its security.

The first ground of appeal is that the learned chambers judge did not have jurisdiction to issue a declaratory judgment with respect to the interpretation of section 116 of the Income Tax Act. In the appellant’s submission, the trial division of the Federal Court has exclusive jurisdiction to make declaratory orders which are in pith and substance concerned with the correct interpretation of section 116 of the ITA. In the court below, no objection was taken by the appellant to the jurisdiction of the chambers judge to make the declaratory orders sought. It would also appear from the reasons that no submission was made as to whether the chambers judge should exercise his discretion to grant declaratory orders, which required an interpretation of section 116 of the ITA, on the basis of hypothetical facts.

The second ground of appeal is that the chambers judge improperly interpreted the application, purpose and effect of section 116 of the Income Tax Act, and wrongly determined that the issue before him was a priorities issue. I propose to consider this ground first.

The chambers judge characterized the issue before him as a priority dispute, and in doing so he apparently accepted the following submission of counsel for the bank:

Counsel for the applicant says that as section 116 of the Income Tax Act does not say that it operates notwithstanding the BIA, the latter prevails. Any claim, he says, that Revenue Canada has pursuant to section 116 in the circumstances of this case is a claim “in relation to a bankruptcy" and as a result, Revenue Canada has an unsecured claim which must be subject to the fixed secured claim of American Express.

With deference to the learned chambers judge, the issue could not properly be characterized as a priority dispute. A priority dispute presupposes the existence of competing claims of creditors to the same fund. In this case, there is no "fund" and there is no certainty that there will ever be a "fund" to which both the bank and the Crown could have a claim. Until the hotel properties are sold and tax liability incurred, the Crown is not and could not be a "creditor" as a result of taxes arising from capital gains or recapture.

Under subsection 2(3) of the ITA, non-residents who dispose of taxable Canadian property are subject to tax liability. The method of calculation of that tax liability is detailed in section 115 of the Act. Section 116, on the other hand, deals neither with the creation of non-resident’s capital gains liability nor the method of calculation. Section 116 is a mechanism for collection, designed to ensure that non-residents will pay their outstanding taxes.

Under the Income Tax Act, the non-resident’s capital gains tax liability is only incurred when the property is sold. Prior to that, there is no tax liability as between the non-resident andq the Crown. In other words, until the property is sold, the Crown has no interest or rights to any payment by the non-resident, nor does any legal relationship exist, creditor-debtor or otherwise, between the Crown and the non-resident or, as in this case, the non-resident’s creditor, the bank.

In considering the relationship between the ITA and the BIA, the chambers judge, based on subsection 86(1) of the BIA, concluded that the bank’s secured claim must rank ahead of the Crown’s unsecured claim, with the result that the bank had priority over the Crown to any funds derived from the sale of the properties, at least to the extent of any indebtedness to the bank by 1873 Ltd. and Pacific.

The difficulty with that chain of reasoning is that there is no existing tax liability from capital gain or recapture which is provable in bankruptcy. Subsection 86(1) of the BIA states:

86(1) In relation to a bankruptcy or proposal, all provable claims, including secured ones, of Her Majesty in right of Canada or a province rank as unsecured claims....

Subsection 121(1) defines provable claim as:

121(1) All debts and liabilities, present or future, to which the bankrupt is subject on the day on which the bankrupt becomes bankrupt or to which the bankrupt may become subject before the bankrupt’s discharge by reason of any obligation incurred before the day on which the bankrupt becomes bankrupt shall be deemed to be claims provable in proceedings under this Act.

In this instance, the Crown has no provable claim under the BIA as tax liability from capital gains and recapture, assuming there is any, only arises upon the disposition of the properties-an event which in this case can only take place after the date of bankruptcy. Hence, no capital gains tax liability has been incurred prior to bankruptcy.

I agree with the submission of appellant’s counsel that the bankruptcy of 1873 Ltd. and Pacific does not create a priorities issue. The second order made by the chambers judge, which is reproduced above, clearly contemplates that it does.

As noted earlier, the bank’s purpose in seeking a declaratory order was to determine how best to proceed, that 1s, to sell the hotels or to take title through foreclosure. Put another way, what the bank wanted to determine, understandably, was whether the Bank’s security could be undermined through the operation of section 116 of the ITA, if the hotels were sold. Before that question could be determined, however, it would be necessary to know or assume facts which were not before the court below. I should add that the issue of whether the chambers judge should have exercised his discretion to grant the declaratory orders based on hypothetical facts was not an issue which was argued before us, because appellant’s counsel abandoned that portion of her argument in her factum.

I am of the view that the declaratory orders made by the chambers judge must be set aside. In exercising his discretion to grant the declaratory orders, the chambers judge proceeded on the basis of some assumed facts, and somme conclusions about the nature of the issue before him, which were erroneous.

A declaratory judgment is a judicial statement confirming or denying the existence or non-existence of a legal right of the applicant. (See Sarna, Lazer, The Law of Declaratory Judgments, p. 1; Zamir &; Woolf, The Declaratory Judgment, second ed. 1993, p. 1.) Courts have granted declaratory judgments cautiously. In Russian Commercial and Industrial Bank v. British Band for Foreign Trade Ltd., [1921] 2 A.C. 438 , All E.R. Rep. 329 at page 448 (All E.R. 332), Lord Dunadin described the granting of a declaration as a matter of discretion which ought to be exercised "with extreme caution". The Supreme Court of Canada, in Solosky v. The Queen, [1980] 1 S.C.R. 821, 105 D.L.R. (3d) 745 at D.L.R. page 753, described declaratory relief as follows:

Declaratory relief is a remedy neither constrained by form nor bounded by substantive content, which avails persons sharing a legal relationship, in respect of which a "real issue" concerning the relative interests of each has been raised and falls to be determined.

At present, the bank and the appellant do not share a legal relationship, and it is not clear that they ever will.

What effect the declaratory orders would have in relation to statutory requirements imposed by section 116 is uncertain. Section 116 provides that after the land is sold, while the tax liability is incurred by the nonresident vendor, it is the purchaser, (a third party, as yet undetermined) who is liable to withhold proceeds and remit funds to the Minister of National Revenue.

It is not necessary to determine the jurisdictional issue, in view of the conclusion I reached on the second ground of appeal. I note, however, that in Longley v. M.N.R. (1992), 66 B.C.L.R. (2d) 238, 6 C.P.C. 230 (C.A.), (to which we were not referred by counsel) the British Columbia Supreme Court was asked to make a declaration against the Minister of National Revenue with respect to tax consequences. The plaintiff had developed a tax scheme concerning financial contributions to a political party and sought, in addition to relief under the Charter of Rights and Freedoms, a declaration that the Minister of National Revenue may not refuse to honour political contribution tax credit claims arranged, in essence, identically to previous claims which the Minister had honoured. Hutcheon J.A., for the majority, stated at page 243:

Insofar as this claim brings into question section 127 of the Income Tax Act, Mr. Gill, counsel for the Attorney General, submits that a declaration related to the interpretation and application of section 127 is within the jurisdiction of the Federal Court under section 18 of the Federal Court Act.

That may be so, but the Supreme Court of British Columbia, as a provincial court of general original jurisdiction, is bound to take cognizance of all laws, whether enacted by the federal Parliament or by the provincial legislature: Canada (Attorney General) v. Law Society (British Columbia), [1982] 2 S.C.R. 307, 137 D.L.R. (3d) 1. I have no doubt of the jurisdiction of the Supreme Court of British Columbia to make declarations as the court did in the case of Dyson v. Attorney-General, [1911] 1 K.B. 410, [1912] 1 Ch-148 (U.K. C.A.).

I would allow the appeal and set aside the orders made. The appellant is entitled to costs both here and in the court below.

Appeal allowed.