Jean Lemelin Inc. v. Minister of National Revenue, [1992] 2 CTC 2832, [1992] 1 CTC 2303, [1992] 1 CTC 2488, [1992] DTC 1584

Garon, T.C.C.J.:—This is an appeal of an income tax assessment dated February 14, 1989, issued under subsection 224(4) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") for failure to comply with requirements for payment which will be discussed later, established under subsection 224(1.2) of that Act. The assessment which is the subject of this appeal amounts to $22,553.56.

The relevant facts were not disputed.

Jean Lemelin testified on behalf of the appellant. At the relevant time, he was the chairman and sole shareholder of the appellant.

On January 22, 1988, the Motel Pal in Val-d'Or (a property composed of several lots) was sold by the company Espalau Inc. to Pierre Dubuc. The contract of sale included, inter alia, an assignment of rents clause in favour of the vendor, to secure payment of the sale price; that clause read as follows:

As further security, the purchaser cedes and assigns to the vendor, who is present and agrees thereto, all present and future rents of the said property, under written or oral leases, but the vendor agrees not to exercise its rights until sixty (60) days after failure by the purchaser to comply with his obligations, and after service on the tenants of its intention to exercise its rights under this assignment.

The vendor shall then collect or have collected all rents due or which may fall due, and shall give a good and valid release therefor, without incurring any liability, and may further rent the said property on such terms and at such price as it may deem appropriate.

The rents so collected shall, after deduction of the normal commission, be used to discharge and pay any claims which have priority over its own and maintenance and repair expenses, and then to reduce any balance owing to the vendor for principal and interest.

[Translation.]

The appellant was the tenant of commercial premises within the Motel Pal under a lease dated February 10, 1986, executed before a notary, between Espalau Inc. and the appellant. The lease was granted for a period of one year commencing on February 1, 1986. The lease had been renewed at least once, formally, for one additional year commencing on February 1, 1987. The same lease had further remained in effect after the acquisition of the property in question by Mr. Dubuc on January 22, 1988. It is admitted that during 1988 the appellant was required to pay monthly rental to Mr. Dubuc in the amount of $6,600. The appellant at first used the rented premises for several years to operate a disco, and then later a bar where dancers performed.

It emerged from the evidence that from March 1988 to November 1988, Mr. Dubuc failed to pay certain source deductions to the Receiver General of Canada and thus became indebted in the amount of $22,553.56.

On July 20, 1988, the respondent sent to the appellant an initial requirement for payment requiring that the appellant pay to the Receiver General of Canada the moneys payable to Mr. Dubuc. This requirement for payment referred to a maximum of $9,711.59 payable to the Receiver General of Canada. This initial requirement for payment was followed by five further requirements for payment bearing the following dates and amounts:

The appellant did not comply with the requirements for payment received from the respondent, but sent the rental payments, each in the amount of $6,600, to Gestion Espalau Inc. for the months of August, October and November 1988 and January 1989, and made payments to Hydro-Quebec for the months of September and December, 1988 in the amounts of $6,600 and $5,500, respectively.

This decision by the appellant to make rental payments to Gestion Espalau Inc. for the months referred to above was made after the appellant received a letter dated August 2, 1988 from the chairman, hotel division, of Espalau Inc. The following passage appears in the body of that letter:

We wish to inform you that Pierre Dubuc has failed for more than 60 days to comply with his obligations under the contract of sale signed before Roger Vachon, notary, last January 22. Consequently, we are advising you of our intention to exercise our rights under the assignment of rents clause included in that contract, a copy of which you will find enclosed herewith.

Consequently, and in accordance with the assignment of rents clause, we shall expect that you will comply with this notice and that all present and future rents which you owe to Pierre Dubuc will be sent to us in accordance with the said assignment of rents clause.

[Translation.]

The evidence established that this assignment of rents clause was served on the appellant on August 3, 1988 and that the initial requirement for payment issued by the respondent was received by the appellant on July 20, 1988. As was noted earlier, the appellant also made payments during this period directly to Hydro-Quebec for September and December, 1988. The appellant was not bound to make these payments to Hydro-Quebec since, under its lease, the cost of supplying electricity was to be borne by the lessor. Since the appellant had been informed by the property manager, on behalf of Mr. Dubuc, that some Hydro-Quebec accounts had not been paid by Mr. Dubuc and that there was a real possibility that service would be cut off, the appellant decided in the circumstances to make payments to Hydro-Quebec. Maintaining electricity service was absolutely essential to the operation of the appellant's business.

It is also in evidence that the appellant became the owner of the property in question in January 1989. However, it kept this property for only six months, at which time Gestion Espalau Inc. bought the property back.

Counsel for the appellant submitted, first, that the assignment of rents clause contained in the contract of sale between Espalau Inc. and Mr. Dubuc had the effect of transferring property in the receivable to Espalau Inc., relying on this point on the decision of the Supreme Court of Canada in Rejane Bastien et vir v. J. M. Dessureault Inc., [1962] S.C.R. 97, and accordingly that the rights of the assignee, Espalau Inc., took priority over the rights of the respondent. Counsel for the appellant added that as of the moment when the assignment of rents was served on the appellant, the rents were no longer owing to Pierre Dubuc but to Espalau Inc. As a second argument against the assessment, counsel for the appellant relied on the decision of the Alberta Court of Appeal in Lloyds Bank of Canada v. Int. Warranty Co., [1990] 2 C.T.C. 360, 60 D.L.R. (4th) 272, and in particular referred to passages in that decision in which it was held that the provisions of subsection 224(1.2) did not give the Minister of National Revenue priority or effect a transfer of the property right in the funds in question to Revenue Canada. Finally, dealing with the issue of the payments by the appellant to Hydro-Quebec, counsel for the appellant submitted that these payments were owing to Espalau Inc. as of the moment when the notice of assignment of rents was served on the appellant, and that, in response to the suggestion by Mr. Dubuc's manager for the property in question, the appellant was justified in making the payments to HydroQuebec.

Counsel for the respondent argued that the debt owing to the Minister of National Revenue under subsection 224(1.2) took priority over the secured debts, in view, inter alia, of the decision of the Saskatchewan Court of Appeal on the scope of that subsection in Royal Bank of Canada v. Saskatchewan Power Corp., [1990] 2 W.W.R. 655.

In the alternative, because the first requirement for payment was communicated to the appellant before service of the assignment of rents, he argued that the respondent's claim in the amount of $9,711.59, as set out in the requirement for payment dated July 22, 1988, accordingly had priority over the claim for rent by Espalau Inc. Counsel for the respondent made the additional argument that the assignment of rents clause did not effect a transfer of the property right in the claim to Espalau Inc.

It is important, first, to consider whether the assignment of rents clause, set out in the contract of sale of January 22, 1988 between Mr. Dubuc and Espalau Inc., effected a transfer of the property right in that claim to the assignee, Espalau Inc., as of the time of service of the contract on the appellant on August 3, 1988, or rather whether the effect of that clause was simply to give the rents receivable as security for the benefit of the assignee company, thereby giving it the right to be paid preferentially.

This issue, the legal nature of assignment of rents clauses, was the subject of a thorough study in an unreported decision of Judge Rodolphe Bilodeau of the Court of Quebec in Alfred Dallaire Inc. v. Fonderie St-Vincent de Paul Ltée, Caisse Populaire St-Vincent de Paul and M.N.R., dated May 16, 1990, cited by counsel for the respondent. I also noted the decision of the Supreme Court of Canada in Bastien, cited above.

In light of the principles set out in those decisions, I am of the opinion that the clause that concerns us here did not definitively strip the purchaser, Mr. Dubuc, of his right of property in the rents owing, having regard to the following observations.

First, it is expressly stipulated right at the beginning of the clause referred to above that this assignment of rents was given "as further security”. Second, that clause makes provision for the use of the rents collected by the assignee: it indicates that the assignee shall even "discharge and pay any debts which have priority over its own" and the balance shall be used “to reduce any balance owing to the vendor for principal and interest”. It seems obvious to me that such a clause necessarily supposes that the assignment of rents is not a straight sale of receivables but rather a perfected security and the beneficiary was thereby entitled to be paid preferentially, to the extent determined by the Civil Code.

Thus it is clear that we have here a clause assigning rents due and which may fall due, which is in the nature of a collateral security to a contract of sale to secure payment of the sale price. It is a collateral obligation to a deed of sale as are, in the same contract, the mortgage and the resolutive clause.

We should now consider the scope of subsection 224(1.2) of the Income Tax Act and determine, specifically, whether that subsection gives the claim of the Minister of National Revenue priority over secured claims, such as, in the present case, the rents receivable which had been given as security.

Subsection 224(1.2) reads as follows:

Notwithstanding any other provision of this Act, the Bankruptcy Act, any other enactment of Canada, any enactment of a province or any law, where the Minister has knowledge or suspectsthat a particular person is or will become, within 90 days, liable to make a payment

(a) to another person who is liable to pay an amount assessed under subsection 227(10.1) or a similar provision, or to a legal representative of that other person (each of whom is in this subsection referred to as the "tax debtor"), or

(b) to a secured creditor who has a right to receive the payment that, but for a security interest in favour or the secured creditor, would be payable to the tax debtor,

the Minister may, by registered letter or by a letter served personally, require the particular person to pay forthwith, where the moneys are immediately payable, and in any other case, as and when the moneys become payable, the moneys otherwise payable to the tax debtor for the secured creditor in whole or in part to the Receiver General on account of the tax debtor's liability under subsection 227(10.1) or a similar provision.

This subsection was added by subsection 66(1) of chapter 46 of the Statutes of Canada, 1987. That Act is entitled An Act to amend the Income Tax Act, a related Act, the Canada Pension Plan and the Unemployment Insurance Act,

Subsection 66(1) of that Act applies, under subsection 4 of that section, “to assessments in respect of amounts that are deducted or withheld after the day on which this Act is assented to”. That Act was assented to on December 17, 1987. It is therefore clear that this subsection applies to the assessment under appeal.

The provision set out in subsection 224(1.2) was analyzed with great care by Mr. Justice Vancise in Royal Bank of Canada, cited above.

The following passages of that judgment are of particular interest:

Subsection 224(1) is a garnishment provision which sets out the procedure involved in the garnishment process. The garnisher is the Minister of Finance, the garnishee is the person liable to make payment to a tax debtor under the Act and the party to be paid is the Receiver General. The garnishment power consists of the Minister’s ability to make a demand for payment when he knows or suspects payment will be made to a tax debtor by personal service or registered letter notifying the garnishee that funds otherwise payable to the tax debtor are to be redirected to the Receiver General. The reason advanced for garnishment under the section is the tax debtor's liability under the Act. Payment recovered is payment on account of the tax debtor's liability.

The scope of the applicability of section 224 is clear. Secured creditors fall within the general class of stated garnishees as persons potentially liable to make payment to tax debtors under the Act. Subsection (1.2) makes specific reference to garnishment applicability to secured creditors, and the garnishment section encompasses third parties. There are no listed or implied exceptions.

Revenue Canada's power to receive funds on account of the tax debtor's liability is equally clear. The power granted is not merely custody of the funds pending a determination of priority status. The redirected funds are to be applied to the tax debtor's account. The words non-account of the tax debtor's liability” mean something more than the limited extra judicial attachment interpretation contended by the Bank.

A transfer of property in the funds is the logical implication, otherwise the Minister lacks the ability to apply the funds to the taxpayer's account and to subsequently use the funds in furtherance of income tax objectives.

Nowhere in subsection 224(1.2) is there a provision that Revenue Canada is to receive a charge on property or priority status. However, subsection (1.2) makes it clear that when the stated procedure is complied with, Revenue Canada is to receive the funds in preference to a secured creditor, notwithstanding other enactments. Priority and a corresponding charge upon property are thus clearly intended if not specifically stated.

This section did not exist at the time of the Lamarre decision. It gives primacy to the provisions of the Income Tax Act and clearly takes precedence over all other laws. Thus the Act takes precedence over the assignment sections in the Bankruptcy Act which state that attachments do not have primacy over the rights of a secured creditor. The assignment provisions in the Bankruptcy Act were a major underpinning of Lamarre and subsection 224(1.2) fundamentally change the rights between the competing parties.

The Condorde Travel decision relies mainly upon Lamarre and Lloyds Bank, which are based on provisions of the Act that have since changed in form and substance. I am not persuaded that the result reached in this case is correct for the reasons previously stated.

Apart from the erroneous reference to the Minister of Finance rather than to the Minister of National Revenue in the first paragraph of the passage quoted from the judgment in Saskatchewan Power Corp. (the word "Minister" is defined in section 248 of the Income Tax Act as referring to the Minister of National Revenue) I am entirely in agreement with the clear and lucid analysis of the Saskatchewan Court of Appeal with respect, in particular, to the scope of subsection 224(1.2) of the Act. I also believe that Court expressed well the reasons for which it believed that the judgment of the Alberta Court of Appeal inLloyds Bank Canada was wrong.

With the greatest respect, I am of the opinion that the Alberta Court of Appeal erred in that decision when it held that the difference between subsection 224(1) and subsection 224(1.2) is not significant, at least in determining priority between the claim of the Minister of National Revenue and the claims of other creditors of the tax debtor. In my view, there are two fundamental differences.

First, the introductory part of subsection 224(1.2) clearly indicates that Parliament intended to confer on the Minister of National Revenue the right to compel a person who owed money to a tax debtor or to a secured creditor to pay the money to the Receiver General of Canada, ” notwithstanding any other provision of this Act, the Bankruptcy Act, any other enactment of Canada, any enactment of a province or any law”. This first part of subsection 224(1.2) clearly indicates by the words used, which I have just quoted, that in the event of a conflict with, inter alia, other provincial or federal legislation, this provision must prevail. On the other hand, there is no provision creating such a priority over other federal and provincial legislation in subsection 224(1). The second difference derives from the fact that, unlike subsection 224(1), subsection 224(1.2) deals specifically with cases where the person who would normally be entitled to receive payment of the debt in question is a secured creditor. Subsection 224(1.2) provides that the claim of the Minister of National Revenue, of the nature specified, must take priority over secured claims.

I am therefore of the opinion that the claims of the Minister of National Revenue, as set out in the requirements for payment, take priority in the instant case over the claims of Espalau Inc. in respect of rents payable by the appellant.

The appellant should have complied with the requirements for payment issued by. the Minister of National Revenue and was not justified in law in making the payments in question to Espalau Inc. and Hydro-Quebec.

For these reasons, the respondent's assessment is correct and the appeal is dismissed.

Appeal dismissed.