Harvey
J.-The
Attorney
General
of
Canada,
representing
Her
Majesty
the
Queen,
applies
by
way
of
notices
of
motion
dated
July
5,
1994
and
October
31,
1994,
respectively,
seeking
orders
of
this
court
for
payment
to
Her
Majesty
the
Queen
in
Right
of
Canada
of
funds
held
in
trust
by
the
trustee
in
Bankruptcy
of
San
Diego
Catering
Ltd.,
the
firm
of
Campbell,
Saunders
Ltd.
Facts
On
March
26,
1993,
San
Diego
Catering
Ltd.
(“San
Diego”)
filed
a
proposal
with
the
trustee,
Campbell,
Saunders
Ltd.
(the
trustee”)
which
was
accepted
by
the
creditors
of
San
Diego
at
a
meeting
held
on
August
15,
1993.
On
or
about
January
20,
1994,
the
trustee
was
advised
by
the
solicitor
for
San
Diego
that
a
sale
of
the
operating
assets
of
San
Diego
had
completed.
In
a
letter
from
counsel
for
San
Diego
addressed
to
the
attention
of
the
trustee,
the
trustee
was
put
on
notice
that
there
was
a
“very
real
possibility
that
there
will
be
no
surplus
after
payment
of
San
Diego’s
postproposal
creditors”.
The
significant
post-proposal
creditor
is
Her
Majesty
the
Queen.
As
a
result,
the
trustee
filed
an
ex-parte
notice
of
motion
on
February
7,
1994
for
an
order
that
the
proposal
be
annulled
pursuant
to
Section
63
of
the
Bankruptcy
and
Insolvency
Act.
On
June
29,
1994
the
Honourable
Chief
Justice
of
this
court
order
that
the
proposal
of
San
Diego
be
annulled
and
an
Assignment
into
Bankruptcy
made
as
of
the
date
of
the
order,
with
the
trustee
being
appointed
trustee
of
the
Estate
of
the
bankrupt.
The
Attorney
General
of
Canada,
representing
Her
Majesty
the
Queen,
seeks
orders
for
payment
to
Her
Majesty
the
Queen
of
funds
held
in
trust
by
the
trustee
in
Bankruptcy
of
San
Diego
Catering
Ltd.
Her
Majesty
the
Queen
seeks
payment
to
it
in
the
sum
of
$40,178.62,
pursuant
to
the
relevant
provisions
of
the
Income
Tax
Act
and
the
sum
of
$21,558.06,
pursuant
to
the
relevant
provisions
of
the
Bankruptcy
and
Insolvency
Act
and
the
Excise
Tax
Act.
As
of
November
18,
1994,
the
total
amount
held
in
trust
by
the
trustee,
pursuant
to
both
the
proposal
and
the
subsequent
bankruptcy
of
San
Diego,
was
$62,566.71.
Source
deductions
Counsel
for
the
trustee
in
bankruptcy,
Campbell,
Saunders
Ltd.
has
indicated
that
out
of
the
sum
of
$40,178.62,
$25,708.58
(the
trust
claims)
will
be
paid
in
full
as
required.
Counsel
submits,
however,
that
penalties
and
interest
under
the
Income
Tax
Act
are
not
payable
to
the
government
in
priority
over
other
creditors.
Counsel
cites
the
decision
of
the
Ontario
Court
of
Justice
in
Canadian
Asbestos
Service
Ltd.
v.
Bank
of
Montreal
(1993),
21
C.B.R.
(3d)
120,
in
support
of
the
proposition
that
the
deemed
trust
provision
in
the
Income
Tax
Act
relates
only
to
principal
and
does
not
apply
to
penalties
and
interest.
Counsel
refers
to
the
judgment
of
Chadwick
J.
at
page
123:
Subsection
227(4)
of
the
Income
Tax
Act
provides
that
every
person
who
deducts
or
withholds
any
amount
under
this
Act
shall
be
deemed
to
hold
the
amount
so
deducted
or
withheld
in
trust
for
Her
Majesty.
There
are
similar
provisions
in
both
the
Canada
Pension
Plan
and
the
Unemployment
Insurance
Act.
There
is
no
issue
that
the
Crown
is
entitled
to
100
per
cent
of
the
moneys
that
have
been
deducted
at
source.
The
dispute
arises
as
to
whether
they
are
entitled
to
rank
in
priority
over
other
creditors
for
both
the
penalty
and
interest.
The
penalty
and
interest
arises
as
a
result
of
the
failure
of
the
monitor/receiver-
manager
to
remit
source
deductions
in
the
time-frames
as
prescribed
in
the
various
Acts
and
regulations.
The
deemed
trust
provision
in
the
various
Acts
relates
to
the
principal
sums
only
and
does
not
apply
to
penalties
and
interest.
The
Crown
will
have
priority
with
reference
to
the
principal
amount
of
source
deduction
but
will
have
no
priority
with
reference
to
the.
claim
for
interest
and
penalty.
They
will
rank
with
the
other
creditors
for
those
claims.
I
accept
the
logic
of
the
Ontario
Court
of
Justice
as
applicable
to
this
case.
Goods
and
Services
Tax
A
requirement
to
pay
was
issued
to
the
solicitor
for
San
Diego
on
February
11,
1994.
Counsel
for
Her
Majesty
the
Queen
submits
the
G.S.T.
moneys
that
San
Diego
collected
were
at
the
time
of
collection
trust
moneys
and
never
formed
part
of
the
property
of
San
Diego.
Furthermore,
he
submits
upon
the
bankruptcy
of
San
Diego
an
amount
equal
to
the
G.S.T.
moneys
collected
continue
to
be
held
in
trust
for
Her
Majesty
the
Queen
and
form
no
part
of
the
estate
of
the
bankrupt.
It
is
the
position
of
counsel
for
Her
Majesty
the
Queen
that
the
affidavit
of
Lynda
Fielden
makes
it
clear
that
there
were
moneys
collected
at
the
material
times
in
relation
to
this
tax.
Counsel
for
Her
Majesty
the
Queen
relies
heavily
upon
the
relevant
provisions
of
the
Excise
Tax
Act
insofar
as
the
G.S.T.
is
concerned.
In
particular,
reliance
is
placed
upon
subsections
222(1),
222(3)
and
317(3).
Subsection
222(1):
Subject
to
subsection
(1.1)
where
a
person
collects
an
amount
as
or,
on
account
of
tax
under
Division
II,
the
person
shall,
for
all
purposes,
be
deemed
to
hold
the
amount
in
trust
for
Her
majesty
until
it
is
remitted
to
the
Receiver
General
or
withdrawn
under
subsection
(2).
Subsection
222(3):
In
the
event
of
any
liquidation,
assignment
or
receivership
of
or
by
a
person,
an
amount
equal
to
the
amount
deemed
under
subsection
(1)
to
be
held
in
trust
for
Her
Majesty
shall,
for
all
purposes,
be
deemed
to
be
separate
from
and
to
form
no
part
of
the
estate
in
liquidation,
assignment
or
receivership,
whether
or
not
that
amount
has
in
fact
been
kept
separate
and
apart
from
the
person’s
own
moneys
or
from
the
assets
of
the
estate.
Subsection
317(3):
Notwithstanding
any
other
provision
of
this
Part,
any
other
enactment
of
Canada
other
than
the
Bankruptcy
and
Insolvency
Act,
any
enactment
of
a
province
or
any
law,
where
the
Minister
has
knowledge
or
suspects
that
a
particular
person
is
or
will
become,
within
90
days,
liable
to
make
a
payment
(a)
to
a
tax
debtor,
or
(b)
to
a
secured
creditor
who
has
a
right
to
receive
the
payment
that,
but
for
a
security
interest
in
favour
of
the
secured
creditor,
would
be
payable
to
the
tax
debtor,
the
Minister
may,
by
a
letter
served
personally
or
by
registered
or
certified
mail,
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
or
the
secured
creditor
in
whole
or
in
part
to
the
Receiver
General
on
account
of
the
tax
debtor’s
liability
under
Division
V,
and
on
receipt
of
that
letter
by
the
particular
person,
the
amount
of
those
moneys
that
is
required
by
the
letter
to
be
paid
to
the
Receiver
General
shall,
notwithstanding
any
security
interest
in
those
moneys,
become
the
property
of
Her
Majesty
in
Right
of
Canada
and
shall
be
paid
to
the
Receiver
General
in
priority
to
any
such
security
interest.
Counsel
for
Her
Majesty
the
Queen
submits
that
a
reading
of
these
provisions
makes
it
clear
that
with
regard
to
the
liability
to
pay
the
G.S.T.,
the
Bankruptcy
and
Insolvency
Act
is
inapplicable
as
the
moneys
in
question
were
obtained
from
the
sale
of
the
remaining
assets
of
San
Diego
and
never
became
property
of
San
Diego
under
the
Bankruptcy
and
Insolvency
Act,
rather
they
were
held
in
trust
for
Her
Majesty
the
Queen.
At
the
time
of
the
sale
of
the
operating
assets
of
San
Diego,
San
Diego
was
not
in
default
of
the
terms
of
the
proposal.
Her
Majesty
the
Queen
therefore
submits
that
the
order
annulling
the
proposal
is
without
prejudice
to
the
validity
of
the
sale
of
the
operating
assets,
and
the
particular
under
takings
and
provisions
pertaining
to
that
sale.
This
submission
is
based
on
subsection
63(2)
of
the
Bankruptcy
and
Insolvency
Act,
which
provides:
An
Order
made
Subsection
(1)
shall
be
made
without
prejudice
to
the
validity
of
any
sale,
disposition
or
property
or
payment
duly
made,
or
any
thing
duly
done
under
or
in
pursuance
of
the
proposal
and
notwithstanding
the
annulment
of
the
proposal,
a
guarantee
given
pursuant
to
the
proposal
remains
in
full
force
and
effect
in
accordance
with
its
terms.
Counsel
for
the
trustee
submits
that
Mr.
Justice
Thackray,
in
the
case
of
Canoe
Cove
Manufacturing
Ltd.
Re,,
[1994]
6
W.W.R.
598
held
that
a
requirement
to
pay
will
constitute
a
transfer
of
whatever
property
interest
the
debtor
taxpayer
has
in
those
funds.
In
other
words,
the
requirement
to
pay
operates
as
a
garnishing
order.
(Canada
Trustco
Mortgage
Corp.
v.
Port
O’Call
Hotel
Inc.
(1994),
24
C.B.R.
(3d)
257
(Alta.C.A.).
Counsel
for
the
trustee
submits
the
priority
to
be
afforded
G.S.T.
payments
is
set
out
in
the
Bankruptcy
and
Insolvency
Act
and,
in
the
circumstances
here,
Her
Majesty
the
Queen
becomes
an
unsecured
creditor.
Counsel
for
the
trustee
further
submits
that
as
of
the
time
the
Requirement
to
Pay
was
served
on
Harper,
Grey,
Easton,
there
was
no
property
interest
in
those
funds
to
attach.
It
is
the
position
of
the
trustee
that
no
transfer
of
property
occurred.
The
moneys
forwarded
to
Harper,
Grey,
Easton
were
forwarded
on
undertaking
to
pay
certain
claims
and
no
money
was
stated
to
be
due
and
owing
to
the
taxpayer.
Therefore,
counsel
for
the
trustee
submits
that
the
priority
to
be
afforded
to
G.S.T.
is
set
out
in
the
Bankruptcy
and
Insolvency
Act
whereby
they
can
become
an
unsecured
creditor.
Counsel
for
the
trustee
also
responds
to
counsel
for
the
Crown’s
argument
that
a
solicitor’s
undertaking
constitutes
a
security
interest
under
the
Excise
Tax
Act.
Counsel
for
the
trustee
submits
that
based
on
Cordery’s
Law
Relating
to
Solicitors
and
the
literal
interpretation
of
the
relevant
sections
of
the
Excise
Tax
Act,
a
solicitor’s
undertaking
is
not
a
security
interest
nor
was
it
ever
contemplated
to
be
such
by
Parliament
when
it
enacted
the
Excise
Tax
Act.
Counsel
for
the
trustee
further
submits
that
in
the
alternative
any
payment
of
G.S.T.
as
a
result
of
service
of
the
Requirement
to
Pay
on
February
11,
1994,
would
constitute
a
fraudulent
preference.
Counsel
submits
that
it
is
a
reasonable
inference
to
draw
from
the
material
filed
that
the
Crown
was
encouraged
to
issue
the
Requirement
to
Pay
by
the
directors
of
San
Diego
for
the
purposes
of
preferring
them
over
other
creditors
of
San
Diego.
This
would
have
benefited
the
directors
of
the
company
who
would
otherwise
have
become
liable
for
G.S.T.
payments.
It
is
the
position
of
the
trustee
that
these
actions
constitute
a
fraudulent
preference
and
the
application
should
be
dismissed
on
those
grounds.
With
respect
to
counsel
for
the
trustee,
I
do
not
accept
those
submissions.
I
find
the
reasoning
in
Canoe
Cove,
supra,
to
be
applicable
in
the
case,
and
the
fact
that
the
proposal
had
been
entered
into
prior
to
bankruptcy
does
not
distinguish
it.
As
Thackray
J.
stated
at
page
606:
The
Attorney
General
further
noted
that
the
phrase
“property
of
the
bankrupt”
under
the
Bankruptcy
and
Insolvency
Act
has
been
found
to
include
property
subject
to
a
security
interest
irrespective
of
whether
legal
title
of
the
property
remains
in
the
bankrupt
or
is
transferred
to
the
security
holder.
And
at
page
608:
However,
in
my
opinion
the
position
of
the
Attorney
General
is
correct
in
that
the
Excise
Tax
Act
now
provides
for
an
explicit
transfer
of
property
from
the
“particular
person”
to
the
government
upon
receipt
of
a
“demand
letter”.
Therefore,
the
moneys
owing
were
no
longer
the
property
of
the
Bankrupt
at
the
time
of
the
bankruptcy
and
are
not
subject
to
the
Bankruptcy
and
Insolvency
Act’s
scheme
of
distribution.
The
trustee
submitted
that
Parliament
intended,
by
having
the
exclusion
to
the
Bankruptcy
and
Insolvency
Act
in
317(3)
of
the
Excise
Tax
Act,
that
the
Excise
Tax
Act
would
not
interfere
with
the
distribution
scheme
found
in
the
Bankruptcy
and
Insolvency
Act
upon
the
bankruptcy
of
a
tax
debtor.
In
my
opinion
317(3)
is
specifically
phrased
so
as
to
overcome
the
rights
of
a
secured
creditor
and
the
distribution
scheme
of
the
Bankruptcy
and
Insolvency
Act.
The
case
law
showed
confusion
over
the
exact
nature
of
the
government’s
interest
under
a
317(3)
claim
and
the
government
clarified
this
by
stating
it
was
a
transfer
of
property
to
the
government
upon
receipt
of
a
demand
letter.
The
Excise
Tax
Act
legislation
does
seem
harsh
to
the
extent
that
it
allows
the
government
to
usurp
a
secured
creditor’s
security
for
a
tax
debtor’s
previously
incurred
tax
liability.
However,
a
debtor
should
not
be
allowed
to
conduct
business
yet
remain
immune
from
the
normal
incidents
of
the
legal
process,
such
as
liability
for
the
Goods
and
Services
Tax.
To
the
extent
Revenue
Canada’s
claim
is
for
Goods
and
Services
Tax
incurred
through
ongoing
business
after
the
security
agreement
was
in
place,
this
legislation
does
not
seem
unjust.
The
bank,
as
a
secured
creditor,
should
not
be
entitled
to
any
more
than
the
tax
debtor
would
have
been
entitled
to
had
it
not
assigned
its
book
debts.
I
agree
with
Thackray
J.
that
while
the
Excise
Tax
Act
legislation
appears
harsh,
it
is
inconsistent
that
the
creditors
of
San
Diego
should
be
in
a
position
to
avoid
the
G.S.T.
tax
which
San
Diego
should
have
paid
at
the
time
it
actually
collected
such
tax,
particularly
when
the
relevant
legislation
says
that
if
those
moneys
are
not
available,
the
amount
should
be
taken
from
any
other
assets
of
the
bankrupt
estate.
Conclusion
For
the
reasons
stated,
supra,
I
find
that
the
Crown
has
priority
with
reference
to
the
$25,708.58
(source
deductions)
but
that
the
Crown
will
rank
with
other
creditors
with
reference
to
the
claim
for
interest
and
penalties.
I
order
that
the
sum
of
$25,708.58
be
paid
out
to
Her
Majesty
the
Queen
in
Right
of
Canada.
I
am
satisfied
upon
the
evidence
that
the
appropriate
amount
of
G.S.T.
funds
under
consideration
is
$21,558.06.1
also
order
that
the
sum
of
$21,558.06
in
G.S.T.
funds
currently
held
by
the
trustee
be
paid
out
to
Her
Majesty
the
Queen
in
Right
of
Canada.
Since
each
party
was
successful
on
one
of
the
issues,
each
should
bear
their
own
costs.
Since
I
have
found
the
funds
held
in
trust
did
not
form
part
of
the
“property
of
the
bankrupt’,
I
consider
there
is
no
risk
that
the
government’s
money
will
be
used
to
fund
the
trustee’s
portion
of
this
litigation.
Order
accordingly
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