Erna A. Davis, Trustee of the Estate of Donald Martin McLeod, a Bankrupt v. Minister of National Revenue, [1991] 2 CTC 2648, 92 DTC 1033

Sobier, T.C.J.: —The appellant appeals from the assessment of the respondent for the 1987 taxation year whereby the respondent included in the appellant's 1987 income amounts paid to secured creditors of Mr. McLeod, a bankrupt, pursuant to assignments of income averaging annuity contracts ("I.A.A.C.s").

An agreed statement of facts was filed and is set out below.

AGREED STATEMENT OF FACTS

1. The appellant is the Trustee of the Estate of Donald Martin McLeod, a bankrupt. Donald Martin McLeod made an Assignment into Bankruptcy on January 29, 1986.

2. At the time of bankruptcy, Donald Martin McLeod held four (4) income averaging annuity contracts (I.A.A.C.'s). Copies of these four (4) I.A.A.C.'s are attached hereto as Schedules 1 through 4 [not reproduced]. Payments under these I.A.A.C.'s were being received by the Bank of Nova Scotia pursuant to specific assignments granted by Donald Martin McLeod in favour of the bank in 1979 and 1983. Copies of these assignments are attached hereto as Schedules 5 through 8 [not reproduced].

3. At the time of the bankruptcy the amount owing to the Bank of Nova Scotia was $13,140.08. Upon receipt of this amount as a result of continuing to receive the payments pursuant to the I.A.A.C.'s, the Bank of Nova Scotia was fully paid off at some point in 1987 and the bank released its interest in the I.A.A.C.'s.

4. A further assignment of the I.A.A.C. payments was made by Donald Martin McLeod on October 23, 1981 in favour of Charles Leslie Abrahams. A copy of the Assignment is attached hereto as Schedule 9 [not reproduced]. The remainder of the I.A.C.C.'s payments for 1987 were paid to Abrahams. Abrahams was fully paid off in May 1988 and all subsequent I.A.A.C/s payments were made to the appellant.

5. The appellant prepared and filed a 1987 "in Bankruptcy" Tax Return pursuant to paragraph 128(2)(e) of The Income Tax Act without including in income any of the payments made pursuant to the I.A.A.C/s to either the Bank of Nova Scotia or to Charles Leslie Abrahams. Throughout 1987, the annuity companies prepared and issued T4A supplementaries in the name of Donald Martin McLeod.

6. The appellant was assessed by the respondent on August 2, 1988 to include in income all I.A.A.C/s payments made to the Bank of Nova Scotia and Charles Leslie Abrahams. A Notice of Objection to the August 2, 1988 assessment was filed by the appellant on August 29, 1988. Notification of Confirmation of Assessment was issued by Revenue Canada, Taxation on August 31, 1990.

At issue is whether the tax is properly payable by the estate of the bankrupt or by the bankrupt himself.

In order to be payable by the estate through the trustee, the income must be such that the trustee is required to file a tax return in respect of such income. The applicable provisions of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") are paragraphs 128(2)(c) [1] and 128(2)(e) [2] .

Subsection 128(3) states that for the purposes of section 128 “bankrupt” and “estate of the bankrupt” have the meanings assigned by the Bankruptcy Act. Unfortunately, the term “estate of the bankrupt" is not defined in the Bankruptcy Act. The term is used to refer to the property of the bankrupt which is subject to administration by the trustee.

Did the I.A.A.C.s or their proceeds form part of the estate of the bankrupt or put another way were they subject to administration by the trustee?

Although the "estate of the bankrupt" is not defined, the Bankruptcy Act does provide a definition of "property" [3] or "property of a bankrupt" [4] .

Prior to his bankruptcy, the I.A.A.C.s had been assigned by the bankrupt to the Bank of Nova Scotia and Charles Leslie Abrahams (the "secured creditors"). Therefore, at the time of his bankruptcy the bankrupt was unable to deal with the I.A.A.C.s except as may have been permitted by the secured creditors. The bankrupt had no control over the I.A.A.C.s and was unable to deal with them until the interests of the secured creditors had been extinguished.

It is trite law that a trustee in bankruptcy has no greater rights than the bankrupt. What the trustee may deal with are those assets which come into his hands and are available for distribution among the unsecured creditors. Therefore the trustee could do nothing more with respect to the I.A.A.C.s than could the bankrupt.

Notwithstanding the assignments to the secured creditors, the bankrupt did have an interest in the I.A.A.C.s and this interest formed part of the property of the bankrupt and accordingly was vested in the trustee. However, this interest was in the nature of an equity of redemption which did not permit the bankrupt and therefore the trustee to deal with the I.A.A.C.s or their proceeds except in accordance with the assignments.

In order for the trustee to be liable for payment of the tax under paragraph 128(2)(e), the income had to arise from dealings in the estate. Since the trustee was unable to control or deal with the proceeds of the I.A.A.C.s until the interests of the secured creditors had ended, the income could not be said to have arisen from dealings in the bankrupt's estate. By virtue of the assignments, all dealings were of a contractual nature outside of the estate.

The right of the trustee to call in and inspect the property of the bankrupt in order to make an inventory of the same is not the same as being engaged in dealings with the estate.

For the same reasons, there were no dealings in the estate by the annuity issuers or the secured creditors. They were not dealing with the bankrupt's property interest in the I.A.A.C.s.

Accordingly, the trustee was not required to report as income in 1987 payments under the I.A.A.C.s received by the Bank of Nova Scotia or Charles Leslie Abrahams. For the above reasons, the appeal is allowed, with costs, and the assessment referred back to the respondent for reconsideration and reassessment on the basis that the income from the I.A.A.C.s should not be included in the appellant’s income for the 1987 taxation year.

Appeal allowed.