TAX AUTHORITIES, SET-OFF/COMPENSATION AND ENFORCEMENT MEASURES IN AN INSOLVENCY CONTEXT REGARDING GST AND QST

March 29th, 2017

Good news for companies undergoing restructuring

ANTOINE LEDUC, Ad. E., Partner, Lawyer and PIERRE-MARC LEMIRE, Lawyer | Montreal

Indeed, in Arrangement relatif à Métaux Kitco inc., 2017 QCCA 268, the Quebec Court of Appeal confirms that the tax authorities cannot compensate notices of assessment issued prior to the application of the Company’s Creditors Arrangement Act ("CCAA") with tax credits (GST and QST) owed to the debtor arising from transactions that occurred after the beginning of the insolvency proceedings.

In this case, the tax authorities are claiming repayment of sales tax credits that Métaux Kitco inc. ("Kitco") would have fraudulently collected prior to the commencement of the insolvency proceedings ($313 millions), which is contested by Kitco.

Kitco continues its operations after the filing of the insolvency proceedings and, accordingly, claims sales tax credits ($1.8 million), which are not contested by the tax authorities, but for which they oppose compensation due to the contested tax debt, which is the subject of the dispute between the parties. At trial, the Superior Court (Métaux Kitco Inc. (Syndic de), 2016 QCCS 444) concludes that the tax authorities cannot set off the contested tax debt and the uncontested credits, because the conditions required in order to operate compensation are not met (i.e. the two debts are not related, certain, liquid, exigible and prior to the insolvency proceedings).

For the Court of Appeal, [translation] "the terms of the CCAA, as interpreted by the case law, do not allow compensation between the contentious tax debt born prior to the insolvency proceedings and the debt for uncontested credits, born after these proceedings."

This ruling clarifies when compensation occurs, in confirming that it is on the day of the opening of the insolvency proceedings that the temporal reciprocity between the claims is established.

However, contrary to the first instance judgment, the Court of Appeal did not rule on the issue of defeating the presumptions of exigibility and validity of tax laws regarding GST and QST.

Nevertheless, the current state of the law is that these presumptions are inapplicable in an insolvency context, because they are contrary to the principle of equality of creditors. It remains to be seen whether the case will be brought before the Supreme Court of Canada.

In practice, these decisions bring latitude to any company challenging the tax authorities with regards to sales tax by allowing it to continue its operations and maintain the status quo during the restructuring.

They also benefit secured creditors who do not see their claims diminished by enforcement measures undertaken by the fisc or its compensation rights.

**For information regarding your rights and remedies for insolvency and restructuring matters, do not hesitate to contact the lawyer in charge of your mandates at BCF or our insolvency and restructuring specialists. **