Canada: The Supreme Court Of Canada Finds A Limit To The Scope Of The Requirement To Pay Under Section 224 ITA

Last Updated: July 26 2011
Article by Marc Lemieux

The Supreme Court of Canada rendered a much awaited judgment in the case of Canada Trustco Mortgage Co. v. R. on July 15, 2011.

In that case, a lawyer, Mr. McLeod, owed tax to the federal government.

Revenue Canada issued requirements to pay to Canada Trustco Mortgage Co. (theBank), in a branch of which Mr. McLeod maintained a trust account for the purposes of his legal practice. Mr. McLeod also maintained at the same branch of the Bank a joint account together with another person. The requirements to pay were issued pursuant to pursuant to section 224 of the Income Tax Act (ITA), which provides that the Minister of National Revenue (the Minister) may require a person who is, or will be within one year, liable to make payment to a tax debtor to instead pay the money the person owes the tax debtor to the Receiver General.

The case concerns cheques which Mr. McLeod drew on his trust account, made payable to himself, and deposited in the joint account, during the period of effectiveness of these requirements to pay.

The Bank credited the proceeds of the cheques to the joint account notwithstanding the requirements to pay. The Minister accordingly assessed the Bank pursuant to section 224 ITA. The Bank filed an objection which the Minister rejected. The Bank unsuccessfully appealed to the Tax Court of Canada, and thereafter to the Federal Court of Appeal.

In a divided decision, the Supreme Court of Canada allowed the Bank's appeal and overturned all decisions below.

The majority emphasized at the outset two important concessions made by the Minister. On the basis of existing and unchallenged case law interpreting section 224 ITA, it was acknowledged that the requirements to pay did not apply to funds on deposit in the trust account, nor to funds on deposit in the joint account.

It was also undisputed that the Bank was not indebted to Mr. McLeod by reason only of the fact that the cheques payable to Mr. McLeod were drawn on the Bank. Section 126 of the Bills of Exchange Act (BEA) provides that a billdoes not operate as an assignment of funds in the hands of the drawee available for the payment thereof, and the drawee of a bill who does not accept [i.e., certify] is not liable on the instrument.

It followed that the central question on appeal was whether the Bank had become indebted to Mr. McLeod in the course of the receipt of the cheques by the Bank for deposit to the joint account, and presentment of the cheques to itself for payment out of the funds in the trust account .

The Minister argued thatthe best way to view the receipt of the cheques for deposit is to break the transactions down in two steps: at the first, Mr. McLeod demanded to be paid as payee of the cheques and also demanded, as drawer, that the amounts be repaid out of the funds owed to him in relation to the trust account; at the second, he instructed [the Bank] to deposit the funds into the joint account. In other words, notional payments were made to Mr. McLeod before the funds were deposited into the joint account.

The majority rejected this argument. It noted that Mr. McLeod's instructions were to deposit the funds into the joint account, and that he did not demand that any payment be made to him as payee. In addition the record showed that the joint account was credited with the funds prior to the cheques being paid and funds being debited from the trust account. The Bank accordingly made no payment to Mr. McLeod prior to crediting the amounts of the cheques to the joint account.

The majority then considered the Bank's obligations as collecting bank. It found that the Bank collected the cheques on behalf of Mr. McLeod and Mr. Meier jointly, not of Mr. Mcleod alone, as the contract that imposes on the Bank the duty to collect the cheques is one between the Bank and the holders of the joint account. Consistent with section 126 BEA, the majority stressed that there is no contract between the Bank and Mr. McLeod as payee of the cheque. Finally, the majority considered the Bank's obligation to pay the cheques as drawee, which it foundis triggered only at the time the holder presents the cheque to the drawee for payment, consistent with section 86 BEA. At the time of presentment, Mr. McLeod was no longer the holder of the cheques. The Bank was, in the accomplishment of its collection duties on behalf of the joint account holders.

It followed that in the course of the receipt of the cheques by the Bank for deposit to the joint account, and presentment of the cheques to itself for payment out of the funds in the trust account, the Bank had not become indebted to Mr. McLeod.

While agreeing with the majority that[o]rdinarily, the bank on which a cheque is drawn (the drawee bank) is under no liability to pay the payee of a cheque, the dissenting justices found thatwhere the payee and the drawer are the same person [...], the [drawee] bank is liable to the payee once the cheque is presented [for deposit by the payee]. They also expressed the view that the cheques were payable to the Bank as agent of the payee.

These views do not sit well with established principles governing banking and bills of exchange law, and given the outcome they must now be considered to be without merit.

The dissenting justices were obviously influenced by the equities of the case and the fact that the requirement to pay was frustrated by cheques which the tax debtor wrote to himself. They expressed concerns that the view of joint accounts adopted by the majoritymay negatively impact other areas of the law:Child and spousal support ought not to be defeated by the mere existence of a joint account.

These dissenting remarks, as well as the majority's conclusions, send a strong message to federal and provincial legislators: the current scope of application of the requirement to pay under section 224 ITA and perhaps other comparable garnishment provisions in other areas of the law (including family law) is limited, and suffers from a loopholes which from a policy perspective it may be appropriate to remedy by a revision of the applicable statutes.

About Fraser Milner Casgrain LLP (FMC)

FMC is one of Canada's leading business and litigation law firms with more than 500 lawyers in six full-service offices located in the country's key business centres. We focus on providing outstanding service and value to our clients, and we strive to excel as a workplace of choice for our people. Regardless of where you choose to do business in Canada, our strong team of professionals possess knowledge and expertise on regional, national and cross-border matters. FMC's well-earned reputation for consistently delivering the highest quality legal services and counsel to our clients is complemented by an ongoing commitment to diversity and inclusion to broaden our insight and perspective on our clients' needs. Visit: www.fmc-law.com

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