Canada: The Bloom Lake Decision: Restricting The Tax Authorities' Use Of Set-Off In The Context Of CCAA Proceedings

On November 8, 2021, the Superior Court of Québec (Commercial Division) (the "Court") delivered its judgment in the Bloom Lake case. Justice Michel A. Pinsonnault held that GST and QST input tax credits/refunds ("ITCs/ITRs") claimed by a petitioner in connection with damage payments arising from agreements disclaimed in the course of proceedings under the Companies' Creditors Arrangement Act ("CCAA") were post-filing claims ("post-filing claims" are claims against CCAA petitioners arising after the "filing date", i.e. the date of the issuance of an Initial Order pursuant to the CCAA). This decision comes in the wake of the Court of Appeal's decision in Kitco that the tax authorities were not entitled to set-off a pre-filing tax debt against post-filing ITCs/ITRs in the context of restructuring proceedings under the CCAA.

• The Court did not allow the Agence du revenu du Québec (also acting on behalf of the Canada Revenue Agency in the proceedings; collectively, the "Tax Authorities") to set off a tax debt that predated the filing of the CCAA liquidation proceedings against the ITCs/ITRs that had been "earned" subsequent to the filing of the proceedings, during a period in which the taxpayer was under CCAA protection.
• The Court found that the unambiguous wording of subsection 182(1) of the Excise Tax Act ("ETA") and section 318 of the Act respecting the Québec sales tax ("QSTA") was dispositive of the issue. The petitioner's right to claim the ITCs/ITRs only arose once the GST and QST were deemed to have been paid on the damage payments, which was during the post-filing period.
• Citing the Supreme Court of Canada's decision in 9354-9186 Québec Inc. v. Callidus Capital Corp., the Court rejected the Tax Authorities' argument to the effect that the principle in Kitco only applies to CCAA restructuring proceedings, as opposed to CCAA liquidation proceedings. The Court concluded that nothing in the CCAA or case law justifies subjecting CCAA restructuring proceedings and CCAA liquidation proceedings to separate sets of rules.

Background

On January 27, 2015 (the "Filing Date"), CCAA proceedings were initiated in respect of Cliffs Quebec Iron Mining ULC ("CQIM") and other affiliated companies (collectively, the "CCAA Parties"), which operated the Bloom Lake mine in Fermont, Québec. On June 29, 2018, Justice Stephen W. Hamilton sanctioned a plan of arrangement to wind down the estates of the CCAA Parties such that net proceeds could be distributed to their creditors (the "Plan of Arrangement").

In implementing the Plan of Arrangement, FTI Consulting Canada Inc., in its capacity as court-appointed monitor (the "Monitor"), commenced the first interim distributions to unsecured creditors. Accordingly, on August 16, 2018, four of CQIM's creditors received partial damage payments from CQIM as a result of the latter's having resiliated or disclaimed certain of its contracts by virtue of section 32 CCAA.

Pursuant to specific deeming rules in subsection 182(1) ETA and section 318 QSTA, the damage payments were deemed to be consideration for a taxable supply and GST and QST were also deemed to be included and paid by CQIM on those payments. CQIM was therefore in a position to claim corresponding ITCs/ITRs to recover such GST and QST deemed to be included as part of the damage payments. In this respect, CQIM claimed a total amount of $7,459,258 in its GST and QST returns for the period ending November 30, 2018 (the "ITC/ITR Claim").

As the Tax Authorities already had large pre-filing claims for an aggregate amount of $13,392,753 in the context of the CCAA proceedings (the "Pre-Filing Claims"), they sought to offset the ITC/ITR Claim with the Pre-Filing Claims. The Pre-Filing Claims were notably based on unpaid GST and QST on taxable supply of goods and services received by CQIM prior to the Filing Date and which remained unpaid as at the Filing Date. Had the position of the Tax Authorities been correct, they would not have had to disburse $7.5M to the Monitor for the ITC/ITR Claim, as the ITC/ITR Claim could then have been satisfied by reducing the Pre-Filing Claims by an equivalent amount.

The Monitor challenged the validity of this "set-off/compensation" mechanism on the basis that the ITC/ITR Claim is a post-filing claim that cannot be set-off against a pre-filing claim and filed a motion with the Court. 

Analysis

In its decision, the Court agreed with the Monitor and CQIM that the ITC/ITR Claim is a post-filing claim that may not be set-off against the Pre-Filing Claims (which were undisputed).

The Court relied on the unambiguous wording found in both subsection 182(1) ETA and section 318 QSTA, which it found to be dispositive of the issue. Indeed, the wording makes it clear that GST and QST are deemed paid on certain types of payments, such as the partial damage payments, at the time of payment, which in this case, was during the first interim distributions of August 2018.

It follows that CQIM rightfully made the ITC/ITR Claim in its GST and QST returns filed for a reporting period after the partial damage payments were made (Callidus). The right to make the ITC/ITR Claim only arose when the relevant sales tax provisions deemed GST and QST to be due, which was upon the payment of the first interim distributions, more than three years after the Filing Date. In the Court's view, CQIM had no right to make the ITC/ITR Claim at any time before the first interim distributions.

Finally, the Court found that there was no valid reason to allow for a so-called pre/post set-off or compensation. In so concluding, the Court relied on the Kitco decision, which stands for the general proposition that a post-filing claim cannot be compensated or offset with a pre-filing claim. It disagreed with the Tax Authorities' position to the effect that the principle in Kitco only applies to restructuring proceedings under the CCAA as opposed to liquidation proceedings. Nothing in the CCAA or case law suggests that CCAA proceedings which involve a sale of assets, as in the present case, should be subject to a different set of rules than those which contemplate the restructuring of an insolvent company intending to carry on its operations, as was the case in Kitco.

The court consequently ordered the Tax Authorities to pay, without set-off or compensation of any kind, the ITC/ITR Claim in the amount of $7.5M with applicable interest.

Conclusion

In the context of insolvency proceedings, petitioners often disclaim contracts and leases (notably, pursuant to section 32 CCAA). The Bloom Lake decision is therefore significant inasmuch as it characterizes ITC/ITR claims relating to damage payments for agreements disclaimed in the course of insolvency proceedings as being post-filing in nature due to the effect of subsection 182(1) ETA and section 318 QSTA. Moreover, it confirms that the well-established principle in Kitco extends to both restructuring and liquidation proceedings under the CCAA, thereby greatly limiting the scope of the set-off or compensation mechanism that the tax authorities regularly employ.

The author would like to acknowledge the support and assistance of Alexandra Fedor, articling student at law.

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