Canada: Deemed Trust For Unremitted GST Primes Bank's Security Interest

On April 29, 2020, the Federal Court of Appeal (the "FCA") released their decision in The Toronto-Dominion Bank v Canada¹ ("TD v Canada"), in which the FCA concluded that a deemed trust in respect of unremitted goods and sales tax ("GST") pursuant to the Excise Tax Act² (the "ETA") primes a secured lender's security interest, outside of a bankruptcy or Companies' Creditors Arrangement Act³ (the "CCAA") proceeding. The FCA also concluded that a secured creditor who receives proceeds from a tax debtor's property, at a time where the tax debtor owes GST to the Crown, is required to pay the proceeds equalling the amount of the tax debt to the Crown.

In reaching this conclusion, the FCA considered three central issues: (1) whether the deemed trust requires a triggering event to cause the trust to crystallize around specific assets, (2) whether secured creditors can avail themselves of the bona fide purchaser for value defence, and (3) whether the Federal Court failed to consider that the security interests of The Toronto-Dominion Bank (the "Bank") were granted in connection with personal loans to Mr. Weisflock (the "Debtor"), and were not created and granted pursuant to a financing of the Debtor's business.

Background

The Debtor owned and operated a landscaping business as a sole proprietorship. Prior to obtaining a loan from the Bank, he failed to remit GST payments pursuant to the ETA to the Receiver General of Canada in the amount of $67,854. In 2010, two years after the Debtor had failed to remit those GST payments, the Bank extended a line of credit and a mortgage to the Debtor and his wife, both loans were secured against the couple's real property. At the time of advancing the loans, the Bank was unaware of any debts owed by the Debtor pursuant to the ETA. In 2011, the Debtor sold the real property and repaid the line of credit and the mortgage to the Bank. It is important to emphasize that the Bank did not enforce their security but rather that the loan was simply repaid. Subsequent to the sale of the property and the discharge of the Bank's mortgage, the Canada Revenue Agency (the "CRA") asserted a deemed trust claim under Section 222 of the ETA against the Bank on the basis that the proceeds the Bank had received from the sale of the property ought to have been paid to the Receiver General up to the amount deemed to be held in trust.

Overview of Section 222 of the Excise Tax Act

A deemed trust with respect to amounts that are collected as GST is created pursuant to Subsection 222(1) of the ETA:

222(1) Subject to subsection (1.1), every person who collects an amount as or on account of tax under Division II is deemed, for all purposes and despite any security interest in the amount, to hold the amount in trust for Her Majesty in right of Canada, separate and apart from the property of the person and from the property held by any secured creditor of the person that, but for a security interest, would be property of the person, until the amount is remitted to the Receiver General or withdrawn under subsection (2)⁴ [emphasis added].

Furthermore, Subsection 222(3) extends the deemed trust created under Subsection 222(1) to the property of the tax debtor and property of the tax debtor held by any secured creditor:

222(3) Despite any other provision of this Act (except subsection (4)), any other enactment of Canada (except the Bankruptcy and Insolvency Act), any enactment of a province or any other law, if at any time an amount deemed by subsection (2) to be held by a person in trust for Her Majesty is not remitted to the Receiver General or withdrawn in the manner and at the time provided under this Part, property of the person and property held by any secured creditor of the person that, but for a security interest, would be property of the person, equal in value to the amount so deemed to be held in trust, is deemed

(a) to be held, from the time the amount was collected by the person, in trust for Her Majesty, separate and apart from the property of the person, whether or not the property is subject to a security interest, and

(b) to form no part of the estate or property of the person from the time the amount was collected, whether or not the property has in fact been kept separate and apart from the estate or property of the person and whether or not the property is subject to a security interest

and is property beneficially owned by Her Majesty in right of Canada despite any security interest in the property or in the proceeds thereof and the proceeds of the property shall be paid to the Receiver General in priority to all security interests⁵ [emphasis added].

In light of the provisions of the ETA, which were in place at the time the Debtor failed to remit GST payments to the Receiver General and when the Bank lent the money to the Debtor and took its security interest, the FCA concluded that the Debtor's property, to the extent of the GST payments, was already deemed to be beneficially owned by the Crown. Therefore, when the Debtor's property was sold, by operation of Subsection 222(3) of the ETA, the Bank was under a statutory obligation to remit the proceeds it had received to the Crown.

Deemed Trust Triggering Event

The Bank acknowledged that the deemed trust provisions granted an absolute priority to the Crown, but argued that the Federal Court had erred in finding that the deemed trust did not require a triggering event to crystallize around the assets. The Bank submitted that a triggering event, such as bankruptcy or the initiation of proceedings by the Crown, is necessary for the deemed trust to crystallize.

In considering this argument, the FCA found that the operation of the deemed trust does not require a triggering event to have occurred and that the property is deemed to be held in trust at the moment GST is collected and not remitted. Any argument by the Bank as to the need for a triggering event was further challenged by the fact that the deemed trust language in the ETA had previously included triggering events such as liquidation, assignment and bankruptcy, but such language had been specifically removed as a result of amendments.

Bona Fide Purchaser for Value Defence

The bona fide purchaser for value defence allows the a third-party purchaser to obtain the assets free and clear of any pre-existing equitable proprietary rights, and the Bank submitted that it had received the assets of the Debtor as a bona fide purchaser. However, the FCA rejected this argument, citing various cases that note that lenders are not comparable to third-party purchasers. Therefore, secured creditors and the property over which they assert their security interest continue to be subject to the deemed trust and remain so at the time of the sale of encumbered assets.

Financing of Debtor's Business vs. Personal Home

The Bank's final argument on appeal was that the Federal Court should have distinguished between the Debtor carrying on business as a sole proprietorship and the Debtor transacting in his personal capacity, given that this was a personal line of credit and mortgage rather than financing for the Debtor's business. However, the FCA noted that Subsection 222(1) of the ETA clearly states that "every person who collects an amount as or on account of GST is deemed to hold the amount in trust for Her Majesty". As the Bank was aware that the Debtor was a sole proprietor, it would have been aware that he had an obligation to collect amounts as or on account of GST and to remit those amounts to the Crown.

Conclusion

In TD v Canada, the FCA confirmed that deemed trusts for unremitted GST are operative against secured creditors, including where there is a voluntary repayment of secured loans. In reaching this decision, the FCA found that a proprietary right is automatically created in favour of the Crown at the time the GST is collected and unremitted without any further action by the Crown. In reaching this conclusion, the FCA also seemed to find that secured creditors have a duty, and are in a position, to determine if any arrears of GST are owing to the Crown prior to applying the funds to the repayment of their loan. In light of this decision, lenders should manage their risk by performing proper due diligence on their borrowers, including requiring borrowers to give evidence of tax compliance or requiring borrowers to provide authorization to allow the lender to verify with the CRA whether there are outstanding GST liabilities owing.

However, it's important to note that the ruling in TD v Canada still does not apply in the context of a bankruptcy or a CCAA proceeding. In 2018, the Supreme Court of Canada (the "SCC") held in Callidus Capital Corporation v Canada⁶ ("Callidus") that, as at the date of a tax debtor's bankruptcy, deemed trusts in respect of GST and HST become ineffective against a secured creditor who received, prior to that date, proceeds from the tax debtor's assets that were deemed to be held in trust for the Crown. The SCC's Callidus decision re-established the principle that the priority in favour of the Crown is reversed in a bankruptcy or a CCAA proceeding.

Footnotes

1. Toronto-Dominion Bank v Canada, 2020 FCA 80.

2. Excise Tax Act, R.S.C., 1985, c. E-15.

3. Companies' Creditors Arrangement Act, R.S.C., 1985, C. C-36.

4. Supra note 2 at s. 222(1).

5. Ibid at s. 222(3).

6. Callidus Capital Corporation v Canada, 2018 SCC 47.

Originally published May 14, 2020

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