In Toronto-Dominion Bank v Canada,1 the Federal Court of Appeal (FCA) upheld the Federal Court’s decision2 that the Toronto-Dominion Bank (TD) was required to pay to the Canada Revenue Agency (CRA) proceeds of $67,854 for unremitted GST that TD received as repayment from a borrower upon the discharge of a TD mortgage.
The FCA’s decision confirms that amounts paid to a secured creditor from a debtor with an outstanding Goods and Services Tax/Harmonized Sales Tax (GST/HST) liability are deemed to be held in trust for the CRA. Outside of certain types of insolvency proceedings and prescribed security interests, the CRA’s deemed trust rights rank in priority to secured creditors.
What you need to know
- Secured creditors may be liable to repay the CRA amounts received from a borrower with an outstanding GST/HST liability.
- Secured creditors’ priority is subordinate to the CRA, even if the security was registered before the GST/HST debt arises and the secured creditor had no knowledge of the GST/HST debt.
- The CRA may enforce its super priority interest without prior notice to the secured creditor.
- There are limited exceptions to this super priority, including certain types of insolvency proceedings and prescribed security interest (e.g., conventional mortgages) registered prior to the section 222 deemed trust.
In 2010, TD granted a customer, Mr. Weisflock (the Borrower), a mortgage and a home equity line of credit, both of which were secured against a property owned by the Borrower (the Property). TD was not aware that in 2007 and 2008, the Borrower had collected GST in the amount of $67,854 as a sole proprietor operating a landscaping business, but had failed to remit this amount. In 2011, the Borrower sold the Property and used the proceeds to repay TD in full, clearing the outstanding mortgage and line of credit.
The CRA subsequently issued a demand letter to TD demanding a portion of the proceeds to satisfy the GST debt. No prior notice had been provided to TD regarding any existing lien over the Borrower’s property. Upon TD’s refusal to pay the amount, the Crown commenced legal action in 2015. The Crown’s position was that the proceeds received by TD on the repayment of the mortgage and line of credit were subject to a deemed trust in favour of the Crown, pursuant to section 222 of the Excise Tax Act (ETA).
The Federal Court decision
The Federal Court held that TD was liable to pay to the CRA the amount of $67,854 plus interest on account of the Borrower’s outstanding GST debt. In arriving at this conclusion, the Federal Court found that the amounts paid by the Borrower to TD were subject to the deemed trust provisions in section 222 of the ETA.
Subsection 222(1) provides that a person who collects GST/HST is deemed to hold those funds in trust for the Crown, “despite any security interest that may be registered against that amount.” Section 222 applies to any GST/HST amounts collected by a tax debtor, whether or not such collection is required by law. The deemed trust extends to all property of the tax debtor, including property or proceeds held by a secured creditor. It therefore imposes an obligation on secured creditors to remit amounts received from the tax debtor to the Crown.
The Federal Court ultimately concluded that the Crown was entitled to super priority over TD in respect of the Borrower’s property, as was clearly intended by Parliament. Pursuant to subsection 222(3) of the ETA, which extends the deemed trust to property of the tax debtor that is held by a secured creditor, TD had the obligation to remit to the CRA the portion of the proceeds it had received to satisfy the Borrower’s GST debt despite not having had any knowledge of such debt.
The FCA decision
The FCA upheld the Federal Court’s ruling that when the Borrower collected GST, he was deemed to hold such amounts in trust for the Crown. When the Borrower failed to remit those amounts, his property was deemed to be held in trust and beneficially owned by the Crown, regardless of other non-prescribed security interests. TD was under a statutory obligation to remit the proceeds it received from the Borrower as a result of this deemed trust and its super priority over secured creditors.
The FCA considered the arguments that TD had advanced before the Federal Court and reiterated on appeal. TD took the position that there was no triggering or crystallizing event that brought the deemed trust into operation, such as the exercise of enforcement rights or bankruptcy remedies by creditors. The FCA upheld the Federal Court’s finding that no triggering event was required and that the deemed trust operates in a continuous manner once GST is collected but not remitted.
TD also took the position that it was a good faith bona fide purchaser for value, which is the defence that when a third party purchases property without knowledge of an existing interest in that property, the existing interest is defeated. The FCA held that it would be incompatible with the ETA if this defence was available to TD or other secured creditors, given that it would defeat the purpose of the deemed trust which is to ensure the recovery of unremitted GST/HST in priority to other debts. The FCA further pointed out the case law has drawn a sharp distinction between secured creditors and bona fide purchasers for value, such that the two categories are mutually exclusive. Interestingly, the Federal Court had held that this defence would remain available to unsecured creditors such as suppliers, landlords or public utilities.
The FCA also rejected TD’s argument that there should be a distinction between the Borrower’s collection of GST as a sole proprietorship and the Borrower’s transactions with TD in his personal capacity. The FCA found that there is no basis for such a distinction, stating that the Borrower was both TD’s customer and the person who had collected the GST and was obliged to remit the amount to the Crown.
Finally, the FCA considered the following policy arguments advanced by TD, pointing out the absurdity of the Federal Court’s interpretation of the deemed trust provisions:
- Such a broad interpretation requires a secured creditor to continuously confirm with the CRA that all deemed trust amounts have been paid by a borrower;
- This interpretation puts secured creditors in a worse position than unsecured creditors, given that it imposes upon secured creditors the liability to pay unremitted GST amounts to the Crown while unsecured creditors do not have the same obligation; and
- This interpretation promotes liquidation and bankruptcy over restructuring alternatives.
The FCA stated Parliament had made a considered choice to prioritize the protection of a significant portion of the government’s tax revenues over the interests of secured creditors. The FCA held that Parliament had already considered the potential harshness of this choice by providing a remedy under subsection 222(4), which carves out an exception for “prescribed security interests” from the deemed trust rules. Pursuant to this carve-out, mortgages registered before the borrower’s failure to remit GST/HST retain priority over the Crown’s deemed trust. However, in the present case, TD’s security interest had come about after the Borrower’s tax debt had already arisen.
Importantly, the FCA found that the potential harshness of the deemed trust rules is also tempered by the fact that the Crown’s deemed trust rights are eliminated in cases of bankruptcy of the tax debtor under the Bankruptcy and Insolvency Act (BIA) and arrangements under the Companies’ Creditors Arrangement Act (CCAA). The Supreme Court of Canada confirmed in its decision in Callidus Capital Corporation v Canada3 that a secured creditor is not liable to repay proceeds received from a borrower prior to the borrower’s bankruptcy. Given that the Borrower in the present case did not become bankrupt, the FCA held that the deemed trust applied, and TD was required to pay to the Crown the sum of $67,854 plus interest.
Secured creditors may need to revisit their lending practices to protect against the CRA’s super priority. The FCA’s decision confirmed that the deemed trust operates without any notice or triggering event, and without providing any sort of due diligence or bona fide purchaser defence to the prudent creditor.
Secured creditors can best protect themselves from unanticipated CRA demands by reviewing and revising their current risk management practices; both at the due diligence stage when vetting new borrowers and through the lifetime of any secured credit facility. The Federal Court of Appeal has suggested this could include practices such as:
- Identifying higher risk borrowers, such as personal borrowers who operate sole proprietors;
- Requiring borrowers to give evidence of tax compliance; or
- Requiring borrowers to authorize the lender to verify a borrower’s outstanding GST liabilities with the CRA on an ongoing basis.
Please feel free to contact our commodity tax group or our insolvency and restructuring group with any questions you may have about how this decision affects your business.
The authors wish to thank Charlotte Chien for her assistance with this article.
1 2020 FCA 80.
2 2018 FC 538.
3 2018 SCC 47