Canada: The New Version Of The State´s Deemed Trust Provisions

Last Updated: July 25 2001
Article by Valerie Beaudin

Whether or not you are a lawyer, the "deemed trust" provisions are difficult to grasp. What do they refer to? What are their purpose? Who are their beneficiaries? To put it simply, a deemed trust is a fiction of law which the legislator has created in favour of the State to allow it to collect, in priority to other creditors, fiscal debts which have not been remitted by a tax debtor.

For several years, the Income Tax Act (federal) ("ITA") and the Act respecting the Ministère du Revenu (provincial) ("AMR") have stated that a tax debtor (for example, an employer) who withholds deductions at source from his employees' pay cheques (the "DAS"), holds those amounts in trust for the tax authorities, separate and apart from his own property, hence the expression "deemed trust".

Until 1997, Revenue Canada and Revenue Québec benefited from a priority over secured creditors for the payment of unremitted DAS under the deemed trusts provisions contained in the ITA and the AMR. However, in 1997, the Supreme Court of Canada, in the case of Sparrow, held that the wording of the ITA was not clear enough to give Revenue Canada the priority it thought it had, particularly with respect to the rights of banks and their security. As a result, significant changes were made to the ITA and the Bankruptcy and Insolvency Act ( "BIA") in 1998. The deemed trust provisions under the ITA were "improved", and it is now often referred to as the State's "super priority".

Legislative Amendments To The ITA And The BIA

With respect to the changes made to the ITA, the provisions now state that when DAS are not remitted, the property of the tax debtor equal in value to the amount of the unremitted DAS is deemed to be held in trust, separate and apart from the property of the tax debtor. That property is beneficially owned by the State notwithstanding any other security interest held by a third party in such property and in the proceeds thereof, and the proceeds of such property is paid to the Receiver General in priority to such a security interest. The definition is very general, which indicates that the State's claim for unpaid DAS takes precedence over the rights of all creditors, even secured creditors, subject, however, to some exceptions contained in the ITA and the Income Tax Regulations ("ITR") discussed below.

The new provisions are retroactive to June 15, 1994, the date of the last amendments to the ITA. According to Revenue Canada, the reason for making them retroactive is to prevent files settled between June 15, 1994 and February 27, 1997, on the basis of the prior claim the State thought it held, from being the object of an action in restitution on the part of secured creditors who have paid significant amounts to Revenue Canada. Revenue Canada will potentially apply the new provisions retroactively if the proceeds of sale of the employer's property was paid to secured creditors after April 7, 1997, the date the amendments were made public by the Minister of Finance.

Scope Of The Deemed Trust Provisions

It is important to note that claims which are covered by the super priority are limited, on the federal level, to DAS not remitted by the employer and to certain amounts due under the Canada Pension Plan and the Employment Insurance Act. On the provincial level, and in the case of bankruptcy only, the super priority covers DAS for provincial tax and contributions to the Régie des rentes du Québec. Although the first version of the amendments were to include the payment of the GST in the State's super priority, the GST is not yet covered by it.

Exceptions To The State's Super Priority

As mentioned above, ALL the tax debtor's property is covered by this super priority, with the following three exceptions:

  • the goods of unpaid supplies in the case of bankruptcy because these goods are already the object of a specific priority;
  • property which is excluded by regulation (land and buildings); and
  • sheriff's and bailiff's fees, in order to guarantee payment of their costs if they are given a mandate to liquidate the property.

The most complex part of the new legislative provisions stems from the second exception mentioned above which deals with property excluded by regulation. This regulation, dated August 18, 1999 but retroactive to June 15, 1994, excludes from the super priority land or buildings on which a secured creditor has a security interest, provided such security interest was registered before the DAS were deducted, i.e. before the deemed trust was created. At first, this seems to imply that the State cannot pretend to have a prior claim to the proceeds of sale of an immoveable given as security under a loan or advance of credit if that security interest was registered before the problems with the DAS started. However, the State made sure to impose limitations to this exception for immoveables so that it would be able to participate in the proceeds of sale of such immoveables.

Since January 1, 2000, two limitations apply to the exception which relates to immoveables. Firstly, if the secured creditor holds other secured interests besides the immoveable hypothec granted by the tax debtor, the actual value of such other secured interests, or the value estimated by the State in the event it is not sold, will reduce the value of the charge on the immoveable by as much. The law thus requires secured creditors with multiple security to first exhaust the secured interests which will leave the State's charge intact. The second limitation to the exception is that if the secured creditor authorizes additional credit which is guaranteed by an immoveable hypothec, such as, for example, a revolving line of credit, any withdrawal from that line of credit after January 1, 2000 will be subject to any deemed trust created after registration of the immoveable security. Accordingly, as of January 1, 2000, advances granted after a failure to remit DAS will be subject to the State's deemed trust provisions.


The new deemed trust provisions are extremely complex and vague, especially with respect to the limitations to the exception involving charges on immoveables. The new limitations imply that lenders will have to tighten up their methods for auditing and controlling their debtors in the future with regard to remitting DAS to the tax authorities, failing which secured creditors could see their moveable and even immoveable security substantially eroded by claims of the State. These new provisions involving deemed trusts are sure to generate interesting cases before the courts. Do not hesitate to contact us. As experienced professionals in the field, we can advise you on all aspects of your business.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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