Courts and lawmakers often refer to Canada Revenue Agency ("CRA") as an involuntary creditor when businesses fail to make required tax payments to the governmental authority. The timely collection of taxes and payroll deductions also plays a fundamental role in the financing of government. Accordingly, federal statutes give CRA significant and powerful status, rights and remedies to assist in collecting amounts owing from tax debtors. CRA can in many cases claim priority over the property of the tax debtor against other creditors. Lenders, trustees in bankruptcy, other creditors and their respective lawyers require an understanding of CRA priority rights to effectively manage an insolvency, security enforcement or debt collection proceeding. This newsletter focuses on CRA's rights to assert claims against a debtor's property.
Generally, there are three main amounts that a tax debtor may owe to CRA: (1) corporate income tax; (2) employee source deductions for income tax, employment insurance and Canada Pension Plan amounts; and (3) GST/HST collected. While the most powerful collection remedies have been assigned to the recovery of source deductions and GST/HST, each of the three main amounts requires consideration.
CRA as Secured Creditor
Amounts owing for corporate income tax, penalties and interest (including penalties and interest on source deductions and GST/HST) are typically unsecured claims, ranking equal with all other general creditors of a debtor. However, CRA has the ability to obtain a lien or charge against the real property and personal property of a debtor by filing the appropriate documents in the applicable registries. By doing so, CRA will be treated as a secured creditor for those claims.
When a tax debtor owes CRA money, applicable federal law permits CRA to "certify" the amount owing in a certificate. The certificate can then be registered in the Federal Court. The registered certificate is referred to as a "memorial." The memorial may then be registered in a province's land title system or personal property security registry to create a lien in favour of CRA on the tax debtor's real property or personal property, respectively. By this method, CRA can convert its otherwise unsecured debt claim to a secured claim against all of the property of a debtor.
Note that this process does not create a "running" charge – the lien created will only secure the amounts that were the subject of the certificate. If the debtor incurs further debt to CRA, a new certificate, memorial and registrations for those amounts would be required to obtain the benefit of the lien.
The priority of CRA's lien for certificated amounts is based on first-in-time principles. Any creditor that has taken all steps necessary to perfect its security interest before CRA registers a certificate in the land registry or personal property registry will have priority over CRA's claims.
Deemed Trust and Deemed Trust Lien
As alluded to above, the recovery of source deductions and GST/HST has been enhanced by the imposition of statutory deemed trusts for these amounts. There are two elements to the deemed trust remedy. Firstly, any person who is required to deduct or withhold source deductions, or collect GST/HST, is deemed to hold that amount in trust for Her Majesty, separate and apart from all other property of the person and in priority to all secured creditors. Secondly, where any amounts are owed for source deductions or GST/HST, property of the tax debtor equal to that amount is deemed to be held in trust for Her Majesty, again in priority to all secured creditors (subject to the exceptions discussed below). This is commonly referred to as a deemed trust lien. The priority of the deemed trust and the deemed trust lien operates even if a creditor has properly perfected its security interest before a deemed trust arises. This intrusive nature of the deemed trust greatly impacts the recovery options available to lenders and other creditors on enforcement.
However, the super-priority of the deemed trust lien is subject to "prescribed security interests," which are defined as mortgage security against real property. The amount of a creditor's prescribed security is subject to a calculation that considers payments received by the secured creditor after the debtor failed to pay CRA and the value of any collateral security, such as personal property security or guarantees, held by the secured creditor. The exact calculation of the prescribed security interest is often an issue between CRA and a secured creditor holding a mortgage.
The bankruptcy of the tax debtor will also eliminate the deemed trust for GST/HST. Encouraging the debtor to make an assignment into bankruptcy, or obtaining a bankruptcy order against the debtor, is often a worthwhile tactic for a secured creditor where the debtor owes a large amount of GST/HST.
Practical Tips for Creditors
Information - as early as possible - is the key to understanding the potential CRA exposure and to managing any super-priority issues. The nature and quantum of amounts owing to CRA will often dictate what type of enforcement proceeding a creditor should choose to recover a debt. Contact with the appropriate CRA representative should be made as quickly as possible.
Lenders should consider obtaining consents from the borrower authorizing CRA to release information to the lender at the time a loan is first being placed. This will allow regular monitoring of CRA account balances and avoid any roadblocks to getting information at the onset of insolvency.
While the priority rules surrounding CRA amounts can be disruptive, a creditor armed with sufficient information and sound legal advice will be in the best position to manage CRA priorities and realize the highest recovery possible in a commercial insolvency.
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.