Canada: GST/HST Deemed Trust: Potential Harsh Consequences For Secured Lenders

  • On May 25, 2018 the Federal Court ruled that a major Canadian bank ("the Bank") was liable to pay proceeds received in repayment of a tax debtor's mortgage to the Government.
  • Section 222 of the Excise Tax Act ("ETA") provides the Crown with absolute priority regarding proceeds remitted to a secured creditor from the assets of a tax debtor, where those proceeds are deemed to be held in a deemed trust.
  • The Court held that the proceeds at issue were subject to the deemed trust mechanism in section 222 of the ETA.
  • Although the Bank had not been aware of the tax debt, the Court found that the bona fide purchaser for value defence (which the Bank attempted to assert) is incompatible with Parliament's intention in enacting the relevant sections of the ETA and is unavailable to secured creditors.


A sole proprietor (the "Tax Debtor") carried on a landscaping business. In 2007 and 2008, the Tax Debtor collected a total of $67,854 in Goods and Services Tax ("GST") from his clients, which he failed to remit to the Receiver General.

In 2010, the Bank granted the Tax Debtor a Home Equity Line of Credit and a loan, both of which were secured upon the Tax Debtor's house. At the time, the Bank was unaware of the Tax Debtor's GST debt. In 2011, the Tax Debtor sold his house and fully repaid the outstanding secured debt to the Bank out of the proceeds.

In April 2013, the Canada Revenue Agency ("CRA") issued a demand letter to the Bank seeking payment for the Tax Debtor's GST debt (including interest) on the basis of the deemed trust mechanism in section 222 of the ETA. The Bank had no prior notice of the CRA's claim. In February 2015, the CRA issued a revised demand letter to the Bank seeking payment of revised amount of $67,854 (excluding interest this time), which the Bank refused to pay.

The Issues

As stated by Justice Grammond (see para. 15), to determine the validity of the CRA's claim, the Court had to examine the following questions:

  1. Does section 222 of the ETA impose an obligation on the Bank to repay the amount received from the Tax Debtor?
  2. Is the Bank a bona fide purchaser for value of the money received from the Tax Debtor and therefore not liable to repay the GST debt?
  3. Is it relevant that the Bank was no longer a secured creditor when the obligation to pay was triggered?
  4. Are there any policy considerations that could outweigh the CRA's claim?

The Ruling

Obligation to pay proceeds

Firstly, it is important to note that although this case deals exclusively with section 222 of the ETA, the Court's analysis suggests that the same reasoning would apply to the Income Tax Act (section 227) and other federal statutes.

The Court ruled that the Bank has an obligation to repay the proceeds it received from the sale of the Tax Debtor's house. According to section 222 of the ETA, if a taxpayer fails to remit GST/HST owed to the Receiver General, all of the property of the taxpayer (up to the amount that he or she owes to the Government) shall be deemed to be held in trust, and the Crown becomes the beneficiary. Section 222 also gives absolute priority to the deemed trust over all other secured creditors. In this case, the house was subject to the deemed trust as it was acquired after the relevant GST was collected (and not remitted). Moreover, section 222(3) of the ETA imposes a statutory obligation on the Bank to repay the debt because it received the "proceeds" of the property that was the subject matter of the deemed trust when the Tax Debtor reimbursed his secured loan. While the Bank argued that subsection 222(3) only applies when the secured creditor enforces its security, Justice Grammond reinforced previous case law (Vallée de l'Or, Lyster and Callidus) and found that the word "proceeds" has a broad meaning that is not limited to a forced sale.

Bona fide purchaser for value

The Court also rejected the Bank's argument that it is a bona fide purchaser for value. The "bona fide" defence is a principle of equity that is firmly rooted in trust law. In general, if a person acquires property from a trust, and genuinely does not know that the transfer amounted to a breach of trust, the claim of the beneficiary of the trust is defeated.

Justice Grammond confirmed that deemed trusts are governed by trust law. Thus, equitable defences are available, but only to the extent that they are compatible with legislation. In the case at hand, the Court ruled that it is incompatible with the ETA to allow the bona fide defence to be available to secured creditors. Justice Grammond reasoned that "if the defence were available, secured creditors would almost always be able to invoke it" as "they are almost always unaware of the existence of a tax debt" (see para. 46). Moreover, the Court reasoned that the 2000 amendment of section 222 of the ETA specifically targeted secured creditors and that it would therefore be inconsistent with Parliament's intentions to allow this defence. However, the Court did allow the possibility that the bona fide defence could be invoked by an unsecured creditor and did not limit it to "purchasers" who obtain property through a contract of sale (see paras. 43 and 47).

Triggering event

The Bank also argued that the deemed trust only comes into operation upon a "triggering event", which in this case was the CRA's demand to pay in 2013. According to the Bank, since it was no longer a secured creditor in 2013, section 222 of the ETA should not apply. The Court rejected this argument and referred to First Vancouver and Callidus which also rejected the need for a crystallization or triggering event for a deemed trust to arise.

Policy considerations

There were two main policy arguments. Firstly, the Bank argued that the payment it received is, in effect, being expropriated. Justice Grammond upheld that section 222 of the ETA simply prioritizes the trust as a creditor, which does not equate to expropriation. While the deemed trust does increase the risk that creditors will not be able to collect their debts, it does not categorically prevent them from doing so. The debtor is still liable to pay back its creditors, even if it must first deal with its debt to the Government.

Secondly, the Bank referred to a principle mentioned in Sparrow Electric and First Vancouver, that a "tax on one person cannot be collected out of the property belonging to another" (see para. 58). While the Court agreed that this is an important tax principle, Parliament had been fully aware of the consequences that section 222 would have for secured creditors' proprietary interests and chose to disregard them. The Court accordingly deferred to Parliament's intentions and rejected this argument.

Finally, Justice Grammond conceded that this judgment may be interpreted as being too harsh on secured creditors. However, he defended his stance by pointing out that subsection 222(4) of the ETA already considers this potential unfairness and excludes "prescribed security interests" from the deemed trust mechanism. The prescribed security interest exclusion allows for a certain portion of a mortgage or hypothec to be excluded from the deemed trust, provided that it is registered before the time an amount is deemed under section 222 of the ETA to be held in trust by the person. In the case at hand, the Bank did not have a "prescribed security interest" because its secured loan had been registered after the amounts of GST were collected by the Tax Debtor. Justice Grammond could only conclude that Parliament, having considered the potentially harsh consequences for lenders, had "drawn a line as to what is exempted" and that it was therefore beyond his authority to "draw the line elsewhere" (see para. 65).

Key Takeaways

  • The Court reinforced previous case law and found that voluntary transactions impose an obligation on secured creditors to remit proceeds received that are subject to a deemed trust.
  • The bona fide purchaser for value defence can apply to a transaction only involving money and to unsecured creditors, but not to secured creditors as applying it to them would be incompatible with Parliament's intentions.
  • Secured creditors, especially when they are lending to individuals, should always ask whether the borrower may have potential past tax debts that could be subject to deemed trusts under tax legislation. Those who are registered for GST/HST purposes or with payroll accounts may be particularly at risk.

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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