Canada: Supreme Court Of Canada Rules Against Canada Revenue Agency In GST/HST Deemed Trust Case

Last Updated: November 30 2018
Article by Julia Parent and David Wedlake, Summer Student

In a rare decision from the bench, the Supreme Court of Canada ("SCC") allowed the appeal of Callidus Capital Corporation in the matter of Callidus Capital Corporation v Her Majesty the Queen. The appeal dealt with the competing interests of the Crown's claim to a deemed trust for GST/HST under the Excise Tax Act (the "ETA") and the interests of secured creditors of a tax debtor once the tax debtor declares bankruptcy. In adopting the dissenting reasons of Justice Pelletier of the Federal Court of Appeal, the SCC confirmed that subsection 222(1.1) of the ETA extinguishes the Crown's "super priority" for GST/HST arrears of a tax debtor over the interests of secured creditors to the assets of a tax debtor upon the bankruptcy of the tax debtor, regardless of when the bankruptcy occurs.

As a result, secured creditors can continue to rely on a subsequent bankruptcy to invert the statutory priority afforded to the Crown with respect to a tax debtor's outstanding GST/HST remittances and any corresponding liability to the Crown with respect to proceeds is extinguished upon the bankruptcy of the tax debtor. That said, the SCC declined to comment on the priority of secured creditors in a non-bankruptcy context and a recent decision of the Federal Court of Appeal suggests that secured creditors may be personally liable where there is no bankruptcy of the tax debtor.

BACKGROUND

Statutory provisions

Similar to other statutory deemed trusts in favour of the Crown, the deemed trust provisions of the ETA grant the Crown "super priority" status with respect to amounts owing by a tax debtor in respect of GST/HST. 

Subsection 222(1) of the ETA provides that all amounts collected by a person under Division II of the ETA (i.e. GST/HST) are deemed to be held in trust for the Crown, separate and apart from the property of the person and the interest of any secured creditor (even previously existing security) in the property of the person. Subsection 222(3) extends this deemed trust over the property of a person upon their failure to remit to the Crown amounts collected in respect of GST/HST, irrespective of any pre-existing security interest. Accordingly, subsection 222(3) purports to give priority to the Crown for amounts collected and not remitted (and not otherwise claimed as input tax credits or other deductions) over the interest of a secured creditor with a pre-existing security interest in the assets of the tax debtor. This provision is a departure from the normal rule that "first in time" has priority. The deemed trust created by subsection 222(3) also extends to the proceeds of any assets of a tax debtor and therefore, to the extent that a secured creditor has enforced its security and collected proceeds from the tax debtor, the Crown's priority extends to such proceeds in the hands of the secured creditor.

Subsection 222(1.1) creates an important exception to the deemed trust - the deemed trust created pursuant to subsection 222(1) is extinguished upon the bankruptcy of the tax debtor. 

Lenders and insolvency professionals have relied on this provision as confirmation that the bankruptcy of a tax debtor retroactively eliminates the deemed trust and the priority afforded to the Crown over the tax debtor's assets or the proceeds thereof. A secured creditor that obtained proceeds from the sale of the tax debtor's assets would thus not be liable to the Crown in respect of the tax debtor's outstanding GST/HST remittances, provided that the tax debtor made an assignment or was petitioned into bankruptcy.

The Federal Court of Appeal decision

The question raised in Callidus was whether subsection 222(1.1) extinguishes the deemed trust where a secured creditor receives proceeds from the sale of the assets of a tax debtor prior to the tax debtor's bankruptcy.

In Callidus, the tax debtor borrowed monies from a financial institution starting in 2004. In 2011, the tax debtor defaulted in its obligations to the financial institution. Around that time the financial institution assigned its loans and related security to Callidus Capital Corporation. The tax debtor and Callidus entered into a forbearance agreement whereby the tax debtor agreed to sell one of its properties and pay the proceeds of the sale to Callidus in order to reduce its debt. The property was sold and Callidus received approximately $1.4 million from the sale of the property.

In the background, between 2010 and 2013 the tax debtor was alleged to have collected GST in the amount of approximately $178,000 which it failed to remit to the CRA. In 2012, the CRA wrote to Callidus claiming approximately $90,000 on the basis of the deemed trust. Callidus did not respond to this demand and the following year, at the request of Callidus, the tax debtor made an assignment in bankruptcy. The CRA subsequently brought an action against Callidus to recover under its deemed trust claim.

The Federal Court found in Callidus' favour; however, on appeal, the majority of the Federal Court of Appeal found Callidus liable for the unremitted GST debts of the tax debtor. The majority of the Federal Court of Appeal held that the bankruptcy of a tax debtor does not extinguish the liability of a secured creditor to pay proceeds it received prior to a bankruptcy that were subject to the deemed trust. As a result, the amounts received by Callidus pre-bankruptcy remained subject to the deemed trust created by subsection 222(3) of the ETA and, notwithstanding the bankruptcy, Callidus was liable to the Crown for such amounts.

However, the dissenting opinion would ultimately carry the day at the SCC.

THE SUPREME COURT OF CANADA DECISION

At the conclusion of the hearing, the SCC unanimously allowed Callidus' appeal for the reasons of the dissenting justice in the Federal Court of Appeal. In the dissenting opinion, Justice Pelletier of the Federal Court of Appeal held that the bankruptcy of the tax debtor extinguished the deemed trust.

Justice Pelletier conducted a close reading of the statutory text, finding that subsections 222(1) and 222(3) of the ETA create distinct but interlinked remedies. Justice Pelletier noted that the deemed trust under subsection 222(1) relates to unremitted amounts while the deemed trust under subsection 222(3) relates to the property of the tax debtor, to the extent of the amounts deemed to be held in trust pursuant to subsection 222(1). Justice Pelletier found that the result of this interlinking is that the creation of the subsection 222(3) trust depends on the existence of the subsection 222(1) trust; if no amounts are deemed to be held in trust pursuant to subsection 222(1), then no subsection 222(3) trust arises.

Applying this analysis to the subsection 222(1.1) exception to the deemed trust, Justice Pelletier held that, on the bankruptcy of the tax debtor, subsection 222(1.1) provides that the deemed trust amount under subsection 222(1) does not apply to any amounts collected on account of tax prior to that time. Accordingly, after the bankruptcy of a tax debtor, there is no amount deemed to be held in trust under subsection 222(1) for amounts collected as tax but not remitted pre-bankruptcy. Therefore, based on the above analysis, Justice Pelletier found the subsection 222(3) deemed trust, which the majority of the Federal Court of Appeal had held attached to the proceeds (and formed the basis of the secured creditor's liability to the Crown), had no subject matter and was nullified by the bankruptcy. 

Notably, Justice Pelletier held that the demand the CRA had sent Callidus in no way "crystallized" the Crown's entitlement or the secured creditor's liability. However, it is worth noting that this reference relates to the reasons of the trial judge. The majority similarly did not find it necessary that the demand letter had been sent, although it did analogize other remittance sections of the ETA (e.g. the garnishment provisions) which require such a letter to crystallize their claim.

WHAT THIS MEANS FOR YOU

The decision of the SCC confirms the status quo with respect to competing priorities over a tax debtor's assets in a bankruptcy where GST/HST remittances are outstanding. The direct result for clients involved in secured lending, restructuring, and collections is that they may continue to rely on a subsequent bankruptcy in order to invert the statutory priority to proceeds afforded to the Crown obtained by the secured creditor prior to such bankruptcy.

The decision of the SCC in effect confirms that the intent of Parliament is that, with respect to GST/HST remittances, the Crown becomes an unsecured creditor upon the bankruptcy of a debtor in relation to amounts owed pre-bankruptcy. Both the majority and dissenting reasons in the Federal Court of Appeal raise the issue that this retroactive effect of a bankruptcy may incentivize secured creditors to resist the payment of GST/HST amounts in the hope that a bankruptcy will wipe out any Crown priority. Accordingly, it remains open Parliament to make amendments to the ETA and Bankruptcy and Insolvency Act to deal with any such concerns.

In result, it appears that claims by the Crown against secured creditors post-bankruptcy of the tax debtor are less likely. 

However, the SCC ruling expressly excluded consideration of potential secured creditor liability in a non-bankruptcy context. There is recent case law from the Federal Court of Appeal to suggest that secured creditors may be personally liable for the CRA's deemed trust claim if the debtor does not become bankrupt. Secured lenders should also remain vigilant for other methods of collection available to the Crown outside of the deemed trust. For example, the Crown's issuance of a requirement to pay under the garnishment provisions of the ETA will require a secured lender to provide to the Crown amounts received from a tax debtor, regardless of a bankruptcy.

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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