Canada: Supreme Court Of Canada Decides Federal Crown's Deemed Trust Priority For Unremitted GST/HST Doesn't Survive Bankruptcy In Canada v. Callidus Capital Corporation

Last Updated: November 30 2018
Article by Romain Viel

On November 14, 2018, the Supreme Court of Canada decided a tax debtor's bankruptcy retroactively extinguishes the federal Crown's deemed trust priority under section 222 of the Excise Tax Act over the debtor's assets –  including proceeds received by creditors. The Court's decision in Canada v. Callidus Capital Corporation means a creditor's personal liability to the Crown for a tax debtor's unremitted GST/HST will be terminated once the debtor is bankrupt unless the Crown has issued a Requirement to Pay to that creditor.

Section 222 of the Excise Tax Act allows the Crown to claim a tax debtor's GST/HST arrears against a creditor that obtains proceeds from the debtor's assets. Subsections 222(1) and 222(3) of the Act provide that every person who collects GST or HST is deemed to hold the collected amount in trust for the Crown until it's been remitted to the Receiver General. This deemed trust gives the Crown a super priority over all competing security interests in the debtor's real and personal property up to the amount of the unremitted tax arrears (subject to prior registered mortgages). But subsection 222(1.1) provides that the deemed trust does not apply "at or after the time a person becomes a bankrupt". The Supreme Court of Canada's decision that a tax debtor's bankruptcy reverses the priority over proceeds that creditors received after enforcing security against tax debtors' assets is certainly a victory for creditors – but creditors still have exposure for debtors' liability to the Crown:

  • Source Deduction Liability. The Crown's deemed trust priority for source deductions, such as Canada Pension Plan (CPP) contributions, will still survive a tax debtor's bankruptcy. The decision doesn't affect the Crown's deemed trust priority for source deductions because the applicable legislation doesn't contain an exception similar to subsection 222(1.1) of the Excise Tax Act
  • Requirements to Pay. The Excise Tax Act allows the Crown to issue a "Requirement to Pay" to third parties, including creditors, when the third party receives proceeds from the tax debtor's assets. A creditor that receives a Requirement To Pay before the tax debtor goes bankrupt will still be liable to the Crown for the tax debtor's unremitted GST/HST amount after the debtor's subsequent bankruptcy. In the Callidus case, the Crown only issued a letter to the creditor, which didn't have the same legal effect as a Requirement To Pay; as a result, the tax debtor's subsequent bankruptcy still extinguished the creditor's liability to the Crown. To minimize the exposure a Requirement to Pay poses to a creditor, when taking steps to enforce security against a debtor a creditor is wise to carefully consider the debtor's financial situation and the possibility it owes unremitted taxes to the Crown, such as by examining whether the Crown has obtained judgment against the debtor. If the debtor does owe the Crown unremitted taxes, a creditor can consider whether petitioning the debtor into bankruptcy post-security enforcement is the most effective strategy to maximize recovery – and consider it promptly given the significant consequences of receiving a Requirement To Pay after the creditor has successfully enforced its security.
  • Creditor's Pre-Bankruptcy Liability. There's still the question of the scope of the Crown's deemed trust before a tax debtor's bankruptcy, in which the Court expressly declined comment. This is likely because there's ongoing litigation (Canada v. Toronto-Dominion Bank) about this issue in which the Federal Court decided section 222 of the Excise Tax Act does require secured creditors to remit to the Crown any proceeds up to the unremitted GST/HST amount it receives from a tax debtor's property when the tax debtor isn't bankrupt.

The Facts. In Canada v. Callidus Capital Corporation, Cheese Factory Road Holdings Inc. failed to remit to the Crown the GST and HST it collected as part of its business operations and defaulted on its obligations to Callidus under certain credit facilities. As part of a forbearance agreement with Callidus, Cheese Factory sold real property and transferred the net sale proceeds to Callidus. But before the sale closed, the Crown sent to Callidus a letter requesting that pursuant to the deemed trust provisions, Callidus pay the sale proceeds to the Crown up to the amount of Cheese Factory's unremitted taxes. Callidus didn't comply. Several months later, Cheese Factory filed an assignment into bankruptcy at Callidus' request. Shortly after the bankruptcy, the Crown sued Callidus seeking recovery of the sale proceeds on the basis it had priority over the amounts pursuant to the Excise Tax Act's deemed trust provisions. Callidus argued the bankruptcy retroactively extinguished the deemed trust and the Crown's priority over the sale proceeds, so Callidus was entitled to keep the proceeds.

The Federal Court of Appeal. In July 2017, a majority of the Federal Court of Appeal disagree and decided the federal Crown's deemed trust priority over a tax debtor's assets, including proceeds received by secured creditors from the assets, survived the debtor's bankruptcy. The consequence: creditors would remain personally liable to the Crown for any proceeds they received from enforcing security against a tax debtor's assets pre-bankruptcy up to the debtor's outstanding GST/HST amount, despite the debtor's bankruptcy. But a single dissenting judge interpreted subsection 222(1.1) of the Excise Tax Act to mean a bankruptcy retroactively extinguishes the federal Crown's deemed trust priority over a tax debtor's assets, including proceeds a secured creditor received from the tax debtor's assets before bankruptcy. This would mean that when a tax debtor becomes bankrupt, subsection 222(1.1) operates to release the tax debtor's unremitted GST/HST amount from the Crown's deemed trust. And while the priority reversal upon a bankruptcy might encourage creditors to petition tax debtors into bankruptcy to extinguish the Crown's deemed trust, the dissenting judge decided that absent clear language to the contrary, legislation should be "interpreted on the assumption that the Crown only collects amounts which it is owed and not more". 

The Supreme Court of Canada. On November 14, 2018, the Supreme Court of Canada adopted the reasons of the lone dissenting judge and overturned the decision of the majority of the Federal Court of Appeal.

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