Canada: Return To Certainty: Supreme Court Of Canada Provides Clarity To GST/HST Deemed Trust And The Liability Of Secured Creditors For Funds Received

Last Updated: January 14 2019
Article by Jeremy Bornstein

Overview

On November 14, 2018, the Supreme Court of Canada delivered its reasons for reversing the Federal Court of Appeal's decision in Callidus Capital Corporation v Her Majesty the Queen, 2018 SCC 47. The question before the court was whether, as a result of the deemed trust provisions of the Excise Tax Act (the ETA), a secured creditor who received the proceeds of a debtor's assets prior to the debtor's bankruptcy was liable to remit those funds to the Crown on account of the debtor's unremitted GST/HST following the debtor's bankruptcy.

This decision that the deemed trust provisions of the ETA become inoperative on bankruptcy, and therefore secured creditors are not liable to account for proceeds received from a debtor pre-bankruptcy, is an important one for secured creditors. The Supreme Court's ruling overturns the Federal Court of Appeal's decision which held that a secured creditor who accepted payment prior to a bankruptcy from a debtor while there was unremitted GST/HST would be liable to remit those funds to the Crown even after the debtor's bankruptcy. The Federal Court of Appeal's decision meant that a secured creditor could not obtain certainty regarding priority to payments received from a debtor, and risked encouraging secured creditors to bankrupt distressed debtors instead of agreeing to some form of work-out or other reorganisation.

The Supreme Court of Canada's decision that the deemed trust is ineffective in relation to a bankrupt and its secured creditors, including in relation to funds received by a secured creditor pre-bankruptcy, returns certainty to the priority regime. It allows for a return to the long-standing prior practice where, as part of its risk analysis, secured creditors can rely on the bankruptcy of a debtor to terminate the deemed trust in favour of the Crown in connection with any GST/HST amounts owed, and relegate these claims to being unsecured.

Case Facts

Callidus dealt with the Crown's proceedings against Callidus Capital Corporation (Callidus), a secured creditor of the bankrupt Cheese Factory Road Holdings Inc. (CFRH), that had unpaid GST/HST owing. Callidus had purchased the debt obligations of CFRH and related security from the Royal Bank of Canada and, at the same time, entered into a forbearance agreement. Under the forbearance agreement, certain segregated bank accounts were created in the name of CFRH and daily cash sweeps were initiated from the accounts to reduce the outstanding obligations owed to Callidus. While Callidus was receiving these payments, amounts were owed by CFRH to the Crown for unremitted GST/HST. The Crown sent a demand letter to Callidus on April 2, 2012, claiming such amounts on the basis of the deemed trust under the ETA. On November 7, 2013, the debtor made an assignment under the Bankruptcy and Insolvency Act (the BIA) at the request of Callidus. It is important to note that the Crown did not issue a Requirement to Pay to Callidus in relation to CFRH.

GST/HST Deemed Trust Under the ETA

Subsection 222(1) of the ETA provides that GST or HST collected but not remitted is deemed to be held in trust by the collector for the Crown. Subsection 222(1.1), however, provides that the deemed trust created in subsection 222(1) does not apply upon bankruptcy of the tax debtor. If collected amounts are not paid under subsection 222(1), subsection 222(3) of the ETA extends the deemed trust to the property of the tax debtor in an amount equal to the GST/HST owing, despite of, and in priority to, any security interests. Unlike subsection 222(1.1), there is no equivalent subsection addressing how the deemed trust over the general assets of the tax debtor in subsection 222(3) is treated on bankruptcy.

Federal Court Decision

The Federal Court's trial level decision held that the deemed trust and its super priority are extinguished upon bankruptcy, causing the Crown to become an unsecured creditor in connection with unremitted GST/HST amounts. The Court based its reasoning on, in its view, a plain reading of the legislation.

Citing well established case law, the Federal Court also observed that Parliament has made clear exceptions to the general rule under the BIA that deemed trusts are ineffective in bankruptcy, and unremitted GST/HST amounts do not fall into those exceptions. Subsection 67(2) of the BIA renders deemed trusts held for the benefit of the Crown inoperative in bankruptcy subject to subsection 67(3), which expressly upholds deemed trusts for certain unremitted employee source deductions.

Federal Court of Appeal Decision and Subsequent Reversal

The Federal Court of Appeal overturned the Federal Court and held that although subsection 222(1.1) releases the bankrupt from the deemed trust on bankruptcy, it does not release a secured creditor's liability for receiving proceeds deemed to be held in trust for the Crown pre-bankruptcy. The Federal Court of Appeal held that the claim against the secured creditor continued to exist because it arises as a result of the secured creditor's breach of its statutory obligation under the ETA to remit the deemed trust property it received to the Crown. The unpaid GST/HST amounts, therefore, could be pursued by the Crown against third-party recipients, independent of any subsequent bankruptcy of the tax debtor. If this was not the case, the Federal Court of Appeal held, then the deemed trust mechanism would be ineffective: the termination of the deemed trust on bankruptcy would allow secured creditors to benefit from the debtor's failure to remit pre-bankruptcy.

As a basis for its decision, the Federal Court of Appeal cited Canada (Procureure Generale) c. Banque du Canada, 2004 FCT 92. In that case, the Federal Court held that the Crown has priority over proceeds from property subject to a deemed trust under the source deductions provisions of the Income Tax Act (the ITA), and a secured creditor receiving those proceeds is liable to account to the Crown for them. Justice Rennie extended this reasoning to Callidus and drew no distinction between the deemed trust obligation in respect of withholding taxes under the ITA on one hand and unremitted GST/HST under the ETA following bankruptcy on the other.

Justice Pelletier dissented from the majority of the Federal Court of Appeal. In his view, Parliament's intention was to move away from having the Crown claim priority in bankruptcy. He found that the trust over the property of the tax debtor created by subsection 222(3) of the ETA ceased to exist following the debtor's bankruptcy because it was entirely reliant on the deemed trust in subsection 222(1) over GST/HST collected and not remitted, which ceases to apply on bankruptcy pursuant to subsection 222(1.1):

Subsection (1.1) provides that at or after the time of bankruptcy, subsection (1) does not apply to any amounts that were collected on account of tax prior to that time. The result is that after bankruptcy, there is no amount deemed to be held in trust pursuant to subsection (1) for amounts collected as tax but not remitted pre-bankruptcy. The subsection (3) trust which arose prior to bankruptcy no longer has any subject matter because the trust only attached to property of the tax debtor to the extent of the subsection (1) trust which no longer exists. This is true for the tax debtor as well as for the tax debtor's secured creditors.

The Supreme Court of Canada unanimously reversed the decision of the Federal Court of Appeal and adopted the reasons of Justice Pelletier's dissent in the Federal Court of Appeal. In its decision, the top court explicitly declined to rule on whether a creditor would be liable to the Crown for a debtor's unpaid GST/HST amounts outside of the bankruptcy context.

Conclusions for Lenders

The Federal Court of Appeal decision in Callidus created uncertainty for secured lenders, particularly where a debtor was in financial distress. It was feared that the prospect of unremitted GST/HST obligations would encourage secured creditors to force distressed borrowers into bankruptcy, as opposed to allowing other restructuring options to be pursued. With this uncertainly removed, secured creditors can now consider a wider set of work out options and take comfort that a bankruptcy will relieve deemed trust obligations under the ETA, including in relation to funds received pre-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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Sign Up
Gain free access to lawyers expertise from more than 250 countries.
 
Email Address
Company Name
Password
Confirm Password
Position
Industry
Mondaq Newsalert
Select Topics
Select Regions
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions