Introduction — CRA Tax Collection Powers and the Deemed Trust
The Canada Revenue Agency has a wide variety of powers at its disposal to collect tax amounts owing from taxpayers with unpaid tax assessments. CRA can garnish a tax debtor’s bank accounts, wages and accounts receivable for unpaid taxes. CRA can also register certificates in Federal Court against the tax debtor and thereby place liens on a taxpayer’s property, which function much the same way as a mortgage on title to real property.
When source deduction and GST/HST withholdings are not paid when withheld or collected CRA enjoys enhanced security, typically referred to “super priority”, over most of a tax debtor’s real property and personal assets vis-a-vis other creditors by virtue of deemed trust provisions in the Income Tax Act and Excise Tax Act. Unlike CRA’s more well-known and oft-utilized collection powers, noted above, CRA’s super priority exists by operation of law and does not have to be crystallized or otherwise evidenced by any formal process or document. Certain security interests are exempt from CRA super priority for source deduction and GST/HST tax arrears, but the exemptions are narrow and technical. If you are interested in investing in a business, speak with one of our top Canadian tax lawyers to make well-informed decisions with respect to potential security for your investment.
CRA Super Priority Liens by Operation of Tax Law — No Registration Required
All of a taxpayer’s assets are deemed to be held in trust for the Crown if such a taxpayer fails to remit source deductions and/or GST/HST to CRA as and when required by the Income Tax Act and Excise Tax Act, respectively. The deemed trust arises immediately and automatically upon the failure to remit and is not contingent on CRA first issuing a notice of assessment or reassessment to the tax debtor, although in practice CRA will not be aware of the failure(s) to remit prior to a CRA tax audit. The concept of the deemed trust means that CRA is entitled to any proceeds of sale that stem from property subject to the deemed trust, in priority to substantially all secured creditors. Courts have even recognized that CRA can directly pursue any entity that has received proceeds from the sale of assets to which the deemed trust applies and demand payment thereof. For this reason, practitioners generally describe CRA’s priority with respect to unremitted source deductions and GST/HST as “super priority”.
Because the existence of the deemed tax trust arises by operation of law and does not require any documentation to be prepared and filed by CRA, it can be difficult for interested parties to ascertain whether or not one is in place. In this way, the deemed trust has the potential to be “invisible”. For instance, a lender may be considering advancing $100,000 to a general construction contractor, who has been operating for several years and not registered for GST/HST, with the intention of securing the funds with a general security agreement (GSA) and a promissory note. Due diligence searches could very well not reveal any judgments, liens or other collection action taken by CRA against the contractor in relation to source deductions or GST/HST. However, at any time CRA can audit the contractor for a period going back several years, assign a GST/HST number and assess them for significant GST/HST arrears. Once this occurs, the GSA and promissory note will be subordinate to CRA’s super priority and potentially worthless. In such a case, the key is that the deemed trust and resulting super priority is not created by the GST/HST assessment, but by the obligation to collect and remit GST/HST, which exists by operation of law. Our experienced Canadian tax lawyers can analyze a given business and its operations, determine whether source deduction and/or GST/HST obligations exist and provide advice as to what evidence should be requested in order to determine those obligations are being met so as to allow you to make an informed decision with respect to your capital investments.
CRA Super Priority Liens— Exemption for Specified Security Interests
When a given taxpayer does not remit payroll source deductions or GST/HST as required by the ITA and ETA, the deemed tax trust applies to the property of the delinquent taxpayer, property held by secured creditors of the taxpayer and sale proceeds from each of the foregoing. In addition, the super priority lien given to CRA that arises from the deemed trust has priority over “any security interest” of a secured creditor which, combined with the invisible nature of the deemed trust, can introduce untenable uncertainty into the affairs of the creditor. “Security interest” is defined in subsection 224(1.3) of the Income Tax Act as “any interest in, or for civil law any right in, property that secures payment or performance of an obligation and includes an interest, or for civil law a right, created by or arising out of a debenture, mortgage, hypothec, lien, pledge, charge, deemed or actual trust, assignment or encumbrance of any kind whatever, however or whenever arising, created, deemed to arise or otherwise provided for”. This definition is expansive and prima facie would encompass a mortgage secured by real property.
Subsection 227(4.2) contains some relief for secured creditors by carving out “prescribed security interests”, defined in Regulation 2201 of the Income Tax Act, from the definition of “security interest”. An equivalent definition for GST/HST in contained in the Security Interest (GST/HST) Regulations. A prescribed security interest is defined as the part of a mortgage registered on title to real property prior to the time a deemed trust arises, adjusted to exclude:
- the value of all other rights of the secured creditor to enforce the obligation, valued at the time the deemed trust arises, including guarantees and rights of set-off; and
- the value of all amounts applied against the obligation following the time the deemed trust came into existence, ie. the time of the failure to remit.
The definition of prescribed security interest in Regulation 2201 makes it clear that mortgages on real property are not simply exempted from the ambit of the deemed trust. Instead, the definition limits the exemption to a dollar figure and essentially forces mortgagees to pursue all other security for the obligation prior to achieving status as a prescribed security interest. For example, a $500,000 mortgage on title to real property owned by a corporation, with a parallel $500,000 personal guarantee having been provided by a director of the corporation, will result in the prescribed security interest being valued at $0 unless the creditor takes all reasonable steps to collect from and/or settle with the guarantor director in order to extinguish the guarantee. Further, mortgages registered on title to real property subsequent to the failure to remit tax source deductions or GST/HST do not qualify under the definition.
Tax Tip — Consult a Tax Lawyer
Although CRA gets a lot of attention for its ability to garnish the bank accounts, wages and/or receivables of a tax debtor, super priority given to CRA over the property of source deduction and GST/HST tax debtors via the deemed trust provisions in the Income Tax Act and Excise Tax Act is arguably its most powerful collection tool. The deemed trust does not have to be crystallized by a tax audit or tax assessment in order to exist and it applies to substantially all of the property of the tax debtor. Prescribed security interests are exempted from the application of the deemed trust provisions and resulting super priority, however the definition of prescribed security interests is extremely narrow and subject to several limiting factors. Failing to ensure your business is up to date with source deduction and GST/HST obligations can not only cause problems with CRA, but also in obtaining capital investment. Speak with our top Canadian tax lawyers to ensure your business is meeting its various tax remittance obligations.