Unpaid Payroll Deductions: Federal Court Of Appeal Affirms Bona Fide Purchaser Defence For Unsecured Creditors

Toronto-Dominion Bank (TD Canada Trust) v. Canada, 2026 FCA 25

Introduction: Unpaid Payroll Deductions: A Hidden Risk for Creditors

The Federal Court of Appeal's decision in Toronto-Dominion Bank (TD Canada Trust) v. Canada addresses an important issue in Canadian tax law: whether the Crown can recover unremitted payroll deductions from an unsecured creditor who received payment without knowing that the employer had failed to remit those deductions.

The case required the Court to interpret the "deemed trust" provisions in section 227 of the Income Tax Act (ITA). These provisions state that when an employer deducts income tax, the employer is deemed to hold those amounts in trust for the Crown. If the employer does not remit the funds, the Crown may assert priority over certain property of the employer.

The central question in this case was whether an unsecured creditor, who received payment from the proceeds of a sale of the employer's assets and had no knowledge of the tax default, must repay the Crown.

Background Facts in TD Canada Trust v. Canada

H.N.J. Enterprises Ltd., a restaurant business, failed to remit payroll source deductions between 2013 and 2015. In October 2015, the company sold its business assets for $100,000. The proceeds were deposited into its bank account.

The Toronto-Dominion Bank (TD Bank) was an unsecured creditor because of overdrafts in the company's account. The company used part of the sale proceeds to repay those overdrafts. The total amount received by the bank exceeded the unremitted source deductions.

At the time the bank received payment, it had no knowledge that the employer had failed to remit payroll deductions. Nearly two years later, the Canada Revenue Agency demanded payment from TD Bank, claiming that the bank must return the funds under the deemed trust provisions.

The Federal Court initially ruled in favour of the CRA, holding that the deemed trust applied and that the bank could not rely on the "bona fide purchaser for value" defence. TD Bank appealed.

The Legal Issues in TD Canada Trust v. Canada

Two questions were posed:

1. Do the deemed trust provisions apply to unsecured creditors?
2. Can an unsecured creditor rely on the bona fide purchaser for value defence?

The Court of Appeal found that the first question was too broad. The real dispute concerned the second question—whether an unsecured creditor who innocently received payment could rely on the bona fide purchaser defence.

The Reasoning of the Court in TD Canada Trust v. Canada

The Deemed Trust Under the Income Tax Act

Section 227(4) and (4.1) of the ITA create a deemed trust when payroll deductions are withheld but not remitted. The trust attaches to property of the employer and gives the Crown priority over secured creditors in certain situations.

Previous cases had established that secured creditors cannot rely on the bona fide purchaser defence. In earlier litigation involving TD Bank as a secured creditor under similar provisions of the Excise Tax Act, courts ruled that secured creditors must repay funds received in priority to the Crown.

However, this case was different. TD Bank was an unsecured creditor.

The Bona Fide Purchaser for Value Defence

The bona fide purchaser for value defence is a long-standing principle in equity. It protects a person who acquires property for value, in good faith, and without notice of another's prior interest.

The Court examined whether Parliament intended to exclude this defence when drafting section 227. The legislation expressly refers to secured creditors but does not mention unsecured creditors or bona fide purchasers. The Court reasoned that Parliament is presumed to know established legal principles. If Parliament intended to remove this defence entirely, it could have said so clearly.

The Court also considered the broader context of the ITA. If employees were paid wages from sale proceeds and later forced to repay the Crown, those wages would still count as taxable income under section 5(1). Section 8(2) generally prohibits deductions from employment income unless specifically allowed. There is no provision allowing an employee to deduct repayment of such funds.

This would create unfair tax consequences. Employees would include the wages in income but receive no deduction if forced to repay the Crown. The Court found it unlikely that Parliament intended such a harsh result.

The Court's Decision in TD Canada Trust v. Canada

The Federal Court of Appeal allowed the appeal. It held that an unsecured creditor can rely on the bona fide purchaser for value defence when receiving payment from the proceeds of an employer's sale of assets, provided that the creditor had no notice of the employer's failure to remit source deductions.

The Court distinguished unsecured creditors from secured creditors. Secured creditors are specifically addressed in the statutory language and have a defined priority relationship. Unsecured creditors are not mentioned in the same way.

Therefore, the Crown cannot automatically recover the funds from an innocent unsecured creditor who received payment in good faith and for value.

Significance of the Court's Decision in TD Canada Trust v. Canada

This decision clarifies the limits of the deemed trust provisions in the ITA. It confirms that while the Crown enjoys strong priority rights, those rights are not unlimited.

The ruling protects ordinary unsecured creditors, including banks and employees, who receive payments without knowledge of a tax default. It reinforces the principle that Parliament must use clear language if it intends to override established equitable defences.

The decision also highlights the importance of interpreting statutes using a textual, contextual, and purposive approach. The Court did not rely solely on the wording of section 227 but considered its broader context within tax law and equitable principles.

In summary, Toronto-Dominion Bank v. Canada provides meaningful guidance on how Canada's tax deemed trust operates and confirms that innocent unsecured creditors are not automatically liable to repay the Crown.

Pro Tax Tips: Secured and Unsecured Creditors Are Treated Differently

If you lend money to a business, understand your legal position. Secured creditors face stricter rules and may be required to repay funds to the Crown when deemed trust provisions apply. Unsecured creditors may have more protection if they acted honestly and without notice. Before extending credit, review whether you should take security, and understand how tax arrears can affect repayment priority. Legal structure matters greatly in insolvency situations. Our top Canadian tax lawyers can guide you in navigating how tax arrears may affect your interests as a creditor.

Frequently Asked Questions (FAQs):

If an equitable principle is now written into a statute, does that mean traditional defences like "bona fide purchaser for value" no longer apply?

No, not automatically. For example, when an equitable relationship such as a trust is created by statute (like the "deemed trust" under section 227 of the Income Tax Act), traditional equitable principles still apply unless Parliament clearly removes them. As a result, historical defences such as "a bona fide purchaser for value without notice' will still apply under section 227, particularly to unsecured creditors who receive payment in good faith and without knowledge of the employer's tax default.

What is Rule 220 (1) of the Federal Courts Rules, and how does it work?

Rule 220(1) of the Federal Courts Rules allows a party, before trial, to bring a motion asking the Court to decide certain issues in advance. Specifically, a party may request that the Court determine a question of law relevant to the action, rule on the admissibility of a document, exhibit, or other evidence, or decide agreed-upon questions presented by the parties in the form of a special case, either before or instead of a full trial. Such determination is final and conclusive for the purposes of the action.

This Rule allows a party to ask the Court, before a full trial takes place, to decide a specific legal question that may affect the outcome of the case. It is meant to clarify important legal issues early and possibly avoid unnecessary litigation. In TD V Canada, the parties asked the Court to answer two legal questions about how the deemed trust rules apply to unsecured creditors. The Federal Court answered them, and the matter was appealed. The Court of Appeal explained that Rule 220 is appropriate for deciding pure questions of law, such as how a statute should be interpreted. It does not decide the full dispute but provides legal guidance that shapes how the case will proceed.

Why can't secured creditors rely on the 'bona fide purchaser for value' defence, for debts arising under section 227 of the Income Tax Act, while unsecured creditors can?

There are various reasons for this, as explained by the court in TD V. Canada. First, the statutory language specifically refers to secured creditors and gives the Crown priority over "security interests," showing that Parliament deliberately targeted them. Second, prior Supreme Court decisions had already confirmed that allowing secured creditors to rely on the defence would undermine Parliament's intention to ensure source deductions are paid first. Third, secured creditors are generally better equipped to protect themselves through due diligence, registration of security, and negotiated protections. Finally, fairness concerns supported distinguishing unsecured creditors, who may receive payment in good faith and without knowledge of tax defaults.