The enforcement by Canada Revenue Agency ("CRA") of its super priority position for deemed trust liabilities has long been an issue of uncertainty for secured creditors. While the Excise Tax Act (the "ETA") has carved out "prescribed security interests" from that super priority, the calculation of the funds that continue to rank in priority to a prescribe security interest is less than clear. Further, and with some irony, CRA's strict adherence to privacy prevents a secured creditor from obtaining any information about unpaid obligations in an ordinary course payout, so as to determine if there are obligations that rank in priority. A secured creditor discharging its security after payout was left with the concern that CRA could assert its super priority over the payout after the secured creditor had discharged its security, leaving the secured creditor unsecured.
The Federal Court of Appeal has recently confirmed that there is merit to that concern.
In Toronto-Dominion Bank v. Canada1 the Federal Court of Appeal upheld the lower court's ruling requiring TD Bank, a secured creditor (the "Bank"), to pay the CRA for the unremitted goods and services tax ("GST") amounts collected by the tax debtor, and Bank's borrower (the "Borrower"). This, despite the fact that almost two years prior, the borrower had repaid their obligations to the Bank, and the Bank had discharged its mortgage security, after a sale of the borrower's real property to a bona fide third party purchaser.
From 2007-2008, in the course of operating his landscaping business, the Borrower collected GST in the amount of $67,854 (the "Amount"). However, the Borrower failed to remit the Amount to the Receiver General, thus incurring a tax indebtedness to the CRA. In 2010, the Bank, unaware of the Borrower's indebtedness, granted the Borrower a line of credit and term loan secured by a mortgage over the Borrower's real property (the "Mortgage"). When the Borrower sold the property one year later, the credit facilities were paid back in full and the Bank discharged its Mortgage security against the property.
In 2013 and 2015, the CRA asserted deemed trust claims for the Amount against the Bank, pursuant to section 222 of the Excise Tax Act (the "Act"). The Act does the following: (i) it creates a deemed trust in favour of the Crown with regards to GST; (ii) it extends such deemed trust to the property of a tax debtor; and (iii) it further extends such deemed trust to include property held by secured creditors, like the Bank in this case. The Bank refused to pay the Amount, setting the stage for legal proceedings. After the Federal Court sided with the CRA, the Bank appealed to the Federal Court of Appeal.
The Federal Court of Appeal agreed with the Federal Court that the proceeds from the sale of the Borrower's property are subject to the deemed trust, and that under section 222 of the Act, the Bank is required to remit the portion of the proceeds that fall under the deemed trust (i.e., the Amount). In other words, it was the Borrower's obligation to pay the Amount out of the proceeds of the sale. Since he failed to do so and, instead, used the proceeds to pay back the Bank, then the Bank as a secured creditor was obliged to pay the Amount to the CRA.2
In analyzing section 222 of the Act, the Court interpreted the words "despite any security interest in the amount" to mean Parliament intended to provide absolute priority to the deemed trust in respect of property that is also subject to a security interest, regardless of when the security interest arose in relation to the time the GST was collected. In this case, when the Bank lent funds to the Borrower and registered its security, the Borrower's property was already deemed to be beneficially owned by the Crown, and upon the sale of the property, section 222(3) obliges the Bank to remit the proceeds it received.3
The Court found that under the Act, a deemed trust does not require a triggering event and arises once GST is collected but not remitted.4 The Court further found that the Bank cannot use the bona fide purchaser defence to skirt the deemed trust provision, and concluded that a secured creditor is not comparable to third party purchasers.5 Lastly, in response to the Bank's argument that requiring the Bank to repay is simply bad policy, the Court deferred to Parliament, and identified the choice to prioritize the collection of GST over the interests of secured creditors to be a considered policy choice.6
What Should Lenders do?
Lenders would be wise to take the advice of the Court.7 They should identify higher-risk borrowers and perhaps change their standard mortgage terms to (i) require borrowers to provide evidence of tax compliance both before lending and in order to obtain a discharge of any security; and (ii) require authorization to be given to verify a borrower's outstanding liabilities directly with the CRA (although, note that such authorizations should be in CRA's required forms and that they expire after 6 months).
Other options, particularly where a discharge of security is required (for example in a sale to a third party) could include having the borrower post cash security in a suitable amount having regard to their business, to stand in lieu of the collateral until a clearance certificate can be provided from CRA.
Of course, if Lenders pursue any of these steps, they should prepare for delays in the closing of transactions, given the difficulty and considerable delay in obtaining clearance certificates from CRA.
1. Toronto-Dominion Bank v. Canada, 2020 FCA 80.
2. Ibid at para 38.
3. Ibid at para 30.
4. Ibid at para 59.
5. Ibid at para 72.
6. Ibid at para 84.
7. Ibid at para 85.
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.