It has been said that nothing in this world is certain, other than death and taxes. Whether any given tax is 'certain' can be debated (our tax team is here to help), but the Federal Court of Appeal has weighed in on the priority of certain tax claims in Toronto-Dominion Bank v. Canada, 2020 FCA 80
Background
The facts initially before the Federal Court, and then on appeal before the Federal Court of Appeal, were not unusual. The Toronto-Dominion Bank had granted a line of credit and a loan to Mr. and Mrs. Weislock in 2010. Both debt obligations were secured by real property owned by the Weislocks. When they sold this property to a third party in 2011, the line of credit and mortgage were paid out in full, and the bank discharged its security. Case closed.
Or case not closed, for one simple reason. Unknown to the bank, Mr. Weislock was indebted to Canada Revenue Agency (CRA) for unremitted GST in relation to the landscaping business he operated as a sole proprietor. The obligation arose before the 2010 loans. After repayment to the bank of all outstanding amounts, and the release of its security, CRA demanded payment from the bank of Mr. Weislock's tax debt, asserting a deemed trust over the Weislock property. The bank declined to pay, and the matter went to court.
Decision
The Federal Court agreed with CRA; the Excise Tax Act creates a deemed trust upon the proceeds of sale, and the trust applied in these circumstances. The bank was ordered to pay, but appealed the decision. The Federal Court of Appeal's decision was recently handed down.
The court upheld the original decision; a portion of the money paid to the bank on sale of the Weislock property was deemed to have been held in trust for CRA, and was ordered 'returned' by the bank. The court addressed four specific positions taken by the bank in its appeal:
- A deemed trust requires a triggering event
- The bank was akin to a bona fide purchaser, and not subject to the deemed trust
- The line of credit and mortgage loan were unrelated to Mr. Weislock's business
- Requiring payment from the bank to CRA would be bad policy
All four positions were rejected. The court found the Excise Tax Act required no triggering event – a deemed trust arises "once GST is collected but not remitted".
The bona fide purchaser defence is also unavailable to a secured creditor in this instance. The court concluded that secured creditors were "not comparable to third party purchasers".
The fact that the tax debt related to a business apparently unknown to the bank likewise did not persuade the court, and was not considered to be relevant to the creation of the deemed trust.
On the position that requiring payment from the bank would be bad policy, TD gave examples of some of the consequences of the trust – including unsecured creditors (not affected by the trust) being preferred, and that it favours bankruptcies (under which the trust is eliminated) over going concerns. The court did not disagree, but called the priority of CRA in this instance an example of Parliament making a "considered policy choice".
Lessons for Secured Lenders
In light of Parliament's decision to give CRA priority in this way, how then do secured creditors protect themselves? Thankfully most registered mortgages are not subject to the deemed trust, provided the borrower's tax debt had not arisen at the time the mortgage was registered.
The Federal Court of Appeal had some further suggestions of its own, namely the identification by lenders of high risk borrowers, requiring evidence of tax compliance from borrowers, and asking for the borrower's consent to release from CRA information on their tax liabilities.
Obtaining tax information directly from CRA does appear the most complete protection, as the provision of information cannot be guaranteed to align with any given payout or closing. Sporadic "spot checks" could mitigate this risk somewhat.
Perhaps the best that can be offered to secured lenders is the almost regretful tone of Justice Grammond in the original decision of the Federal Court in CRA's favour: "Parliament has already considered the potentially harsh consequences of the deemed trust on lenders and has drawn a line as to what is exempted. I cannot draw the line elsewhere".
Caveat creditor.
Originally published June 1, 2020
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.
