The Canada Revenue Agency (CRA) has the power to enforce a super-priority position for deemed trust liabilities, which is an issue for creditors that is both vague and concerning. The Excise Tax Act (The ETA) sets out prescribed security interests from that super-priority. However, it is not easy to ascertain the process for determining how the priority ranking of funds prescribes such security interests, making it a grey-area for many creditors. This is further compounded by the strict privacy policy of the CRA, which means that creditors struggle to access any information on outstanding financial obligations in ordinary course payouts. It can, therefore, be difficult to know whether any pre-existing obligations take priority. For a secured creditor discharging their security following payment, there is the possibility that the CRA could enforce super-priority over the payout, ultimately leaving the creditor without security. The Federal Court Of Appeals has acknowledged that this is a valid area of concern for creditors.
In the case of Toronto-Dominion Bank v. Canada, the Federal Court of Appeals agreed with the lower court’s ruling, which enforced the secured creditor TD Bank (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 ruling was issued despite the borrower having repaid their debt to the Bank two years earlier, and the Bank having already discharged its mortgage security following the successful sale of the Borrowers real estate to a bonafide purchaser.
Toronto-Dominion Bank v. Canada: The Backstory
The chain of events begins with the borrower collecting GST equal to $67,854 (the “Amount”) in 2007-2008 while running their landscaping business. Following this, the Borrower did not succeed in remitting the Amount to the Receiver General, which led to tax liability to the CRA. The Borrower went on to seek a loan from the Bank in 2010 — who, unaware of their tax liability, granted a credit line and term loan — which was held against a mortgage over the Borrower’s real estate, “the Mortgage”. In the following year, the Borrower went on to sell this property, paying their credit facilities back in full. The Bank, therefore, discharged its mortgage security against the property.
Fast forward to 2013. The CRA enforced deemed trust claims for the Amount against the Bank, both in 2013 and 2015, under section 222 of the ETA. This legislation serves the following purposes:
- To create a deemed trust in favour of the Crown with regards to GST and;
- To extend this deemed trust to the property of a tax debtor and;
- To extend this deemed trust to include any property held by secured creditors
Following these deemed trust claims, the Bank refused to pay the Amount, which is where the legal proceedings for the case begin. The Federal Court upheld the arguments of the CRA, and the Bank subsequently took its case to the Federal Court of Appeals.
Toronto-Dominion Bank v. Canada: The Decision of the Federal Court of Appeals
In this case, the Federal Court of Appeals agreed with the Federal Court that the profits on the sale of the Borrower’s real estate fall under the deemed trust and that the Bank is subject to pay the Amount under section 222 of the ETA. What this means is that the Borrower should have used the profits from the earlier property sale to repay the GST to the CRA. When he failed to do so — and instead used the proceeds to repay his obligations to the Bank — this tax liability was shifted onto The Bank as the secured creditor.2
In employing section 222, the Court used the phrase “despite any security interest in the amount” to indicate that Parliament grants absolute priority to the deemed trust in respect of property subjected to a security interest, without regard to the date that security interest arose and the time the GST was collected.
The Court ultimately determined that deemed trusts do not necessitate any triggering events, and simply occur when GST is collected and not remitted.3 The Court rejected the Bank’s use of the bonafide purchaser defence to refute the deemed trust provision, finding that a secured creditor cannot be compared to third-party purchasers.4 The Bank, in turn, attempted to argue that shifting the tax liability onto the Bank is bad policy. The Court deferred to parliament and responded that their responsibility lies with upholding the deemed trust rather than addressing bad policy.5
What is the Key Takeaway for Lenders?
The Court issues standard advise that all Lenders should follow to protect their interests.67 Their advice can be summarized as follows:
- It is the responsibility of the Lender to identify high-risk borrowers before granting any loans and;
- At the lender’s discretion, they should consider adjusting the terms of the mortgage to require tax compliance evidence before lending and discharging security, in addition to;
- Requiring authorization to verify the Borrower’s outstanding liabilities directly with the CRA (note that such authorization should be provided within the CRA’s official forms, which expire within 6 months).
Another security option that Lenders might consider is requiring the Borrower to post an appropriate amount of cash security where a discharge of security is required. Such cash security would stand in place of collateral until a CRA clearance certificate is received. These steps can cause delays in closing transactions, and lenders should be aware that obtaining CRA clearance certificates can be an arduous and lengthy process.