Federal Court of Appeal confirms CRA deemed trust priority for unremitted HST – mortgage lenders beware
The Federal Court of Appeal released its decision in The Toronto-Dominion Bank v. Her Majesty the Queen on Apr. 29, 20201. This decision confirms the earlier ruling of the Federal Court in relation to the priority of the Canada Revenue Agency`s (“CRA”) deemed trust for outstanding Harmonized Sales Tax (“HST”) amounts (outside of a bankruptcy) as against the interests of a secured creditor whose loans were paid out prior to the assertion by the Crown of the deemed trust.
The facts of the case are pretty simple. The tax debtor (Weisflock) was engaged in a landscaping business as a sole proprietor. The business fell into arrears in relation to the collection and remittance of HST. Subsequent to this, The Toronto-Dominion Bank (“TD Bank”) provided loans to the debtor secured by mortgages against his personal residence. There is no indication whether TD Bank made any inquiries at the time in relation to the HST remittances for the business. Ultimately, the property was sold in the ordinary course and the TD Bank mortgages were repaid.
After the property was sold and the TD Bank mortgages repaid, CRA made a claim against TD Bank seeking a portion of the repayment proceeds to pay off the tax debtor’s unremitted HST debt.
The deemed trust for HST collections (founded in section 222(1) of the Excise Tax Act (Canada) – the “ETA”) provides the Crown with a charge over the assets of the tax debtor in priority to the interests of a secured creditor (outside of a bankruptcy).
TD Bank contested the Crown’s claim at the Federal Court but lost. This case was difficult because TD Bank was paid out before the CRA claim was asserted. Seemingly, it would have been difficult for TD Bank to protect its position against a claim it did not know existed.
Federal Court of Appeal decision
The Bank raised three arguments on appeal:
- The deemed trust in the ETA requires a triggering event in order to take priority over the interests of a secured creditor. This trigger would likely take the form of a demand for payment or something similar. In this case, the CRA did not assert any claim until after TD Bank was paid out. Thus, at the time of the triggering event, TD Bank was no longer a secured creditor and, arguably, not subject to the deemed trust provisions. TD Bank was trying to equate the deemed trust with a floating charge based in part of the Supreme Court of Canada’s reasoning in the First Vancouver Finance v. M.N.R., a case decided in 2002. The Court disagreed. The response was based on the view that the ETA deems “the property of a tax debtor and property held by a secured creditor to be held in trust once GST is collected but not remitted.” As a result, the deemed trust arises without the need for a triggering event.
- TD Bank argued it was a “bona fide purchaser for value” of the mortgage repayment funds. The court rejected this argument and concluded that such an argument could not be made by a secured creditor in the position of TD Bank.
- Finally, TD Bank argued that the Court failed to consider that TD Bank did not advance funds for the debtor’s business but rather secured against a personal residence. TD Bank cited no authority to support this distinction. The Court further concluded that there was no evidence before the Court that TD Bank knew anything about the debtor’s source of income.
What this means for you
Please note that the ETA contains a carve-out for prescribed security interests which protects the interest of a secured creditor who takes a real property mortgage before the HST deemed trust arises. That argument was not available in this case as the deemed trust arose first. Note, however, that the prescribed security interest carve-out is rather convoluted and hard to apply. It starts from the principle balance of the mortgage on the day the HST arrears commence. There is some debate as to whether accruing interest is protected under this exception. The protected mortgage amount is reduced by the amount of principle payments made and must also be reduced by the value of any additional security which the lender holds, including the value of guarantees.
On the face of it, this is a harsh result for the lender. One way to potentially address any concern is to seek a comfort letter from the CRA at the time of the repayment of a mortgage as to the status of the HST account of the borrower/tax debtor. The main difficulty with this is the fact that such a letter will be clearly stated to be “subject to audit”. Thus, there is no guarantee that a lender could rely on this letter in the event a subsequent audit would show an HST liability. There is some suggestion that the CRA’s position is that it would not likely go behind a comfort letter even where a subsequent audit may give it grounds to do so except, for example, in the circumstance where the lender has actual knowledge of pending HST issues. A further issue is the time it takes to secure such a letter. Such a process may take 10-14 days or more in some cases to turn around.
On a practical level, there will always be the issue of whether a lender (or its counsel) will actually seek a comfort letter. That prospect may be even more remote where the mortgage payout takes place within the bank itself without the assistance of counsel. Given the current economic climate caused by the COVID-19 pandemic which features ever-increasing federal government budget deficits, it is likely that federal tax authorities will take a more aggressive approach to the collection of delinquent taxes – both income tax and HST. Thus, lenders would be well advised to pay attention to this decision and adopt internal safeguards to protect themselves.
We note that a bankruptcy of the tax debtor would eliminate the HST deemed trust (given the Supreme Court of Canada’s recent decision in the Callidus2 case).
The result in the Toronto-Dominion Bank case would also arise in the case of arrears for source deductions. Note, however, that a subsequent bankruptcy would not eliminate this deemed trust.
There is no indication yet whether TD Bank will seek a further appeal to the Supreme Court.
1 2020 FCA 80.
2 Callidus Capital Corporation v. Her Majesty the Queen, 2018 SCC 47.
This update is intended for general information only. If you have questions about the above, please contact a member of our Banking and Financing group.
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