Are secured creditors liable for retail customers’ GST-HST debt?

  • October 17, 2018
  • Robert G. Kreklewetz and Steven Raphael

To assist the CRA in collecting unremitted GST/HST, section 222 of the Excise Tax Act creates a deemed trust in favour of the Crown for the unremitted amount. These deemed trust provisions create a super-priority for the Crown over all of a tax debtor’s assets, including those held by a secured creditor.

In Canada v Toronto Dominion Bank, 2018 FC 538, the Federal Court of Canada held that these deemed trust provisions encompass the proceeds flowing from the voluntary sale of a tax debtor's property (a house) and payment of the resulting funds to a secured creditor (the bank holding the mortgage security). The court also concluded that the bank, as a secured creditor, could not rely on the equitable bona fide purchaser for value defence to defeat the section 222 deemed trust. Practically speaking, this decision could dramatically affect the way in which secured creditors like banks approach mortgages and other lending transactions where borrowers may have existing tax debts.

In this case, the debtor, who carried on a landscaping business as a sole proprietorship, collected but failed to remit GST totalling $67,854 in 2007 and 2008. In 2010, TD Bank, which was unaware of the debtor’s tax debt, granted the debtor and his spouse a home equity line of credit and a mortgage. These loans were secured on the debtor’s house and charges in favour of TD Bank were duly registered. In 2011, the debtor sold his house and used the proceeds of the sale to repay the outstanding debt of the mortgage and line of credit to TD Bank, which discharged the registered security interests.

The CRA subsequently issued TD Bank a demand letter seeking payment of the $67,854 tax debt as it argued that the statutory deemed trust provision in section 222 of the ETA applied to the proceeds of the property sale and required TD Bank to reimburse the payments made by the debtor out of the property that was deemed to be held in trust. TD Bank disagreed as it argued, inter alia, that it was entitled to rely on the equitable bona fide purchaser for value defence, which holds that if an acquirer of trust property gives value and does not know that the transfer amounted to a breach of the trust, the claim of the beneficiary of the trust can be defeated.

After considering the language of section 222 of the ETA and applicable case law, the court held that the funds paid by the tax debtor to TD Bank constituted “proceeds” of the debtor’s property that were the subject of a deemed trust. In particular, the court found that the phrase “the proceeds of the property shall be paid to the Receiver General” in subsection 222(3) encompasses proceeds flowing from the voluntary sale of a tax debtor’s property. Upon such a sale, a tax debtor is therefore obliged to pay the proceeds to the Receiver General, and if it fails to do so, and instead pays a secured creditor, that secured creditor is statutorily obliged to repay the money to the Crown.

In regards to the bona fide purchaser for value defence raised by TD Bank, the court held that while this equitable defence is available to unsecured creditors, it cannot be invoked by a secured creditor to defeat a section 222 deemed trust. To hold otherwise would, in the court’s opinion, render the deemed trust provisions in section 222 meaningless, and would be inconsistent with the legislative history of these provisions which evidenced an intention by Parliament to single out secured creditors and treat them differently than other creditors.

The court acknowledged that the conclusion that it reached may seem “harsh on secured creditors, especially when they are lending to individual customers as opposed to businesses.” However, it reasoned that subsection 222(4), which provides that for the purposes of the deemed trust provisions, “a security interest does not include a prescribed security interest,” suggested that “Parliament has already considered the potentially harsh consequences of the deemed trust on lenders and has drawn a line as to what is exempted.”

The decision in TD Bank could have a dramatic impact on the way in which secured creditors, like banks, approach housing mortgages and other secured loan transactions (e.g., auto loans) to retail customers with unincorporated businesses because it essentially stands for the proposition that if a creditor provides a secured loan to a retail customer, who unbeknownst to the creditor has an unincorporated business with a tax debt, the loan essentially becomes the property of the Crown and the secured loan cannot be repaid until after the outstanding tax debt is paid. To make matters worse, if the secured loan is repaid before the tax debt is extinguished, the secured creditor becomes personally liable for the individual’s tax debt even if it was still unaware of the tax debt when the secured loan was repaid.

This decision could certainly make it much more difficult for businesses, particularly sole proprietors, to obtain mortgages and bank loans because unlike construction liens, there is no search mechanism in place for a secured creditor to determine the existence of a section 222 deemed trust before advancing funds. Given the significant implications of this decision, we would not be surprised if this decision, which has been appealed to the Federal Court of Appeal, is ultimately overturned.

Robert G. Kreklewetz and Steven Raphael are lawyers with Millar Kreklewetz LLP