Under various tax statutes, the government has delegated tax collection responsibilities from Canada Revenue Agency (“CRA”) to third parties. Two examples of this delegation are collection of employee remittances and sales taxes. In both instances, CRA requires a third party (the employer in the instance of employee remittances, or the retailer/wholesaler in the instance of sales taxes, each referred to as the “Tax Debtor”) to collect these funds on behalf of CRA and remit them to the government.
The relevant tax statutes state that a Tax Debtor collects these funds on behalf of CRA and are deemed to hold said funds in trust (the “Deemed Trust Funds”) on behalf of CRA, until the funds are remitted to the government. When the Tax Debtor either incorrectly reports the Deemed Trust Funds owing, or alternatively, fails to remit the Deemed Trust Funds to CRA, arrears have likely accrued and the Tax Debtor is responsible to account.
In recent years, the question has arisen as to who is responsible for the Deemed Trust Funds in instances where the Tax Debtor can’t, or won’t, account for the arrears? In these instances CRA can look to a number of other parties, and specifically any number of creditors who have received payments. In fact, in recent years, CRA has taken a more aggressive approach to lender liability for a Tax Debtor’s unremitted Deemed Trust Funds.
In Callidus Capital Corp. v. Canada (“Callidus Capital”) CRA took the position that, in instances where a Tax Debtor has pre-bankruptcy HST arrears, any payments by that Tax Debtor to its secured creditors were subject to clawback by CRA on account of those funds being impressed with a statutory trust. CRA’s position was that even though a Tax Debtor’s subsequent bankruptcy eliminates trust claims for HST arrears, this provision of the Bankruptcy and Insolvency Act did not apply to payments received by a secured creditor prior to the bankruptcy date. In November 2018 the Supreme Court of Canada overturned the Federal Court of Appeal decision in Callidus Capital and restored what many insolvency practitioners believed to be the case: That the bankruptcy of a debtor reverses HST trust claims, including trust claims that might have existed at a time when a secured creditor received payment on account of their debt (but no longer exist due to the bankruptcy). Accordingly, in bankruptcy, HST arrears do not enjoy priority to payment over secured and unsecured creditors.
Prior to the Supreme Court of Canada’s decision in Callidus Capital, the Federal Court Trial Division was asked to decide whether a mortgagee that provided financing and had subsequently been repaid on its mortgage could, subsequent to repayment, be required to account for HST arrears owing at the time that the mortgagee was repaid (regardless of whether the lender knew about the HST arrears). In Canada v. Toronto-Dominion Bank (“TD Bank”) the Federal Court held that the mortgagee (in this instance the Toronto-Dominion Bank) was required to account for the mortgagor’s unpaid HST at the time that the mortgagee was repaid.
Toronto-Dominion Bank appealed to the Federal Court of Appeal, however, the Federal Court of Appeal had the benefit of the Supreme Court of Canada’s decision in Callidus Capital. With that background, there was some cautious optimism in the lending community that the Federal Court of Appeal would overturn the decision in TD Bank.
On April 29, 2020 the Federal Court of Appeal released its decision in TD Bank and dismissed the appeal. The Federal Court of Appeal concluded that, in instances where a mortgage is granted and subsequently repaid, all while HST is outstanding, it does not become a “prescribed security interest” under the Excise Tax Act and, as such, repayment of said mortgage remains subject to CRA’s deemed trust claim for HST arrears and thus CRA can hold mortgagees to account.
Among the arguments raised by the appellants in TD Bank, was the concept that a statutory trust takes the form of “floating charge” and, as a result, there needs to be “crystallizing event” (i.e. a demand or enforcement etc.) before payments to a secured creditor are subject to clawback. The concept of a “floating charge” for deemed trust claims was first approved by the Supreme Court of Canada in First Vancouver Finance v. MNR (“FVF”) in the context of a Tax Debtor factoring its receivables to a third party.
The Federal Court of Appeal in TD Bank held that while the deemed trust as a “floating charge” applies in the context of HST arrears owing by a Tax Debtor, the “floating charge” concept in FVF only applies when the Tax Debtor is conducting business in the ordinary course. The “floating charge” does not relate to the lending, and repayment, of funds as between the Tax Debtor and a mortgagee.
The Federal Court of Appeal decision in TD Bank does not fully address a number of practical issues that arise from its decision. For example, why is there a difference between factoring of invoices (which, is more akin to financing than it is to a Tax Debtor selling its products in the ordinary course) and procuring mortgage financing? Further, at paragraph 85 of the TD Bank decision, the Federal Court of Appeal notes various due diligence options available to mortgagees in ascertaining whether a Tax Debtor owes Deemed Trust Funds. Unfortunately, the decision does not address the fact that CRA has employed a self-reporting system for disclosure and payment of Deemed Trust Funds and the self-reporting system is subject to CRA audit. The Federal Court of Appeal’s decision is silent on whether a lender who completes the due diligence suggested would be relieved of responsibility for Deemed Trust Funds arrears that are discovered by way of a subsequent CRA audit.
In short, while the legal ramifications of the Federal Court of Appeal decision in TD Bank are clear, the practical application of this decision may leave mortgagees with significant uncertainty in assessing a Tax Debtor’s statutory trust obligations and their potential liability.