In a “bad news case” for unsecured creditors, the Federal Court has confirmed that the CRA’s deem trusts over things like unpaid GST/HST and income tax source deductions take precedence to prevent loan repayment to unsecured creditors.  This means that related and unrelated persons loaning money to Canadian small businesses on an unsecured basis (which is common - think about the loans being advanced by business partners, parents and spouses) are at risk when those businesses default on their tax obligations.

Canada Trust Case

Canada v. Toronto-Dominion Bank (TD Canada Trust) (2024 FC 441) TD Bank (“TD”) received monies from a customer (“HNJE”).  The monies that HNJE paid to TD were related to the proceeds that HNJE received from the sale of its business assets to a third party.  TD used the monies, as received from HNJE, to pay off an unsecured overdraft on one of HNJE’s accounts. 

Relying on its powers in section 227 of the Income Tax Act (the “ITA”) – which are paralleled in section 222 of the Excise Tax Act (the “ETA”) for GST/HST purposes – the CRA demanded that TD pay those monies over to it, taking the position that the monies had been impressed by a deemed trust, and therefore continued to be held in trust by TD for the CRA.  TD resisted that demand, taking the position that once HNJE conveyed the monies to TD, the deemed trust no longer applied, and that section 227 did not apply to unsecured creditors.  TD also asserted that it was a bona fide purchaser for value and said that was a full defence to the application of the CRA’s deemed trust powers.

Federal Court Decision

The Federal Court ultimately agreed with the CRA’s position, confirming that section 227 creates a statutory obligation that applies to unsecured creditors.  [Interestingly, the statutory obligation, from the language at the end of subsection 227(4.1), was to pay the proceeds of the deemed trust property over to the Crown;  thus, the Court skirted the issue of whether the monies in the hands of TD were also impressed with the deemed trust – which other cases seemed to put at doubt:  see First Vancouver Finance v. MNR (2002 SCC 49)].

The Federal Court also rejected the bona fide purchaser defence, confirming that the purpose of section 227 is to ensure that the CRA is able to collect unremitted tax and that giving recourse to unsecured creditors in a case like this would defeat that purpose.

Takeaways

Canada already has a number of rules aimed at payments made by tax debtors to related parties for less than fair market value (e.g., section 160 of the ITA and section 325 of the ETA - see a prior blog by us on these rules here).

This case highlights that even where there is “fair market value” given by those related parties, and even unrelated parties, other rules in the ITA and the ETA may impact and force the payment of those proceeds to the CRA.   Hence payments of money to relatives and spouses to “extinguish prior loans”, may be subject to CRA collections in the same manner as seen in TD Trust here.

The bottom line is that business owners facing tax difficulties for GST/HST and source deductions ALWAYS need to tackle these tax problems head-on, dealing with their Notices of Assessment when they are issued and using professionals.

Want a PDF copy of this blog?