Lenders, like any businesses, prefer certainty. In many ways the real property lending industry is built around trying to be as certain as possible before a loan is advanced. Does a borrower own their property? How much is that property worth? How much does a borrower make in a year? Can the borrower pay the mortgage, and if they can’t, is there enough value in the property to cover the loan?
In 2018 the Federal Court, in a decision involving the Toronto-Dominion Bank (the “Bank”), reminded lenders that, when it comes to amounts owing by a borrower to the Canada Revenue Agency (the “CRA”), sometimes things really aren’t that certain.
In this case, a landscaping business (the “Borrower”) collected goods and services tax (“GST”, the same analysis applying to HST) in the amount $67,854 relating to that business. The Borrower failed to remit this amount to the Receiver General. In 2010, after the Borrower failed to remit collected GST, the Bank granted the Borrower a line of credit and a mortgage, which were both secured against the Borrower’s property. The Bank was unaware of the Borrower’s unremitted GST amounts. Upon selling the property in 2011, the Borrower repaid the line of credit and mortgage and the Bank discharged the charges registered against the property.
In 2015 the CRA asserted a deemed trust claim in the amount of $67,854 again the Bank pursuant to the provisions of the Excise Tax Act (Canada) (the “Act”). The Act creates a deemed trust in favour of the Crown with respect to GST amounts collected. The Act also extends this deemed trust to the property of the tax debtor, including property held by secure creditors such as the Bank. The Bank refused to pay for the Borrower’s tax debts and the CRA commenced legal action. The Federal Court found in favour of the CRA and ordered the Bank to pay $67,854 plus interest to the Crown. The Bank appealed.
Spoiler: The Federal Court of Appeal in Toronto-Dominion Bank v Canada, 2020 FCA 80, dismissed the appeal, upholding the ruling of the Federal Court.
The issue before the Federal Court of Appeal involved the correct interpretation of the deemed trust provisions of the Act. The Court began its analysis by considering the proper interpretation and history of the deemed trust provisions. The Court noted that Parliament had amended the relevant section of the Act to give absolute priority to the deemed trust over secured creditors and to extend the scope of the deemed trust to include property of the debtor and property held by any secured creditor. Based on its interpretation of the provisions, the Court found that Parliament intended to grant priority to the deemed trust in respect of the property that is also subject to a security interest.
The purpose of the provision is to protect the collection of unremitted GST/HST.
Therefore, when the Bank granted the Borrower a line of credit and mortgage and took security over the Borrower’s property, a deemed trust arose in favour of the Crown to the extent of the tax debt. When the Borrower sold the property, the Bank was statutorily obligated to remit the proceeds it received to the Receiver General.
The Court did note that the super priority normally given to the deemed trust provision of the Act does not survive bankruptcy under the Bankruptcy and Insolvency Act (Canada), nor does it apply to arrangements under the Companies’ Creditors Arrangement Act (Canada). Effectively this means that a secured lender would likely be in a better position if a borrower goes bankrupt, at least as it relates to unremitted GST/HST.
The Court also noted that lenders who advance funds and take security before a borrower fails to remit GST/HST are protected by subsection 222(4) of the Act. This provision provides that the deemed trust will not override certain “prescribed security interests”, which is generally interpreted as including a mortgage on a borrower’s property before the borrower fails to remit GST/HST.
The Federal Court of Appeal ultimately upheld the decision of the Federal Court, requiring the Bank to pay to the Crown the sum of $67,854 plus interest. The Court found that no triggering event is required to bring the deemed trust into operation. It was further held that the Federal Court did not err by finding that the bona fide purchaser for value defence is not available to secured creditors such as the Bank.
Finally, the Court outlined the following potential options for secured lenders to manage the risk posed by deemed trusts: “identify higher risk borrowers (which might include persons operating sole proprietorships), require borrowers to give evidence of tax compliance, or require borrowers to provide authorization to allow the lender to verify with the Canada Revenue Agency whether there are outstanding GST liabilities then known to the Agency.”
Lenders would be wise to follow the advice of the Federal Court of Appeal, at least to the extent that a lender can, however any lender who wishes to verify the status of a GST/HST account with CRA should be prepared for a delay between receiving a loan application and when the transaction will be able to close.
It’s also important to remember that, by the time CRA demanded payment from the Bank, the mortgage was already discharged. Even if the Bank can try to recover the amount they had to pay from their Borrower, without registered security the Bank is an unsecured creditor, and the current financial health, and legal status, of the Borrower is unknown.
It would not be surprising for the Bank to attempt to appeal this decision to the Supreme Court of Canada. Considering the decision of the Federal Court of Appeal was unanimous, though, the likelihood of the Supreme Court agreeing to hear an appeal could be slight. Even if appealed, lenders need to make sure they do their due diligence when underwriting, because, unless overturned by the Supreme Court or amended by Parliament, what is certain is that, if a borrower has unremitted GST/HST from before a mortgage is registered, CRA will continue to look to lenders to ensure that tax debts are paid.
Prepared with the assistance of Katelyn Parry, Student-at-Law.