End of Debate: GST/HST Deemed Trusts Ruled Ineffective Against Secured Creditors Post Bankruptcy

December 21, 2018
  • On November 8, 2018, the Supreme Court of Canada (“SCC”) reversed the Federal Court of Appeal decision in Callidus Capital Corporation v. Canada, 2018 SCC 47.
  • The SCC held that GST/HST deemed trusts become ineffective, as of the date of a tax debtor’s bankruptcy, against a secured creditor who received, prior to that date, proceeds from the assets of such tax debtor that were deemed to be held in trust for the Crown.
  • The Callidus decision has been warmly received by secured creditors as well as insolvency and commodity tax practitioners, as it has been perceived as re-establishing confidence in the secured-financing business sector.
  • However, as suggested by another recent ruling of the Federal Court, Canada v. Toronto-Dominion Bank, a GST/HST deemed trust will likely remain effective in cases where a bankruptcy has not intervened between the secured creditor’s receipt of proceeds from a tax debtor’s sale of assets and the Crown’s enforcement action with respect to those proceeds.
  • It remains to be seen how the SCC ruling in Callidus will impact, from a practical standpoint, the strategies implemented by secured lenders and tax authorities alike in the context of a tax debtor’s insolvency.


In a unanimous decision delivered from the bench, the SCC recently reversed the decision of the Federal Court of Appeal (“FCA”) in Canada v. Callidus Capital Corporation. The SCC agreed with the dissenting judge on the FCA panel that the original ruling of the Federal Court (“FC”), dating from 2015, was correct.

As summarized by the SCC, the issue examined by all three courts was essentially whether:

“…the bankruptcy of a tax debtor and subsection 222(1.1) of the Excise Tax Act (“ETA”) render the deemed trust under section 222 of the ETA ineffective as against a secured creditor who received, prior to the bankruptcy, proceeds from the assets of the tax debtor that were deemed to be held in trust for the [Crown].”

The Crown holds an absolute priority with respect to proceeds remitted to a secured creditor from a tax debtor’s assets, which proceeds are deemed to be held in trust under section 222 of the ETA prior to such tax debtor’s bankruptcy. Although the ETA is clear that this deemed trust does not survive bankruptcy, this was likely the first time that any tribunal had to apply that rule in a situation where proceeds from the sale of a tax debtor’s assets (deemed to be held in trust) were actually remitted to a secured creditor and then claimed in that creditor’s hands by the Crown pre-bankruptcy but where the Crown did not, and was arguably unable to, bring an enforcement action until after the tax debtor’s bankruptcy.

Timeline of Events

Between 2010 and 2013, Cheese Factory Road Holdings Inc. (“Cheese Factory”), which, in spite of its name, carried on business as a real estate investment company, collected $177,299.70 in GST/HST that, contrary to law, it failed to remit to the Receiver General for Canada. Pursuant to subsection 222(1) of the ETA, the amounts thus collected were deemed to be held in trust for Her Majesty.

Meanwhile, Cheese Factory had obtained a secured credit facility from a major chartered bank (the “Bank”). In December 2011, the Bank assigned its interest in Cheese Factory’s indebtedness to Callidus Capital Corporation (“Callidus”). As it was then in default under the Bank’s credit facility, Cheese Factory entered into a forbearance agreement with Callidus that required it to market some of its real estate property and turn over any net proceeds to Callidus. On April 5, 2012, Cheese Factory succeeded in selling one of its properties for $790,000 and duly remitted the net proceeds to Callidus four days later in partial repayment of its outstanding indebtedness.

Just a few days earlier, on April 2, 2012, the Crown sent a letter to Callidus claiming $90,844.33 in respect of unremitted GST/HST pursuant to the deemed trust provided for under subsection 222(3) of the ETA. The Crown requested that all proceeds received by Callidus from Cheese Factory’s asset sale be paid to the Receiver General for Canada up to the amount of the deemed trust - a demand Callidus appears to have ignored. More than 7 months later, in November 2013, Cheese Factory made an assignment in bankruptcy under the Bankruptcy and Insolvency Act (“BIA”), at Callidus’ request. Shortly thereafter, the Crown officially commenced proceedings against Callidus by filing a statement of claim in the FC.

The Rulings

Federal Court

The FC held that the bankruptcy of Cheese Factory had rendered the deemed trusts under subsections 222(1) and 222(3) of the ETA ineffective. In reaching its conclusion, the FC relied on subsection 222(1.1) of the ETA, which provides that the deemed trust under subsection 222(1) is extinguished upon bankruptcy of the tax debtor. The FC noted that subsections 67(2) and 67(3) of the BIA work in conjunction with this provision by reinforcing with strong language that the deemed trust does not survive following bankruptcy unless the amounts deducted are considered source deductions. The FC also relied on the SCC decision in Century Services Inc. v. Canada (Attorney General), in which the SCC stated that subsection 67(3) of the BIA “expressly provide[s] that deemed trusts for source deductions remain effective in insolvency” and that Parliament has therefore “clearly carved out exceptions from the general rule that deemed trusts are ineffective in bankruptcy”. According to the FC, the absence of a BIA carve-out for deemed trusts for sales taxes must be understood as indicating Parliament’s intention that any such trust should lapse upon the commencement of insolvency proceedings.

Federal Court of Appeal

In the majority ruling delivered by Justice Rennie, in which Justice Near concurred, the FCA overturned the FC’s decision. The majority of the FCA held that despite the subsequent bankruptcy of a debtor, a secured creditor who had received proceeds subject to a subsection 222(3) ETA deemed trust remained under an obligation to pay these proceeds to the Crown. In this context, the secured creditor was personally liable to the Crown to make these payments. To rule otherwise, in the majority’s view, would undermine the purpose of the deemed trust by allowing a secured creditor to manipulate both pre- and post-bankruptcy priorities, and would “… create perverse incentives on the part of secured creditors to not abide by the deemed trust.”

In his dissenting reasons, Justice Pelletier held that following the bankruptcy of the debtor, the deemed trust created by subsection 222(3) of the ETA had lapsed due to lack of subject matter by operation of subsection 222(1.1) of the ETA. In the case at hand, as of the date of bankruptcy, there were no amounts subject to a subsection 222(1) ETA deemed trust and as a result, no property of the debtor remained subject to a subsection 222(3) ETA deemed trust. It followed from this that no proceeds of that property were payable to the Crown by the secured creditor Callidus. Justice Pelletier cemented his point by stating that the demand for payment made by the Crown prior to the bankruptcy was irrelevant in this context. Justice Pelletier concluded by stating that:

“…an examination of the text of subsection 222 of the [ETA] teaches that the relationship between the deemed trusts created by subsection (1) [and] subsection (3) is such that the extinction of the former upon bankruptcy - by operation of subsection (1.1) - puts an end to the latter at the same time.”

Supreme Court of Canada

Justice Pelletier’s dissent opened the door for an appeal to the SCC. The SCC did not issue any substantial reasons of its own. Rather, in a ruling delivered from the bench, it adopted the dissenting reasons of Justice Pelletier and reversed the decision of the FCA’s majority, reinstating the decision of the FC. In so doing, the SCC made it clear that deemed trusts under subsections 222(1) and (3) of the ETA become ineffective as of the date of the tax debtor’s bankruptcy against a secured creditor who received proceeds from the assets of such tax debtor that were deemed to be held in trust for the Crown, even where the proceeds were received by the secured creditor prior to bankruptcy.

Editorial Comments

The SCC’s ruling clarifies the applicable state of the law as regards a subsection 222(3) ETA deemed trust in the context of a tax debtor’s bankruptcy. It should be noted, however, that in the absence of a bankruptcy, the result may be quite different.

In Canada v. Toronto-Dominion Bank (May 25, 2018), the FC recently ruled in favour of the Crown, which in that case was pursuing a bank for payments received from a bank customer who had sold his house and used the proceeds to repay his personal line of credit and mortgage. The bank did not enforce its security against its customer and the security registered by the bank against his house was discharged without the customer going bankrupt. At the time of repayment, the bank did not know that the customer’s landscaping business owed an unremitted GST debt to the Crown. On receiving a demand letter from the tax authorities asking it for $67,854 out of the proceeds of the sale of the house to cover its customer’s unremitted GST debt, the bank declined to pay.

The FC was unmoved by the bank’s argument that it was an innocent “bona fide purchaser for value” (any such status being irrelevant in light of the statutory language) and rejected its argument that the reference to “proceeds” in subsection 222(3) of the ETA refers only to the proceeds of a sale initiated by the party from whom payment is being sought (the bank, in this case), rather than to the proceeds of a voluntary sale by the tax debtor. The FC accordingly ruled that the debtor’s house fell under the purview of the section 222 ETA deemed trust and that any proceeds derived from its sale were to be paid in priority to the Crown in accordance with sections 222 of the ETA and 227 of the Income Tax Act. To the extent that they had been paid instead to a secured creditor, such as the bank, such proceeds could be recovered directly from said secured creditor by the Crown. It is noteworthy that subsection 222(4) of the ETA excludes "prescribed security interests" from the deemed trust mechanism. The prescribed security interest exclusion allows for a certain portion of a mortgage or hypothec to be excluded from the deemed trust, provided it was registered before the time an amount is deemed under section 222 of the ETA to be held in trust by the person. However, in Canada v. Toronto-Dominion Bank, the bank did not have a “prescribed security interest” because its security had been registered after the GST amounts had been collected by the bank customer.

In light of the potential personal liability for repayment that may arise if proceeds are subject to a deemed trust, lenders should be cautious when coming across claims for unremitted GST/HST. The foregoing cases are also a stark reminder of the game-changing effects a bankruptcy of the debtor can have. As Justice Pelletier himself noted in his dissenting reasons that were upheld by the SCC:

“I recognize that this results in a situation in which a secured creditor has an incentive to resist payment in the hope that the amount of the subsection (1) deemed trust will be extinguished and may even help that process along by petitioning the tax debtor into bankruptcy…”

It remains to be seen how the SCC ruling in Callidus will impact not only the strategies implemented by secured lenders in insolvency, but also by tax authorities themselves, as the latter may have an added incentive to rely on collection tools to seek payment of all unremitted sales taxes from third parties related to the tax debtor before a bankruptcy occurs.

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