GST/HST deemed trust is rendered ineffective against secured creditors post-bankruptcy

September 24, 2015

In its decision in The Queen v. Callidus Capital Corporation1, rendered on August 17, 2015, the Federal Court of Canada examined, on a retrospective basis, the Crown's absolute priority regarding proceeds remitted to secured creditors from the assets of a tax debtor that are deemed to be held in trust (deemed trust) under section 222 of the Excise Tax Act (the "ETA") prior to such tax debtor's bankruptcy. Although the ETA is clear that this deemed trust does not survive bankruptcy, to our knowledge this is the first time that a tribunal has 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.

Facts and background

The Crown claimed that between 2010 and 2013, Cheese Factory Road Holdings Inc. ("Cheese Factory") collected GST/HST but failed to remit such amounts to the Receiver General. GST/HST amounts collected by Cheese Factory were deemed to be held in trust for Her Majesty pursuant to section 222 of the ETA.

Cheese Factory carried on business as a real estate investment company. It had obtained a secured credit facility from the Bank of Montreal ("BMO") which subsequently assigned its interest in Cheese Factory's indebtedness to Callidus Capital Corporation ("Callidus") in December 2011. At the time of the assignment, Cheese Factory was in default under BMO's credit facility and entered into a forbearance agreement with Callidus pursuant to which Cheese Factory agreed to market some of its real property and deliver the net sales proceeds to Callidus in partial repayment of the outstanding indebtedness. Cheese Factory sold one of its properties to a third party on April 5, 2012 for a sale price of $790,000, and remitted the net sale proceeds to Callidus four days later. This amount only partially reduced the outstanding indebtedness owed by Cheese Factory to Callidus at that time.

A few days prior to the sale, on April 2, 2012, the Crown sent a letter to Callidus claiming an amount of $90,844.33 in respect of unremitted GST/HST under the ETA's deemed trust mechanism. The Crown requested that all proceeds of Cheese Factory's real property sale received by Callidus be paid to the Receiver General up to the amount of the deemed trust - a request that Callidus appears to have ignored. More than 7 months later, in November 2013, at the request of Callidus, Cheese Factory finally made an assignment in bankruptcy under the Bankruptcy and Insolvency Act (the "BIA"). Shortly thereafter, toward the end of the same month, the Crown officially commenced proceedings against Callidus by filing a statement of claim with the Federal Court.

Thus the Federal Court of Canada was called upon to decide whether the bankruptcy of a tax debtor rendered the GST/HST deemed trust ineffective against a secured creditor who, prior to the bankruptcy, had received proceeds from the assets of the tax debtor that were deemed to be held in trust particularly given that the Crown had formally requested payment from that creditor by letter prior to the bankruptcy.

Callidus' submissions

According to Callidus, subsections 222(1.1) and (3) of the ETA should be interpreted to mean that the deemed trust does not apply once the tax debtor becomes bankrupt. Indeed, subsection 222(3) does not attach to any specific property of the tax debtor, but rather acts like a "floating charge," thus enabling the tax debtor to deal with its property free and clear of the deemed trust. Callidus further asserted that, absent clear and unambiguous language to that effect, subsection 222(3) does not allow for the deemed trust to continue to attach to the property of the tax debtor following payment to a creditor, whether or not the tax debtor has subsequently become bankrupt.2

Callidus also pleaded that if the Crown were permitted to recover amounts paid by a tax debtor to its creditors notwithstanding subsequent bankruptcy, creditors would have an incentive to place debtors in bankruptcy rather than trying to reach a settlement3 and that this "would aggravate the social and economic losses of insolvency."4

Crown's submissions

According to the Crown, pursuant to subsection 222(3) of the ETA, the assets of Cheese Factory were deemed to be beneficially owned by, and held in trust for, the Crown despite Callidus' security interest. The Crown submitted that:

[...] the language of section 222(3) [sic] imposes a positive obligation which mandates that proceeds of assets "imprinted" with a deemed trust shall be paid:
222(3) [...] and the proceeds of the property shall be paid to the Receiver General in priority to all security interests.5

Moreover, the Crown asserted that if a secured creditor has failed to comply with the obligation to remit proceeds from the sale of property subject to a deemed trust to the Crown, such secured creditor becomes personally liable for the unpaid amounts and the Crown has an independent cause of action against the former. Because the secured creditor's liability originates, and the ensuing separate cause of action "crystallizes", prior to the bankruptcy, it is not dependent on whether the deemed trust continues to operate post-bankruptcy.


The Court held that the bankruptcy of Cheese Factory had rendered the deemed trust under subsections 222(1) and 222(3) of the ETA ineffective. In reaching that conclusion, the Court relied on subsection 222(1.1) of the ETA, which provides that the deemed trust is extinguished upon bankruptcy of the tax debtor. The Court 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 exist following bankruptcy unless the amounts deducted are considered source deductions.6 The Court also relied on the Supreme Court decision in Century Services Inc. v. Canada (Attorney General)7, wherein the Court stated that subsection 67(3) of the BIA: "expressly provide[s] that deemed trusts for source deductions remain effective in insolvency" and that the Parliament has therefore "clearly carved out exceptions from the general rule that deemed trusts are ineffective in bankruptcy"8. The Court found it clear that the operation of the deemed trust was not confirmed by the BIA, thereby reflecting Parliament's intention to allow it to lapse upon insolvency proceedings being commenced.

The Court noted that since neither subsection 222(1.1) nor subsection 222(3) of the ETA specify which assets remain imprinted by the deemed trust, there is no distinction between assets in the possession of the tax debtor or those which had already been sold before bankruptcy.

In response to the Crown's argument regarding a separate cause of action against the secured creditor, the Court further noted the lack of any "crystallizing" moment, on the facts, that would have immunized the deemed trust from the operation of the BIA and subsection 222(1.1) of the ETA. A mere letter was not enough: the Court stated that if the Crown had issued a "requirement to pay notice" or "notice of garnishment" (a "RTP") under section 317 of the ETA, said notice would have created the obligation for Callidus to pay the unremitted GST/HST despite the subsequent tax debtor's bankruptcy.

Editorial Comments

The Court rightly relied on the Supreme Court decisions in Century Services Inc. v. Canada (Attorney General) and Quebec (Revenue) v. Caisse populaire Desjardins de Montmagny9, wherein the Crown's attempts to maintain deemed trusts after the commencement of insolvency proceedings were denied given the absence of express legislative language authorizing it, to decide that the GST/HST deemed trust becomes ineffective upon insolvency proceedings being commenced, whether or not the assets remain in the possession of the tax debtor.

From a legal standpoint, the Court's comment that a RTP sent to Callidus prior to Cheese Factory's bankruptcy would have created an obligation to pay the unremitted GST/HST seems flawed in this particular context. Indeed, the facts of this case do not indicate that Callidus owed any amounts or was about to loan or advance money to the tax debtor (i.e. Cheese Factory) or to another secured creditor "who has a right to receive the payment that, but for a security interest in favour of the secured creditor, would be payable to the tax debtor."10 As a result, a RTP would likely have been useless in this particular context. The Court's distinguishing of the Supreme Court decision Toronto-Dominion Bank v. Canada11 on the basis that no RTP was issued therefore appears to be a false analogy.

According to the Court: "[t]he question was not whether Callidus was independently liable, but whether the trust continues to operate notwithstanding bankruptcy."12 Even by proving a "pre-existing, fully engaged cause of action," the Crown had to reconcile its position with subsection 222(1.1) of the ETA, which states that the deemed trust under subsection (1) does not survive bankruptcy. However, at any moment prior to bankruptcy, the Crown has an absolute priority on the disposition of the tax debtor's assets, despite any security interest in the property or in the proceeds thereof. In the case at hand, the Crown appeared to have no other means to assert its priority in order to recover the amounts deemed to be held in trust, except for sending a letter to Callidus as soon as possible and subsequently filing a statement of claim. Based on the CRA National Collections Manual, the procedure generally followed by the tax authorities when asserting a deemed trust is to notify the person holding the proceeds of disposition by issuing a deemed trust claim letter.13 In a context where the tax debtor gives the proceeds of disposition of its assets to one of its secured creditors voluntarily, the Crown cannot assess the secured creditor directly, and may not be able to use the other enforcement mechanisms provided for in the ETA. Based on this decision, the Crown's right to exercise its absolute priority pursuant to the ETA deemed trust in the hands of a secured creditor prior to the tax debtor bankruptcy becomes moot in practice: considering that the moment the Crown sends such a letter, a secured creditor can simply provoke the bankruptcy of the tax debtor, thereby nullifying the deemed trust's priority. Moreover, considering that several months can pass between the issuance of the deemed trust claim letter and the actual bankruptcy of the tax debtor, this situation certainly puts the Crown in a puzzling predicament.

It will be interesting to follow the developments regarding this recent case in the coming months. While this decision appears to be a positive development for secured creditors, it must be applied with caution. In this regard, please note that a Notice of Appeal was filed on September 15, 2015.


The authors wish to thank Marc-William Carrothers, Rémi Leprévost and Danny Duy Vu for their valuable collaboration in drafting this article.

  1. 2015 FC 977.
  2. Id., para. 5.
  3. Subsections 61(2) and 67(3) of the BIA specifically provide that any deemed trust created by federal or provincial legislation does not survive following bankruptcy unless the amounts deducted are considered source deductions.
  4. Id., para. 7.
  5. Id., para. 12.
  6. Id., para. 24.
  7. 2010 SCC 60.
  8. Id., para. 45.
  9. 2009 SCC 49.
  10. Para. 317(3)(b) ETA.
  11. 2010 FCA 174, affirmed by the Supreme Court of Canada in Toronto-Dominion Bank v The Queen, 2012 SCC 1.
  12. Supra note 1, para. 40.
  13. CRA National Collections Manual, January 2015, GST Partner (Toronto: Carswell) (CD-ROM database).

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