Primer On CRA's Collection Powers And Its Effect On Secured And Unsecured Creditors

• Published date: 15 October 2020
• Subject Matter: Tax, Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy, Income Tax, Sales Taxes: VAT, GST, Tax Authorities
• Law Firm: Fogler, Rubinoff LLP
• Author: Mr Scott Venton, Vern DaRe and Teodora Prpa

The Canada Revenue Agency ("CRA") has several collection powers under the Income Tax Act² ("ITA") and the Excise Tax Act³ ("ETA") to ensure the remittance of taxes. When taxes are not remitted, the CRA has an arsenal of collection tools including the deemed trust, garnishment, and certification of tax debts with the Federal Court to obtain a judgment. These remedies have different impacts on secured creditors and unsecured (judgment) creditors. They are also treated differently in a bankruptcy situation, with some of the remedies maintaining Crown priority and others losing priority status.

It is important to understand the distinctions between the collection mechanisms and how they operate under the ITA and the ETA in order to advise secured and unsecured creditors or lenders working with individuals who have a tax debt. This article examines each of the collection mechanisms and attempts to clarify the distinctions between them.

Overview

Unremitted employee source deductions under the ITA and collected but unremitted Harmonized Sales Tax and Goods and Services Tax ("HST/GST") under the ETA, are obligations owing to the Crown which give rise to a deemed trust. The deemed trust applies to the whole of the tax debtor's property and to the proceeds of that property equal in value to the amount owed to the Crown. In particular, the deemed trust provides the Crown with a super-priority against all other secured and unsecured creditors (with one exception dealing with "prescribed security interests" as discussed below), if the CRA enforces its deemed trust claim.

Where an obligation owed to the Crown arises from other provisions in the ITA or the ETA (e.g., individual income tax, corporation income tax, benefit overpayments, defaulted Canada Student Loans), or arises under some other statute (e.g., customs or levies under the Customs Act⁴ or the Excise Act),⁵ there are various other collection remedies available to the CRA within the legislative schemes, like garnishment or certification of the tax debt with the Federal Court, but they do not necessarily provide the Crown with a super-priority as against secured or unsecured creditors.

When a bankruptcy occurs, the Crown is treated as an unsecured creditor by operation of s. 86 of the Bankruptcy and Insolvency Act ("BIA"),⁶ except in respect of unremitted employee source deductions owing to the Crown under the ITA. In that case, the deemed trust created under the ITA survives. By contrast, the deemed trust created under the ETA for collected but unremitted HST/GST amounts is extinguished on a bankruptcy. Obligations owed to the Crown under the Canada Pension Plan⁷ and the Employment Insurance Act⁸ are treated the same as the deemed trust created under the ITA within and outside of bankruptcy.

Where the Crown proceeds to collect on an outstanding obligation through garnishment, its Requirement to Pay issued under the ITA or the ETA will survive a bankruptcy if the statutory requirements are satisfied before a bankruptcy occurs. If the Crown certifies its tax debt in Federal Court and obtains a judgment, the Crown may enforce the judgment through execution processes available to other judgment creditors. However, the Crown will rank as an unsecured creditor unless the Crown takes the necessary steps to secure the judgment.

Deemed Trusts

Deemed trusts that arise in conjunction with the obligation to remit employee source deductions under the ITA and HST/GST under the ETA exist by operation of law. A deemed trust exists continuously from the date of the initial collection of source deductions or HST/GST not remitted to the CRA.⁹ It attaches to the property of the debtor (and to any proceeds of the property) to the extent of the amount of the unremitted deductions. This is true whether or not the property is subject to a security interest. Where a deemed trust exists, the Crown can enforce its deemed trust against the debtor and any creditor who has obtained proceeds which are rightly owing to the Crown equal in value to the amount of the unremitted tax, and the CRA does not have to take any steps to enforce its deemed trust (i.e. notice, registration).¹⁰

The implications of a deemed trust are the same for secured creditors and unsecured creditors, except where a secured creditor holds a "prescribed security interest". A prescribed security interest is an interest in land or in a building (a mortgage or hypothec) registered against the tax debtor's property before the tax debtor failed to remit the deductions which gave rise to the deemed trust in favour of the Crown.¹¹

Deemed Trusts and Secured Creditors

Unless a secured creditor's interest satisfies the "prescribed security interest" exception described above, secured creditors are vulnerable to the Crown's deemed trust claim. Where a secured creditor holds a security interest in the property of a tax debtor who has outstanding obligations under s. 227(4) of the ITA or s. 222(3) of the ETA, the secured creditor's interest is subordinate to the Crown's deemed trust claim. This is true even...