Written by Denise D. Bright, John A. Winters and Gregory Whiteside
On May 25, 2018, the Federal Court of Canada released its decision in Her Majesty the Queen v The Toronto-Dominion Bank. The case revolved around whether the proceeds of the sale of a house by a debtor of Toronto-Dominion Bank (TD) were considered funds held in trust for the payment of overdue GST/HST under the Excise Tax Act (ETA).
The issue arose when the debtor, Mr. Weisflock, voluntarily sold his house and used the proceeds from the sale to pay back the TD mortgage, which was secured by the house. The Canada Revenue Agency (CRA) demanded repayment of the proceeds from TD based on the position that it was the rightful beneficiary pursuant to the deemed trust rules in section 222 of the ETA. The bank refused to return the proceeds.
Mr. Weisflock carried on a landscaping business and in 2007 and 2008, and in relation thereto, he collected but did not remit GST. In 2010, TD granted Mr. Weisflock a home equity line of credit and mortgage, secured by his residence. The Court found that TD was unaware of the outstanding GST remittances at the time of application.
In 2011, Mr. Weisflock sold his house and used the proceeds to repay the debts to TD and the applicable security was discharged. In April 2013, CRA issued a demand to TD for payment of the outstanding remittances on the basis of the deemed trust rules under the ETA.
Section 222 of the ETA addresses outstanding GST/HST remittance in two principle ways. First, a deemed trust is created by the statute when GST/HST is collected by a taxpayer.
Second, it also creates a statutory obligation to pay the proceeds of the trust property to satisfy the tax debt. This statutory obligation requires the repayment of the GST/HST from the deemed trust funds, whomever is in possession of those funds. The Crown, being the beneficiary of the trust funds, is the beneficial owner of these funds and the payment takes priority to any other debt from a secured creditor.
During the trial, TD argued that the proceeds of the house sale did not fit into the definition of “proceeds” under the ETA because proceeds should only refer to amounts obtained by a secured creditor realizing a security. As no definition for proceeds is found in the ETA, or other related tax statutes such as the Income Tax Act, the Court looked beyond the ETA for a proper interpretation of “proceeds”. The Court relied on prior case law and personal property security law for the definition, which it found to convey a wider meaning, including any amount received when voluntarily selling property.
With the definition of proceeds defined broadly enough to capture the proceeds of the sale of the house, the bank made a number of other arguments in order to negate that the statutory trust existed over the proceeds. The first argument was that TD, upon receiving the proceeds, was a bona fide purchaser for value. The principle of the defence of a bona fide purchaser for value states that when a third party purchases something with good consideration and without knowledge of an existing interest, legal or beneficial, the prior interest is defeated. Therefore, a bona fide purchaser for value receiving proceeds from a sale would defeat any beneficial interest the Crown may have in unpaid GST/HST.
However, the Court found that the repayment of a loan is not considered a purchase, and therefore TD could not be a bona fide purchaser for value. If that were the case, secured creditors could always invoke this defence when dealing with the proceeds of a security interest, completely undermining the intent of section 222 of the ETA. Secured creditors are not purchasers when they are being repaid for their debt voluntarily, or when they realize their security. Interestingly, the Court noted that the bona fide purchaser for value defence remains available for unsecured creditors.
TD also made the argument that a “triggering event” was required for the trust to come into existence. A triggering event could include the bankruptcy of the debtor or a demand made by the lender. This argument was outright dismissed as the statutory trust operates in a continuous manner as long as the debtor is in default of its obligations to remit.
Ultimately, the Court determined that a secured creditor without any knowledge of a debtor’s tax debt can have the amounts received for repayment of a loan retroactively seized by the Crown, due to the super priority of the Crown in respect to GST/HST.
It is important to note that other federal statutes contain similar provisions to section 222 of the ETA. One of the outstanding issues is that, in many cases, secured creditors may have no way of knowing about their debtors’ GST/HST debt.
While the Court admitted that this super priority is rather harsh, it also determined that this outcome was the proper intent of Parliament. That being said, Parliament gave secured creditors a partial exemption through registering a prescribed security interest under the Security Interest GST/HST Regulations. This exemption retains the priority of a security over the Crown for a portion of a mortgage on land or a building or hypothec, as long as the interest is registered before the deemed trust arises. In other words, the interest must be registered before the tax debtor owes their tax debt, which would not have assisted TD in the case at hand.
While some protection is granted to the secured lender through this prescribed security interest, it exists only in relation to mortgages and hypothecs and is often less than the full value of the debt to the secured creditor.
Not surprisingly, this case has been appealed and the decision of the Federal Court of Appeals is eagerly awaited.