Section 222

Because a garnishment order could only have effect against monies that belong to the debtor, the court ordered that funds that had been seized pursuant to a garnishment order be paid over to the Receiver General to the extent of amounts that had been collected by the debtor on account of GST or deducted on account of employee source deductions. There was no requirement that such amounts have been kept separate and apart from other monies of the debtor.

The respondent (“Callidus”) was the assignee of a bank loan and related security respecting the assets of the debtor (“Cheese Factory”), which was a real estate investment company that had defaulted under the bank loan. Pursuant to an agreement that Callidus entered into with Cheese Factory at the time of the assignment, Callidus applied the net proceeds from the sale of a real estate property by Cheese Factory and various rent receipts of Cheese Factory to reduce the amount owing to it notwithstanding that there was unremitted GST/HST to which the deemed ETA s. 222(1) trust applied, which remained unpaid. Cheese Factory then made an assignment in bankruptcy at the request of Callidus.

The majority in the Federal Court of Appeal had found that, although s. 222(1.1) causes the deemed trust to disappear on bankruptcy, it does not eliminate the liability of a creditor for having received payments prior to bankruptcy that should have been subject to the Crown’s (at that point, still extant) priority under the s. 222(1) deemed trust so that such “personal liability … can be pursued by the Crown in a cause of action independent of any subsequent bankruptcy proceedings” (para. 26).

On this appeal to the Supreme Court, it reversed the decision below for the reasons given by Pelletier JA in his dissenting reasons. Pelletier JA first found (at paras. 60-61) that the s. 222(1) deemed trust was reduced to nil by payments so that, for example, a deemed trust for $20,000 which created a liability for that amount of a mortgage lender who had received sales proceeds of a secured property of the tax debtor, would be reduced to $10,000 if the tax debtor made a $10,000 payment to the Receiver General on account of collected but unremitted GST/HST. He then stated (at paras 62, 63, 64, 73 and 76):

… [A] demand for payment by the Crown does not “crystallize” the amount of the debtor’s or the secured creditor’s liability to the Crown. That liability is determined by the amount deemed to be held in the subsection (1) trust which in turn determines the extent to which property of the debtor is deemed to be held pursuant to the subsection (3) trust.

… Subsection (1.1) provides that at or after the time of bankruptcy, subsection (1) does not apply to any amounts that were collected on account of tax prior to that time. The result is that after bankruptcy, there is no amount deemed to be held in trust pursuant to subsection (1) for amounts collected as tax but not remitted pre-bankruptcy. The subsection (3) trust which arose prior to bankruptcy no longer has any subject matter because the trust only attaches to property of the tax debtor to the extent of the subsection (1) trust which no longer exists. This is true for the tax debtor as well as for the tax debtor’s secured creditors.

I can see no difference in principle between the reduction of the subsection (1) trust to nil by payment or by operation of law. In either case, the subsection (3) trust whose operation depends upon the existence of an amount deemed to held in trust pursuant to subsection (1), is at an end. ...

Subsection 67(2) makes it clear that Parliament intended to do away with the deemed trusts in bankruptcy. … By eliminating these trusts in bankruptcy, Parliament put the Crown on the same footing as unsecured creditors.

Accordingly, the Crown’s s. 22(3) trust lapsed on the bankruptcy.

The respondent (“Callidus”) was the assignee of a bank loan and related security respecting the assets of the debtor (“Cheese Factory”), which was a real estate investment company that had defaulted under the bank loan. Pursuant to an agreement that Callidus entered into with Cheese Factory at the time of the assignment, Callidus applied the net proceeds from the sale of a real estate property by Cheese Factory and various rent receipts of Cheese Factory to reduce the amount owing to it notwithstanding that there was unremitted GST/HST to which the deemed ETA s. 222(1) trust applied, which remained unpaid. Cheese Factory then made an assignment in bankruptcy at the request of Callidus. The Federal Court found that the deemed trust and accompanying priority was extinguished upon such bankruptcy under s. 222(1.1).

After noting (at para. 18) that following amendments in 2000, both ETA s. 222(3) and the equivalent ITA deemed trust provision (s. 313(1.1) “imposed an obligation on secured creditors to pay proceeds derived from trust assets to the Crown,” Rennie JA concluded his textual analysis by stating (at para. 26):

While subsection 222(1.1) releases a tax debtor’s assets from the deemed trust upon bankruptcy, the subsection does not extinguish the pre-existing personal liability of a secured creditor who received proceeds from the deemed trust. The personal liability is fully engaged, the debt is due and can be pursued by the Crown [under s. 222(3)] in a cause of action independent of any subsequent bankruptcy proceedings. The continued existence of the cause of action is not dependent on the debtor’s other assets that may or may not remain in trust, as it arises because of the secured creditor’s breach of a statutory obligation to remit. To find otherwise would effectively neutralize the deemed trust mechanism with respect to GST/HST amounts.

He added (at para 42):

A finding that the secured creditor’s obligation to pay Crown proceeds from the deemed trust disappears on bankruptcy would allow the secured creditor to benefit from the debtor’s failure to remit, as noted by the Supreme Court of Canada in Sparrow. As happened here, a secured creditor could choose the timing of bankruptcy and liquidate the deemed trust assets so as to satisfy their interests at the expense of the Crown. …

Accordingly, Callidus was liable to the Crown under s. 222(3) for its pre-bankruptcy breach of the s. 222(1) deemed trust.

TD Bank made a mortgage loan to an individual who, unbeknownst to it, had unremitted GST collections at the time its mortgage was registered. A year later, the individual sold his home and repaid the Bank in full. TD found out about the unremitted GST two years later when it received a payment demand from CRA. In confirming the decision of the Federal Court that the Bank (notwithstanding its secured interest at that time) was required to comply by virtue of the ETA deemed trust for the unremitted GST following the sales proceeds into the Bank’s hands by virtue of s. 222(3) (similar to ITA s. 227(4.1), Dawson JA stated (at paras 36-38):

[W]hen the Bank lent money to the debtor and took its security interests, the debtor’s property to the extent of the tax debt was already deemed to be beneficially owned by the Crown (subsection 222(3)).

On the sale of the debtor’s property “despite any security interest in the property or in the proceeds thereof … the proceeds of the property shall be paid to the Receiver General in priority to all security interests.”

It follows that when the debtor’s property was sold, by operation of subsection 222(3) of the Act the Bank was under a statutory obligation to remit the proceeds it received to the Crown.

In going on to reject the Bank’s argument that, as a secured creditor, it could avail itself of the defence of a bona fide purchaser for value, she stated (at para. 76):

While finding that bona fide purchasers for value were not caught by the deemed trust, the Court [in First Vancouver] noted that secured creditors were. This is consistent with the conclusion that secured creditors cannot avail themselves of the bona fide purchaser for value defence.

Respecting the implications of this decision, she stated (at para. 85):

[S]ecured lenders … may 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.

The defendant (the “Bank”) made loans, secured on an individual’s home, to that individual, at a time that he had failed to remit GST that he had collected. A year later, the individual sold his home and used a portion of the proceeds to pay off the loans owing to the Bank. Two years later, CRA issued a demand to the Bank to pay the amount of the unremitted GST. The Bank had no prior notice of this claim.

Before ordering the Bank to pay this sum, Grammond J found that “proceeds” as used in s. 222(3) “is not limited to the proceeds of a forced sale” (para. 20) and (at para. 31):

[T]he phrase “the proceeds of the property shall be paid to the Receiver General” in section 222(3) of the ETA encompasses proceeds flowing from the voluntary sale of the tax debtor’s property. Upon such a sale, a tax debtor has an obligation to pay the proceeds to the Receiver General. If the tax debtor fails to do so and pays a secured creditor instead, that creditor has an obligation to repay the money to the Crown.

In rejecting the Bank’s submission that it was a bona fide purchaser for value, he stated (at para. 43) that “ I agree that the defence is not limited to "‘purchasers who obtain property through a contract of sale,” but then stated (at para. 46-47):"

"[T]he 1998 and 2000 amendments to the ITA and ETA deemed trust provisions are based on the premise that a secured creditor cannot invoke the bona fide purchaser for value defence when it enforces its security or receives a payment from its debtor. …

I would add that the defence remains available to unsecured creditors, such as suppliers, landlords or public utilities, who receive payments from a tax debtor. In those cases, denying the defence would give rise to the concerns mentioned by Justice Iacobucci at para 44 of First Vancouver – it "would have a general chilling effect on commercial transactions."

In the course of the debtor's attempted reorganization under CCAA proceedings, the British Columbia Supreme Court ordered that unremitted GST be placed in the monitor's trust account until the outcome of the reorganization was known. When the debtor concluded a successful reorganization was not possible and sought leave from the court to make an assignment in bankruptcy under the BIA, the Crown moved for immediate payment of the unremitted GST.

There was an apparent conflict between the ETA and the CCAA: the ETA provided in s. 222(3) for a deemed trust in favour of the Crown in respect of GST, but created an exception only where the Bankruptcy and Insolvency Act applied; s. 18.3 of the CCAA provided that statutory deemed trusts do not apply in CCAA proceedings. In finding that Section 18.3(1) of the Companies' Creditors Arrangement Act (now reformulated in s. 37) overrode the deemed trust in s. 222(3) of the ETA, even though s. 222(3) purports to apply despite any enactment other than the BIA, Deschamps J. indicated (at paras. 45-53) that to hold otherwise would undermine Parliament's intent. In particular, at para. 48: "creditors' incentives would lie overwhelmingly with avoiding proceedings under the CCAA [rather than the BIA] and not risking a failed reorganization. Giving a key player in any insolvency such skewed incentives against reorganizing under the CCAA can only undermine that statute's remedial objectives and risk inviting the very social ills that it was enacted to avert."