Unremitted source deductions are subject to a deemed trust in favour of the Crown under Section 227 of the Income Tax Act (the “ITA”), Section 86 of the Employment Insurance Act (the “EIA”) and Section 23 of the Canada Pension Plan (the “CPP”). Subsection 227(4) of the ITA creates the trust for income tax deductions and Subsection 227(4.1) creates a super-priority lien in favour of the Crown, in the amount of the trust, over all the debtor’s assets. This Crown lien is subordinate only to the rights, under the Bankruptcy and Insolvency Act, of a supplier who has supplied 30-day goods or who is a farmer, fisherman or aquaculturist, and only in a bankruptcy or receivership of the debtor. An exemption from the effect of the deemed trust and lien is created, however, by legislation which carves-out a “prescribed security interest” from the application of Subsections 227(4) and 227(4.1). This structure is mirrored for employment insurance premiums in the EIA, and for CPP premiums in the CPP.
Recent anecdotal evidence suggests that the Canada Revenue Agency (“CRA”) is becoming more aggressive both in asserting its deemed trust over real estate power of sale proceeds and in limiting the scope of the exemption for prescribed security interests. Lenders with collateral mortgages (among others) should thus be aware that their ability to recover the full value of such mortgages may be increasingly challenged.
The term “prescribed security interest” is not defined in the ITA, the EIA or the CPP. To find the definition, one has to look to regulations, which all define it to mean a debt secured by a real property mortgage registered on title prior to the time the deemed trust arose (i.e. prior to the time the unremitted amount was originally deducted at source) only to the extent such debt exceeds the sum of (i) the value of all other security and guarantees held in respect of such debt and (ii) the value of all payment received in respect of such debt subsequent to the debtor’s failure to remit the source deduction. Because of (i), the exemption from the deemed trust is essentially a collateral mortgagee’s last recourse after having marshalled all other personal property security and guarantees.
Until recently, CRA did not seem to pursue its various statutory liens over mortgage proceeds. In one 2008 British Columbia case, CRA counsel is reported to have stated that it was not CRA’s policy to assert its priority against mortgagees. CRA appears, however, to have been getting more aggressive in pursuing its statutory lien rights to proceeds of realization of real property, including realization under collateral mortgages. This practise, which was apparently more common for CRA in the Maritimes (and, particularly, in Newfoundland and Labrador), is now reportedly being increasingly seen in Ontario and the western provinces.
One cannot necessarily fault CRA for asserting its rights under the ITA, EIA or CPP, but what some lenders have taken issue with is CRA’s interpretation of how the value of a collateral mortgagee’s “exempt security” interest is to be calculated. In particular, CRA has been seen to over-estimate the value of guarantees in deducting such value from the total exempt prescribed security interest. CRA’s position has been that the amount that should be deducted in respect of a guarantee is the net realizable value of that guarantee, but, barring a bankruptcy or completed settlement with the guarantor, CRA tends to assume that the full amount will be collected even where the guarantor is defending the guarantee action or its/ his/her resources minimal. CRA has also taken the position that they are entitled to determine whether a settlement with a guarantor was reasonable if it is completed for less than the full amount of the guarantee and, if not, impute the difference to reduce the prescribed security interest. CRA takes a similar position when it comes to legal fees/costs, allowing only amounts directly related to the sale of the real estate or enforcement of the guarantee to qualify as part of the prescribed security interest exempt from the deemed trust.
Because the definition of “prescribed security interest” is found in the regulations rather than in the statutes themselves, the definition was written by the Minister of Finance rather than by Parliament. Since CRA is the Minister’s agent and thus the authority on what the Minister intended by the definition, it makes any challenge to CRA’s interpretation of the definition very difficult. For perhaps this reason, there is no case law that we are aware of on the issue.
A definition of “prescribed security interest”, mirroring that in the ITA, EIA and CPP regulations, was recently added to the Excise Tax Act (“ETA”) Security Interest (GST/ HST) Regulations, thus giving substance to the exemption for prescribed security interests that is found in the ETA’s GST/HST deemed trust and lien provisions. This addition has retroactive effect to October 20, 2000. Although it is certainly positive for secured lenders that such exemption now exists, it may simply be a sign that the Minister was getting its house in order before embarking on its expanded policy of deemed trust enforcement. One thing to note is that CRA’s deemed trust for GST/HST does not survive bankruptcy or a Companies’ Creditors Arrangement Act filing.