Deemed Trust for Taxes Trumps Bank’s Security Interest

A recent Federal Court decision held that a “deemed trust”, which is a mechanism allowing the government to collect taxes from defaulting taxpayers, takes priority over the security interests of third parties.

In Canada v. Toronto-Dominion Bank, the Bank was sued by the government for $68,000 that a customer named Weisflock had used to pay off a loan secured by his home mortgage. The funds came from the proceeds of the sale of Weisflock’s home.

The claim against the Bank reflected the amount of unpaid GST that Weisflock owed the government, having collected it from customers of his landscaping business.  It hinged on a tax-tracing mechanism known as a “deemed trust”, found in section 222 of the Excise Tax Act (ETA). It allows the government to collect Weisflock’s unpaid taxes that were now in the Bank’s hands, by declaring that: (1) the Bank holds that same amount in trust for the government; and (2) the trust takes priority over the Bank’s secured interest in the money.  Here, the government relied on section 222(3) specifically, which extends that trust concept to cover Weisflock’s property, and operates in priority to any security interest the Bank had in that property or its proceeds.

The Bank objected to the claim on several bases, one being that those “proceeds” of Weisflock’s mortgage would materialize only if the Bank had to realize on its security; in this case, Weisflock had sold his home and repaid the loan voluntarily.  The court rejected this argument, noting that “proceeds” – while not defined in the ETA – is usually given a broader meaning, and includes something received upon selling or otherwise disposing of collateral.  It is not restricted to forced sales or the realization of security interests.

That meant that the deemed trust mechanism could apply even where a tax debtor like Weisflock voluntarily sold his home. If he chose to use the funds not to service his tax debt but rather to pay off a secured creditor like the Bank, then the mechanism was triggered; the Bank became statutorily obliged to remit the funds on Weisflock’s behalf.

The court also rejected the Bank’s equity-based defence, finding it could not circumvent the deemed trust by claiming it was a bona fide purchaser for value of Weisflock’s money. Although the defence is not limited to “sales” transactions only, the Bank had not “purchased” anything here.  It received money in voluntary repayment of a loan, and discharged its security in return.  The court found that a secured creditor like the Bank could not invoke this defence, although it remained available to unsecured creditors (such as suppliers, landlords or public utilities) who receive payments from a tax debtor.

The court conceded that this distinction “might appear absurd”, but pointed out the ETA’s deemed trust provision clearly reflected a legislative intent to disregard the proprietary interests of even secured creditors like the Bank, in order to grant the government an absolute priority respecting taxes.  The court was not entitled to alter that priority, however harsh the outcome may be on lenders.

The court  accordingly ordered the Bank to pay the government $68,000 from the funds it had received from Weisflock. See: Canada v. Toronto-Dominion Bank, 2018 FC 538.