Supreme Court confirms impact of a debtor's bankruptcy on CRA deemed trusts for GST and HST

5 minute read
29 January 2019

In Callidus Capital Corporation v. Her Majesty the Queen,[1] the Supreme Court of Canada overturned a troubling 2017 decision of the Federal Court of Appeal. The Supreme Court held unanimously that the bankruptcy of a debtor extinguishes the deemed trust for unremitted GST and HST created in favour of the Crown ("CRA") by section 222 of the Excise Tax Act ("ETA"). This is the case even with funds that were paid by the debtor to a secured creditor before the debtor's bankruptcy.

The parties agreed to the following facts. Since 2004, Bank of Montreal had provided to its customer (the "Debtor") certain secured credit facilities. In December 2011, while the credit facilities were in default, Callidus Capital Corporation ("Callidus") took full assignment of them from Bank of Montreal. The balance owing to Callidus at the time of the assignment was in excess of $4.7 million.

Callidus and the Debtor immediately entered into a forbearance agreement whereby the Debtor agreed to pay Callidus (a) the net sale proceeds of one of the Debtor's properties, and (b) through a blocked accounts agreement, all funds received by the Debtor from all other sources, including rents. Callidus received $591,957 from the sale of the Debtor's property on or about April 9, 2012 and $780,388 in rents for the period from the date of the forbearance in December 2011 to July 31, 2014. All amounts received were applied against the Debtor's indebtedness to Callidus.

In April 2012, during the term of the forbearance, CRA sent a letter to Callidus claiming a deemed trust under section 222 of the ETA for $90,844.33 over unremitted GST and HST collected by the Debtor between 2010 and 2013. CRA took no further enforcement steps at that time.

In November 2013 the Debtor made an assignment in bankruptcy at the request of Callidus. CRA sued Callidus two weeks later, now claiming to be entitled to $177,300 from Callidus for the Debtor's unremitted GST and HST pursuant to the section 222 deemed trust mechanism.

Callidus and CRA submitted a question of law to the Federal Court. The question, in brief: "Does the bankruptcy of a tax debtor render the deemed trust under section 222 of the ETA ineffective as against a secured creditor who received, prior to the bankruptcy, proceeds of the tax debtor that were deemed to be held in trust?"

The disagreement arose from the language of section 222 which creates two separate trusts. Put simply, subsection (1) of section 222 creates a trust over any amounts collected as GST or HST but not remitted to CRA. Subsection (3) creates a trust over all the property of the tax debtor, including property paid to or held by a secured creditor pursuant to the security interest. Under subsection (1.1) the subsection (1) trust is explicitly terminated by the bankruptcy of the tax debtor, but crucially, there is no such explicit termination of the subsection (3) trust. Is the subsection (3) trust also terminated on bankruptcy?

The Federal Court answered the question in the affirmative and ruled in favour of Callidus. In a split decision, the Federal Court of Appeal overturned the lower court's decision. In a remarkably concise and readable decision, Pelletier J.A., in dissent, held that the subject matter of the subsection (3) trust was property of the tax debtor (including property paid to or held by a secured creditor pursuant to the security interest) only to the extent that amounts are deemed to be held in trust pursuant to the subsection (1) trust. As a result the existence of the subsection (3) trust is conditional and dependent on the existence of the subsection (1) trust, such that both trusts were effectively terminated on bankruptcy. The dissent was prescient.

Callidus appealed to the Supreme Court of Canada. There, a unanimous panel of nine judges overturned the Court of Appeal and reinstated the order of the Federal Court that the subsection (3) trust is terminated on bankruptcy. In granting Callidus's appeal the Supreme Court adopted the reasons of Pelletier J.A. at the Court of Appeal in their entirety.

The power of a bankruptcy to save a secured creditor from a deemed trust under the ETA has therefore been confirmed.

[1] 2018 SCC 47

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