Federal Security Interests Research Study and Report 2000


Unlike a security interest created under a PPSA, a non-consensual security interest arises by operation of law, rather than by an agreement among interested parties.; The non-consensual security interest creates an interest in the debtor’s property, in order to secure payment.; A summary of the federal legislative and regulatory provisions which create non-consensual security interests is provided in Appendix H.

A. Statutory Provisions

There are several federal statutes that create non-consensual security interests.

The Excise Tax Act permits the Minister to take security in any amount or form that is satisfactory to the Minister for the payment of any amount that may become payable or remittable under the Act.; Section 316 permits the Minister to issue a Ministerial Certificate, which can be registered in the Federal Court and has the same force and effect as a judgment.; Likewise, section 317 of the Act proposes a method by which the Minister can garnish the amounts payable from money owed to the debtor.; The practical effect of this garnishment is such that the monies become the property of Her Majesty.; Section 222 of the Act also creates a deemed trust provision, similar to section 227 of the Income Tax Act.; Parliament has now introduced Bill C-24 with the intention of harmonizing the deemed trust provisions under the Excise Tax Act with section 227 of the Income Tax Act.

Several sections of the Income Tax Act (ITA) also create a scheme to impose non-consensual security interests.; These security interests arise when a debtor has failed to remit source deductions (i.e. income tax) to the Minister.; Section 223 permits the Minister to obtain and register a Ministerial Certificate in respect of amounts payable under the Act.; Once the certificate is registered, the certificate acts as a judgment of the Federal Court against the debtor.; Section 223 also permits writs to be issued pursuant to the certificate in order to create a charge on land and property.; By itself, section 223 is not considered to create a “non-consensual security interest” but is more commonly referred to as a “statutory judgment” or a “statutory preference”.; The section merely serves to create a “procedural advantage” that removes the need for the Minister to obtain a judgment from the Court.; Thus, section 223 is intended to operate in concert with sections 224 and 227 of the ITA.

Section 224 of the ITA is similar to section 317 of the Excise Tax Act in that it also creates a form of garnishment procedure.; Under section 224, if a tax debtor fails to remit amounts owed to the Crown (such as source deductions for employees), the Minister may order that any payments to be made to the taxpayer are to be paid to the Receiver General instead.; As under the Excise Tax Act, the effect of garnishment under this section of the ITA is to make the accounts the property of Her Majesty.; Section 224 also captures payments which, but for the security interest of the Crown, would be owed to the tax debtor.

Section 227 of the ITA creates a “deemed statutory trust” with respect to amounts that a tax debtor is required to withhold pursuant to regulations made under section 153(1) of the ITA.; This trust is created regardless of whether or not the taxpayer withheld the amount payable under the ITA, and is held in priority to security interests other than “prescribed” security interests.; These “prescribed” security interests have now been more thoroughly defined in regulations under the ITA.

Section 23 of the Canada Pension Plan also creates a deemed statutory trust similar to that of the ITA, as does section 86 of the Employment Insurance Act such that all amounts that unremitted amounts under these acts are deemed to be held as a trust for Her Majesty.; Section 126 of the Employment Insurance Act also provides for garnishment procedures.

The Security for Debts Due to Her Majesty Regulations state that a Minister responsible for the collection or recovery of any debt or obligation due to Her Majesty.; The Minister is also permitted to execute and deliver, upon payment of any debt, obligation, or claim (or portion thereof), any instrument that will release or discharge any security accepted in respect of the debt, obligation or claim.

Section 13 of the Radiocommunication Act and section 74.1 of the Telecommunications Act state that where an individual is convicted of certain specified offences related to radiocommunications or telecommunications, the apparatus in relation to which or by means of which the offence was committed may be forfeited to the Crown.; Pursuant to these provisions, the Crown is obligated to publish a notice of the forfeiture in the Canada Gazette.; Once this notice is published, anyone who "claims an interest in the apparatus as owner, mortgagee, lien holder or holder of any like interest" may make an application to any superior court of competent jurisdiction for an order declaring that his interest is not affected by the forfeiture and declaring the nature and extent of his interest and the priority of his interest in relation to other interests.; In addition, the court may order that the apparatus to which the interests relate be delivered to one or more of the persons found to have an interest therein, or that an amount equal to the value of each of the interests so declared be paid to the persons found to have those interests.

While most of the comments in this section address the provisions of the ITA, these comments can be generalized to the provisions identified under the Excise Tax Act, the Canada Pension Plan, the Employment Insurance Act, the Radiocommunication Act and the Telecommunications Act.

B. The Income Tax Act, the Excise Tax Act and the Deemed Statutory Trust

The main issue surrounding the creation of the deemed statutory trust is the extent to which the Crown’s deemed trust may claim priority over any other security interests.; For example, to what extent may the Crown claim priority over a bankrupt’s estate (for unremitted source deductions) when other secured creditors have registered claims as well?; Historically, the scheme governing non-consensual and consensual security interests has received criticism for its inability to confidently predict the resolution of a priority dispute between a deemed trust and a consensual security interest.

Deemed statutory trust provisions have evolved throughout the years as well.; Earlier deemed trust provisions provided that the employer was deemed to hold the money collected in trust for the Crown.; Unfortunately, these provisions failed to specify that the money was held in trust regardless of whether or not it was set aside.; Thus, if the taxpayer failed to set aside money in trust, the Crown was put in the position of claiming an interest in a “non-existent” trust account.; As well, withholdings of tax under the ITA are commonly done as a book entry and therefore the deductions are merely notional; no money is actually transferred to the Receiver General.

To address these uncertainties, Parliament enacted versions of sections 227(4) and (5) of the ITA which stated that a person who deducts monies for income tax purposes is deemed to hold them in trust for the Crown and that the money would be deemed to be held separate from and form no part of the estate in liquidation, assignment, receivership or bankruptcy, whether or not the monies had actually been kept separate and apart.; It was Parliament’s intention that these provisions would provide for a clear and unambiguous priority scheme.

Royal Bank of Canada v. Sparrow Electric Corp. is the pivotal case regarding the issue of priority between deemed statutory trusts and consensual security interests.; In this case, the Bank claimed priority over the Crown’s deemed statutory trust (created by section 227 of the ITA) by virtue of its prior general security agreement (GSA) and its Bank Act security.; At trial, the court held that the Crown’s deemed trust took priority over both the Bank Act security and the Bank’s GSA.; On appeal, the Alberta Court of Appeal held that the Bank Act security took priority over the Crown’s deemed trust and gave no opinion on the priority of the GSA.

On appeal to the Supreme Court of Canada, a majority of the Court held that the deemed trust created under section 227 of the ITA was subject to the Bank’s security interest.; In writing for the majority, Justice Iacobucci states:

“The deeming trust is thus not a mechanism for undoing an existing security interest, but rather a device for going back in time and seeking out an asset that was not, at the moment the income taxes came due, subject to any competing security interest.; In short, the deemed trust provision cannot be effective unless it is first determined that there is some unencumbered asset out of which the trust may be deemed.”

Thus in Sparrow, the inventory was subject to the Bank’s security interest at the moment the taxes came due and was not an unencumbered asset. Therefore, the Crown’s deemed trust did not take priority over the Bank’s security.

The Court concludes by stating that the courts should not interfere with the general security agreement (an important financing device relied upon by lenders) unless the statute clearly mandates the interference. Thus, the majority challenged Parliament to produce more clear, unambiguous legislation.; Justice Iacobucci stated:

“That is not to say, however, that Parliament could not legislate otherwise.; Parliament has shown that it knows how to assert priority over rival security interests.; See Alberta (Treasury Branches) v. M.N.R. [1996] 1 S.C.R. 963, at p. 975.; All that is needed to overtake a fixed and specific charge is clear language to that effect. (at p. 431)

Finally, I wish to emphasize that it is open to Parliament to step in and assign absolute priority to the deemed trust.; A clear illustration of how this might be done is afforded by s. 224(1.2) of the ITA, which vests certain moneys in the Crown “notwithstanding any security interest in those moneys” and provides that they “shall be paid to the Receiver General in priority to an such security interest”.; All that is needed to effect the desired result is clear language of that kind. (at p. 432)”

Parliament enacted amendments to the Income Tax Act in June 18, 1998, with retroactive application to June 15, 1994.; These enactments were intended to clarify the Crown’s priority over certain assignments of inventory.; Generally speaking, the effect of the newly worded provisions is to “give the statutory deemed trust priority over pre-existing creditor charges and security interests, with the exception of pre-existing land charges”.; The new ITA provisions provide more specifically that any person who deducts or withholds an amount under the ITA is deemed to do so “notwithstanding any security interest” and such amount is deemed to be held in trust, notwithstanding any act of Parliament.; The deemed trust is limited in that it includes only unremitted employee deductions and the principal amount.; Case law has held, however that Revenue Canada cannot assert a deemed trust claim over interest and penalties that have accrued.; These sections state that any deemed trust amount was to be held “from the time the amount was deducted or withheld by the person, separate and apart from the property of the person” and these amounts are to form no part of the person’s estate.; Such amounts are also deemed to be beneficially owned, notwithstanding any security interest in such property.

While Parliament has attempted to clarify the priority rules surrounding statutory deemed trusts and consensual security interests, it appears that the ITA provisions are not “fool-proof”, so to speak.; Sections 227 and 224 of the ITA were recently considered in a decision by the British Columbia Supreme Court: Royal Bank of Canada v. Tuxedo Transport Ltd.; This case examined whether or not future book debts are subject to the priority and trust provisions created by sections 227(4) and 227(4.1) of the ITA.; Justice Burnyeat, after examining the ITA provisions, stated that “[t]he clear intent of those provisions is that it is only property in existence which is subject to the trust in favour of Her Majesty”.; Thus, in this case, the Crown cannot claim a trust interest over book debts that had not arisen at the time the amounts payable under the ITA became due.; As Justice Burnyeat explained the situation, “[i]t would not be possible for the debtor or secured creditor to hold that which does not exist from the time the amount was deducted or withheld”. In short, the court strictly construed the deemed trust provisions and held that the deemed trust could not extend to “after-acquired property”.

Although this case is currently on appeal to the British Columbia Court of Appeal, the approach taken by Justice Burnyeat has been followed in a decision from the Saskatchewan Court of Queen’s Bench.; In the case of First Vancouver Finance v. Canada (Minister of National Revenue - M.N.R.), Justice Wimmer examined whether or not the deemed trust provisions applied in the case of monies payable on factored accounts.; In this case, First Vancouver Finance purchased Great West invoices at a discount and therefore became the “owner” of the debts.; At the time, Great West owed money to Revenue Canada for unremitted payroll deductions and goods and services tax.; The Crown attempted to garnish payments made by Great West customers to First Vancouver Finance, in accordance with the factoring agreement.; Justice Wimmer held that:

“The Great West delinquencies in respect of payroll deduction remittances referred to in Revenue Canada’s Requirment to Pay arose and were assessed prior to the time when those Canada Safeway invoices [a Great West customer] which were assigned by Great West to First Vancouver came into existence.; The accounts were “after acquired property” and not, according to Mr. Justice Burnyeat, subject to the deemed trust.”

Thus, while this decision has confirmed the court’s “after-acquired property” approach, as applied in Tuxedo, it remains to be seen whether additional uncertainties will arise regarding Parliament’s latest attempt to assure its priority claim over all other security interests.

Section 222 of the Excise Tax Act also creates a deemed statutory trust, however the wording corresponds to the “pre-Sparrow” provisions of the ITA and as such are not considered effective against an assignment of rights in property to secured creditors.

C. Enhanced Garnishment Under the Income Tax Act and the Excise Tax Act

Section 224 of the ITA and section 317(3) of the Excise Tax Act permit Revenue Canada to issue garnishee letters known as “Requirements to Pay” in order to collect accounts receivable from debtors.; These sections further provide that any payment made in accordance with these letters are in priority to any security interest in them - thus the term “Enhanced Garnishment”.; A Requirement to Pay issued under the ITA is effective for a year while one issued under the Excise Tax Act is effective for only 90 days, although proposed amendments suggest the ability to extend this limit to one year.; As well, the Requirement to Pay is restricted to accounts receivable, although Revenue Canada may serve a garnishee letter on lending institutions which are about to advance monies to a tax debtor which are secured.

Uncertainties surrounding the garnishment provisions of these sections relate primarily to the definition of “security interest”.; However, it is now well settled law that “in a non-bankruptcy scenario, an assignment of book debts does not prevail against a Requirement to Pay served pursuant to either of these two sections [s. 224(1.2) of the ITA and s. 317(3) of the Excise Tax Act]”.

The Supreme Court of Canada has held that absolute and unconditional assignments of accounts receivable (as in factored accounts) will escape the effect of Enhanced Garnishment under the ITA (or Excise Tax Act).; In Alberta Treasury Branches v. Canada (Minister of National Revenue - M.N.R.), the majority held that a secured creditor, within the definition of the legislation, excluded creditors who owned property absolutely.; Thus, in this case, an assignment of book debts was classified as a continuing collateral security interest, and not an absolute assignment (and therefore the holder was deemed to be a secured creditor).; The Court also held that the assignment of book debts was a security interest.

In First Vancouver Finance, the court held that a Requirement to Pay did not obtain priority over accounts receivable that were factored (or sold) prior to the service of the Requirement to Pay.; The Requirement to Pay, however, did maintain priority over accounts that were factored after the service.

One distinction that can be made between section 317(3) of the Excise Tax Act and s. 224(1.2) of the ITA is that the Excise Tax Act provision does not include an override of the Bankruptcy and Insolvency Act.; The result is that claims under the Excise Tax Act (being G.S.T.) fall to be determined by the Bankruptcy and Insolvency Act (the BIA).; Under the BIA, Crown claims, including G.S.T. claims under the Excise Tax Act, would be treated as unsecured claims.; To resolve this distinction, Revenue Canada could assert a “property” claim under the bankruptcy and thus, in relation to G.S.T., the Crown could use the legislation and common law tracing principles to “trace” any G.S.T. owed.; Given that the language refers to “property of Her Majesty” after service of a Requirement to Pay, the trust claim would be reserved for those accounts to which the notice relates which are in existence at the date of bankruptcy.; The question also arises as to whether, in the case of property which has passed to Her Majesty, “enhanced” tracing would occur.

D. Certificates Issued Under s. 223 of the Income Tax Act and s. 316 of the Excise Tax Act

As discussed in Part A of this section, both the Income Tax Act and the Excise Tax Act permit the registration of Ministerial Certificates in the Federal Court.; Once registered, these Certificates obtain the same force as “judgments”.; The Federal Court may then issue a writ which may be registered against property of the debtor, including land.; Upon registration, the writ creates a charge, lien, priority on, or binding interest in the property or land.; The writ may then be enforced as any other writ.

In a non-bankruptcy situation, any writ issued pursuant to the processes under the ITA and the Excise Tax Act is unsecured and becomes subordinate to any other prior interests.; Under bankruptcy, at least in the case of a writ issued under the ITA, the situation changes.; On bankruptcy or in the event of a Division I proposal, the writ becomes a “deemed security interest” under the Bankruptcy and Insolvency Act if the writ is registered before the earlier of: (a) the date of filing of the petition; (b) the date of assignment into bankruptcy; (c) the date of filing a Notice of Intention to File a Proposal; or (d) the date of filing the proposal.; Unfortunately, this exception does not apply to writs registered in accordance with the Excise Tax Act.

E. Analysis and Conclusion

While Parliament has clearly attempted to draft its legislation to create unequivocal statutory deemed trusts and priorities in favour of the Crown, uncertainties and ambiguities still exist.; Case law has consistently confirmed that “the court should not interpret legislation so as to deprive third parties of pre-existing property rights unless Parliament makes its intention clear and unambiguous in the wording of the statute”.; Thus the courts, by interpreting these provisions, have applied narrow and strict readings to these statutes, often rendering ineffective the statutory priority and deemed trust provisions.; Parliament is then forced, once again, to remedy these statutory imperfections.

Commentators have called for a comprehensive legislative solution to address the conflicting priority issues relating to consensual and non-consensual security interests.; Legislative flaws usually fall into two categories:; either the statute fails to adequately specify the property to which the non-consensual security interest attaches, or the legislation fails to properly identify the subordinate parties.

It remains to be seen whether further legislative amendments will resolve the remaining uncertainties with respect to priority claims under non-consensual security interests.; Clearly, unambiguous and comprehensive legislative amendments are required to establish absolute priority of the Crown, if that is what Parliament intended.

Next Annual Meeting

2020 Annual Meeting

Place to be Announced

August 9 – 13, 2020