Executive Summary: Key Legal and Evidentiary Issues

• The appeal concerns whether deemed trust provisions under section 227 of the Income Tax Act can compel an unsecured creditor to repay proceeds received from an employer who failed to remit source deductions.

• TD Bank, as an unsecured creditor, received $37,595.07 from a debtor (H.N.J. Enterprises Ltd.) that had $36,250.86 in unremitted payroll source deductions, without any knowledge of the debtor's default.

• Central to the dispute is whether the bona fide purchaser for value defence is available to unsecured creditors against Crown deemed trust claims under the ITA.

• The Federal Court of Appeal reversed the lower court's ruling, finding that unsecured creditors can rely on the bona fide purchaser defence, supported by textual, contextual, and purposive statutory interpretation.

• Contextual analysis highlighted that denying the defence to employees (a class of unsecured creditors) would create inequitable tax consequences under subsections 5(1) and 8(2) of the ITA, with no offsetting deduction available.

• Parliament's deemed trust provisions explicitly target secured creditors but contain no express language precluding the bona fide purchaser defence for unsecured creditors.

Background and facts of the case
H.N.J. Enterprises Ltd. (the Debtor) operated a restaurant business from June 2000 to October 2015. During the years 2013 to 2015, the Debtor withheld certain amounts from the wages paid to its employees for CPP/EI contributions and federal/provincial income taxes but failed to remit all of those amounts to the Receiver General as required by the Income Tax Act. In total, $36,250.86 of the payroll source deductions were subject to a deemed trust in favour of the Crown pursuant to sections 222 and 227 of the ITA. In October 2015, the Debtor ceased carrying on business and sold the assets of the business for $100,000, netting proceeds of $89,500.00 after deductions.

The transactions between the Debtor and TD Bank
The Toronto-Dominion Bank (TD Canada Trust) was an unsecured creditor of the Debtor as a result of various overdrafts in the Debtor's account with the TD Bank. Between October 13, 2015 and January 6, 2016, a total of 92 separate transactions were processed on the corporate account. On October 13, 2015, the Debtor's director deposited the proceeds into the corporate account and used those funds to pay the existing overdraft of $11,344.88. The director then transferred $69,500.00 of the proceeds to a personal account. On October 15, 2015, the director transferred $6,730.48 from the personal account to the corporate account to cover the overdraft of $6,450.19. Between October 15, 2015 and January 6, 2016, the bank advanced funds to the Debtor in the form of overdrafts and the director transferred funds from the personal account to the corporate account to pay off the Debtor's overdrafts. In total, the bank received $37,595.07 from the Debtor between October 13, 2015 and January 6, 2016, and none of these transactions were a result of any demand for payment by the bank or the exercise of any form of security. At the time the sale proceeds were deposited, the bank had no knowledge of the Debtor's sale of the business or the source of the proceeds.

The Crown's claim and the Federal Court's decision
The Canada Revenue Agency notified TD Bank on January 8, 2018 that it was claiming $36,250.86 plus interest for the Debtor's unremitted source deductions. Prior to January 8, 2018, the TD Bank was not aware that the Debtor had failed to remit the required source deductions. The Crown relied on the closing words of subsection 227(4.1) of the ITA, which provide that "the proceeds of such property shall be paid to the Receiver General in priority to all such security interests." Two questions of law were brought before the Federal Court under Rule 220: whether the deemed trust provisions in section 227 of the ITA apply to unsecured creditors, and whether unsecured creditors can rely on the bona fide purchaser for value defence to defend against a deemed trust claim. The Federal Court Judge found that the answer to the first question was yes and the answer to the second question was no (2024 FC 441), following the reasoning in prior cases applicable to secured creditors and finding no reason to distinguish between secured and unsecured creditors.

The statutory framework and prior jurisprudence
Subsections 227(4) and (4.1) of the ITA create a deemed trust over the property of a person who deducts or withholds amounts from employee wages but fails to remit them to the Crown. The provisions expressly reference "secured creditors" and "security interests" but do not mention unsecured creditors or purchasers for value. The Supreme Court of Canada in First Vancouver Finance v. Canada (Minister of National Revenue), 2002 SCC 49, had previously found that the deemed trust is in principle similar to a floating charge over all the assets of the tax debtor and does not operate over assets which a tax debtor has sold in the ordinary course to third party purchasers. Notably, Justice Iacobucci wrote at paragraph 43 of that decision that "purchasers for value are not included in ss. 227(4) and 227(4.1) whereas secured creditors are." In a related earlier case, Toronto-Dominion Bank v. Canada, 2020 FCA 80, the Federal Court of Appeal found that secured creditors could not avail themselves of the bona fide purchaser defence, as doing so would defeat the purpose of ensuring that the unremitted GST was to be paid in priority to all other debts.

The Federal Court of Appeal's analysis
The Federal Court of Appeal, in a unanimous decision authored by Justice Webb and concurred in by Justices Locke and Mactavish, allowed TD Bank's appeal and set aside the answers provided by the Federal Court. The Court conducted a textual, contextual, and purposive analysis of subsection 227(4.1) of the ITA. On the textual front, the Court found no express language in subsections 227(4) and (4.1) of the ITA that would preclude the availability of the bona fide purchaser defence. The reference to "[n]otwithstanding … any other law" at the beginning of subsection 227(4.1) was interpreted as referring to the formation of the trust and the holding of the trust property, not as eliminating equitable defences for third parties who have already received proceeds. Contextually, the Court examined the consequences of denying the bona fide purchaser defence to all unsecured creditors, including employees owed wages. Under subsection 5(1) of the ITA, employees must include salary and wages received in their income for the year of receipt. If employees were then compelled to repay those amounts to the Receiver General for their employer's unremitted source deductions, the limitation in subsection 8(2) of the ITA would deny them any deduction for the amount paid to the Receiver General. The Court found this to be a significant component of the context, supporting the interpretation that Parliament intended unsecured creditors could rely on the bona fide purchaser defence.

The ruling and outcome
The Federal Court of Appeal held that an unsecured creditor can rely on the bona fide purchaser for value defence to defend against a claim by the Crown for the unremitted source deductions of an employer who paid proceeds from the sale of their property to the unsecured creditor. The Court noted that finding the bona fide purchaser defence available to unsecured creditors is not inconsistent with Parliament's policy choice to prioritize protection of the fisc over the interests of secured creditors. The Court also observed that the number of instances where the defence would be available are likely to be rare, as the question would presumably arise only when a tax debtor liquidates all their assets and the proceeds are disbursed. The appeal was allowed in favour of the Toronto-Dominion Bank, which was awarded $1,400 in costs for the appeal and $1,700 as its costs at the Federal Court, as agreed upon by the parties.