Anonymised, illustrative composite. The payout waterfall put the bank first. The deemed trusts for collected-but-unremitted GST/HST and for withheld source deductions put the Crown ahead of the bank and ahead of the sale proceeds — but only two of the three arrears were trust amounts at all.
At a glance
A mechanical contractor with forty employees, working on institutional retrofits in southern Ontario, was sold as a going concern for $7,800,000 on an asset basis. The vendor owed its bank $3,100,000, secured by a general security agreement over everything it owned. The modelled funds flow was the ordinary one: proceeds in, bank paid out and discharged at closing, assets delivered clean, the balance to the vendor.
Tax diligence found the company behind with the Canada Revenue Agency in three separate ways, and the room initially treated that as one number. It is not one number, and the difference is not a matter of degree. Two of the three arrears sit ahead of the bank by force of statute. The third does not, and much of the negotiation turned on getting that separation right rather than on the total.
The instinct on both sides was to treat CRA arrears as a large unsecured creditor to be paid from the vendor's share. That instinct produces a funds flow that cannot lawfully be executed, and it does so silently — the model balances and the agenda looks normal until CRA asserts a claim against money that has gone.
Price $7,800,000 on an asset basis; bank debt $3,100,000, secured. CRA arrears in three parts: $486,000 of GST/HST charged, collected from customers and not remitted across five reporting periods; $203,000 of income tax, Canada Pension Plan and Employment Insurance deducted from pay and not remitted; and $128,000 of GST/HST on supplies wrongly treated as zero-rated — never charged, never collected.
Total arrears $817,000. Amount impressed with a deemed trust and therefore ranking ahead of the bank's security: $689,000. Amount that does not: $128,000. The waterfall the buyer had modelled put $3,100,000 to the bank first and nothing to the Crown at all.
Start with the unit, because this is where the analysis usually goes wrong. Under Excise Tax Act s.221(1), “Every person who makes a taxable supply shall, as agent of Her Majesty in right of Canada, collect the tax under Division II payable by the recipient in respect of the supply.” The obligation to collect is one thing. The deemed trust is another, and it attaches only to what was actually collected.
Section 222(1), marginal note Trust for amounts collected, provides that “every person who collects an amount as or on account of tax under Division II is deemed, for all purposes and despite any security interest in the amount, to hold the amount in trust for Her Majesty in right of Canada, separate and apart from the property of the person and from property held by any secured creditor of the person that, but for a security interest, would be property of the person” until it is remitted.
That is why the $128,000 behaves differently from the $486,000. Tax never charged was never collected, so there is nothing to have been held in trust. It is still owed — under s.225(1) the net tax formula includes “all amounts that became collectible and all other amounts collected by the person in the particular reporting period as or on account of tax under Division II” — but it produces an ordinary Crown claim, not a trust claim. Calling arrears "uncollected GST/HST" and then applying s.222 to them is the commonest way this file is written wrongly.
Why the trust reaches the bank. Section 222(3), Extension of trust, is what breaks the waterfall. Where an amount deemed held in trust is not remitted when it should be, then “Despite any other provision of this Act (except subsection (4)), any other enactment of Canada (except the Bankruptcy and Insolvency Act), any enactment of a province or any other law”, property of the person and property held by any secured creditor that but for a security interest would be the person's property is deemed held in trust from the time the amount was collected and “to form no part of the estate or property of the person”. It closes with the sentence that decides the funds flow: “the proceeds of the property shall be paid to the Receiver General in priority to all security interests.”
So the bank's collateral is impressed, and so are the proceeds of selling it. The discharge the buyer negotiated is a discharge of the bank's registration; it is not a release of the Crown's interest, and the bank cannot give one.
Source deductions are a separate statute with the opposite carve-out. Income Tax Act s.227(4), Trust for moneys deducted, deems “Every person who deducts or withholds an amount under this Act” to hold it separate and apart in trust for Her Majesty. Subsection (4.1) extends it in the same shape as ETA s.222(3) — but read the exception list. It opens “Notwithstanding any other provision of this Act, the Bankruptcy and Insolvency Act (except sections 81.1 and 81.2 of that Act), any other enactment of Canada”. The BIA is carved into the override there; ETA s.222(3) carves it out, and s.222(1.1) separately disapplies the GST/HST trust to amounts collected before a bankruptcy.
So the identical arrears produce opposite priority outcomes: the source-deduction trust survives a bankruptcy and the GST/HST trust does not. Both statutes also exclude a “prescribed security interest” — ETA s.222(4), ITA s.227(4.2) — set by regulation, which was not fetched for this file and is not relied on above.
The funds flow was rebuilt with the Crown first. The buyer required CRA statements of account for each programme rather than the vendor's internal figures. At closing $689,000 went directly to the Receiver General from the purchase price, not through the vendor; the bank was then paid $3,100,000 and gave its discharges. The $128,000 was left as an ordinary liability of the vendor, with a holdback of $175,000 for twelve months against a change in CRA's view of the zero-rating position.
Executed as modelled, the bank would have taken $3,100,000, the vendor the balance, and the corporation — an empty shell — would have been left owing $817,000. CRA's recovery would then have run against the parties who received proceeds impressed with the trust, and the directors would separately have faced liability for the unremitted amounts. See section 160 and when a transfer brings the tax debt with it.
The tell is a trial balance where the GST/HST payable and payroll-liability accounts are large and old while the bank account is not. Money collected from customers or withheld from employees and still on the balance sheet a year later was never the company's money. Ask for the CRA statement of account for each programme, and ask the vendor to split the arrears into what was collected or withheld and what was merely assessed. Related: source deductions two quarters in arrears.
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