Unfiled GST returns found in the data room

The situation

Late in diligence on a $3,600,000 share purchase of a specialty industrial-equipment distributor, the buyer’s accountant working through the data room found the corporation had not filed four consecutive quarterly GST/HST returns — a full fiscal year — despite having invoiced and collected GST from customers throughout that period.

The problem

The estimated unremitted amount was $187,000 — roughly $46,750 collected per quarter across four quarters — plus $9,800 the CRA’s account statement showed as accumulated interest, for a total of $196,800. The buyer’s asset-based lender, once told, raised its own objection independent of the buyer’s: it had been counting on a clean first-ranking general security interest over the target’s receivables and inventory.

The numbers

That objection had a statutory basis. Excise Tax Act s.222(1) deems “every person who collects an amount as or on account of tax” to hold that amount “in trust for Her Majesty,” and the trust applies “despite any security interest in the amount,” separate and apart from the person’s own property. A lender’s general security agreement, however well drafted, does not outrank a deemed trust the Crown already holds over GST actually collected and not yet remitted — and s.222(1.1)’s carve-out only lifts the trust once the person becomes bankrupt, which this corporation was not.

The lender’s real objection, though, was to the next subsection rather than the first. It is a common and comfortable misreading to treat the deemed trust as riding with the collected dollars, so that once those particular funds are spent the trust has nothing left to attach to. Section 222(3) — marginal note Extension of trust — says the opposite. Where a deemed-trust amount “is not remitted to the Receiver General or withdrawn in the manner and at the time provided,” then “property of the person and property held by any secured creditor of the person that, but for a security interest, would be property of the person, equal in value to the amount so deemed to be held in trust,” is deemed to have been held in trust from the moment of collection, to “form no part of the estate or property of the person,” and to be “property beneficially owned by Her Majesty in right of Canada despite any security interest in the property…and the proceeds of the property shall be paid to the Receiver General in priority to all security interests.” Not the collected dollars: $196,800 of value, taken out of the general asset pool the lender was underwriting. Only a narrow class of “prescribed security interest” is carved out, by s.222(4).

The rule that decided it

Because the trust does not stay confined to the collected funds, the parties restructured how closing itself worked: all four returns were filed as a condition of closing, and the full $196,800 was paid directly to the Receiver General out of the sale proceeds at closing — not forwarded by the seller afterward, and not left inside the corporation for the buyer’s new subsidiary to remit later. The lender required the same thing before it would fund, independently of the buyer’s own request.

The outcome

At closing, $196,800 went directly to CRA, clearing the deemed trust and the outstanding returns in the same transaction; the remaining $3,403,200 ($3,600,000 − $196,800) was paid to the seller. The buyer’s general security agreement attached to a corporation with a clean GST account from day one, exactly as the lender had originally underwritten.

What it would have cost otherwise

Had the parties proceeded as first planned — closing on schedule and having the seller forward the $196,800 to CRA out of its own proceeds within a post-closing covenant window — the buyer’s newly acquired corporation would have carried the deemed-trust liability, unremediated, for however many days that gap lasted. Because s.222(3) reaches property of the corporation generally — not merely the dollars originally collected — that window would have exposed the buyer’s own capital: the buyer had planned to deposit $150,000 of working capital into the target’s operating account at closing to fund the first payroll run, and any CRA collection action against that account during an unremediated gap would have reached that $150,000 ahead of the buyer’s own payroll obligations, not just the seller’s money.

The tell

Four consecutive missed quarters is an entire fiscal year of filings — the checkable version of the tell is a document, not an assurance: a dated, signed CRA account statement for the GST/HST program account, showing every period’s filing and payment status, is a request any bookkeeper with online-authorization access to the account can produce in minutes. A target’s bookkeeper being unable to produce one during diligence is worth treating as a filing gap until the statement proves otherwise, not taking on the bookkeeper’s word that “everything’s filed.”

Worth noting what this case was not: the goods and services sold along the way were never in question, and the corporation itself was solvent throughout — this was a filing and remittance failure, not a fraud, and nothing here turned on the corporation’s insolvency or the s.222(1.1) bankruptcy carve-out. That distinction mattered to the buyer’s lender too. Once the deemed trust was cleared at closing rather than merely disclosed, the lender treated the account exactly as it would have if the gap had never existed — no pricing adjustment to the facility, no additional covenant beyond the ordinary GST-compliance reporting already built into its loan documentation.

Takeaways

• • ETA s.222(1) deems GST actually collected to be held in trust for the Crown “despite any security interest” — a lender’s GSA does not outrank it.
• • s.222(3) is the subsection that does the damage: once the amount is not remitted when due, an equal value of the corporation’s other property, and of property held by a secured creditor, is deemed held in trust from the moment of collection and payable to the Receiver General “in priority to all security interests.”
• • The bankruptcy carve-out in s.222(1.1) is narrow: it lifts the trust only on the person’s bankruptcy, not simply because the returns are late.
• • Paying an unremitted GST balance directly to CRA out of sale proceeds at closing clears the deemed trust before it can attach to anything the buyer contributes afterward.
• • A CRA filing-status printout is a specific, checkable document — use it rather than relying on a bookkeeper’s assurance that returns are current.

Sources

• • Excise Tax Act s.222(1) — marginal note Trust for amounts collected: a person who collects an amount as or on account of Division II tax holds it, “for all purposes and despite any security interest in the amount,” in trust for the Crown, separate and apart from the person’s property and from property held by a secured creditor.
• • Excise Tax Act s.222(3) — marginal note Extension of trust — quoted above. This is the provision that gives the Crown priority over the corporation’s general assets, and the reason a post-closing remittance window would have reached the buyer’s own working-capital deposit.
• • Excise Tax Act s.222(1.1) and s.222(4) — the two carve-outs, both narrow: the trust does not apply to amounts collected before a person becomes a bankrupt, and “a security interest does not include a prescribed security interest.” Neither was engaged here.
• • Excise Tax Act s.323 — marginal note Liability of directors: the parallel personal liability for a corporation’s failure to remit net tax, subject in s.323(2) to the same conditions precedent as ITA s.227.1(2). Not engaged here because the returns were filed and paid at closing, but it is what the seller’s directors were exposed to in the meantime.
• • Treadstone Law — Do unpaid source deductions and HST follow a share purchase? — on point for what transfers — “you’re buying the same corporation that owes the money” — and it notes that “tax law gives the CRA strong collection tools and priority in respect of these specific amounts.” It does not explain the deemed trust or how it ranks against a lender’s security; that comes from s.222 itself.