Deemed Statutory Trusts & Super Priority

Lending to self-employed borrowers – Understanding Deemed Statutory Trusts & Super Priority


Why is it so difficult to find financing for self-employed borrowers? What are the risks?

In the alternate lending world, a large portion of borrowers that come to us are self-employed. It is typically quite difficult for them to obtain conventional financing.

But why?

One of the reasons is the risk of deemed statutory trust claims and the super priority of CRA.

What is a Deemed Statutory Trust?

Simply put, this term applies to any monies deemed to be held in trust by a taxpayer, for the Federal Crown.

When an employer collects GST, or deducts income tax, CPP, or EI from its employees pay, these amounts are “deemed” to be held in “trust” for the Crown and must be remitted to CRA. If the employer fails to remit these amounts, or remits insufficient amounts, CRA can pursue the employer, and any assets they hold, or held, to recover the monies.

Super Priority

The Crown has what is called a super priority1; meaning that any claims they have on a taxpayer’s assets take priority over any other secured debt or claim on title, regardless of when the claims were incurred. The Crown can also apply this super priority retroactively on assets that have already been liquidated.

 

Even a secured lender could be at risk for it’s borrowers unremitted GST or employee source deductions.

What does this mean?

Let’s say a business owner did not properly remit his employees’ source deductions in 2008 and 2009. In 2013, the business owner took out a mortgage on his property and subsequently sold the property and paid out the mortgage in 2015. In 2018, CRA discovered the debt owing to the Crown (from 2008 and 2009). CRA could then pursue not only the business owner for this debt, but also the mortgage lender who was paid out in 2015, even though the mortgage lender was unaware of the CRA debt and had already been paid out and discharged the mortgage.

CRA would argue that the Crown debt, although not discovered until 2018, was owing since the employer collected the monies in trust for the Crown in 2008 and therefore any assets liquidated thereafter should be applied to the Crown debt prior to any other claim.

 

Here’s how the Government of Canada website explains it:

“When a business owes a deemed trust amount, the proceeds of sale of any asset must first be used to pay the deemed trust debt of the business, whether the business sells the asset or a secured creditor enforces payment and sells the asset.

If a deemed trust debt is not paid, the CRA may send a deemed trust claim letter to the creditor who has received funds from the sale of the asset, whether the funds were received voluntarily from the business or as a result of enforcement action by the creditor. The CRA can take court action against a creditor who does not pay the amount of a deemed trust claim.”

 

There have been some notable cases that have set precedent in various facets of this matter.

In the instance of unpaid GST amounts, the deemed trust is extinguished upon the bankruptcy of the tax debtor. Further, the recent case of Callidus Capital Corporation v Her Majesty the Queen has set the precedent that this also extinguishes the claim against the secured creditor who received sale proceeds prior to the tax debtor’s bankruptcy.

There is no such provision, however, in the case of unremitted payroll deductions. Therefore, the more employees an employer has, the greater the risk to the lender if these deductions were not remitted to CRA properly.

 

How can a mortgage lender mitigate this risk?

Title insurance coverage may have crossed your mind as a possible remedy. If so, you would be partially right. In some instances, a shortfall to the lender could be covered by title insurance. Title insurance protects the lender from any defects to title at the time the mortgage was registered. So, if there were unknown deemed trust amounts owing to CRA at the time the mortgage was registered on title, then title insurance may cover the shortfall to the lender. However, this insurance only covers a lender during the term of the mortgage. Therefore, if CRA were to pursue a lender on a mortgage that had already been paid out and discharged, title insurance coverage would no longer apply.

A lender can seek to protect themselves by requiring proof that GST and/or payroll deduction remittances are up to date both prior to funding and annually, at the maturity of the mortgage. (For extra assurance, the lender could require this information to come from the borrower’s accountant, 3rd party bookkeeper, or payroll service such as Ceridian or ADP). Either way, this does not ensure that sufficient remittances were made to the applicable legislation, but at least it reduces the risk and amount of any possible future CRA claims.

A lender could also require a borrower to sign the consent form used by CRA allowing the lender access to the borrower’s individual and business tax accounts. However, once again, this information is only a reflection of what the borrower has claimed and what CRA is currently aware of. A tax audit at a later date could bring to light further deemed trust amounts owing, putting the lender at risk for these amounts.

As you can imagine, this only grazes the surface of this complex issue. See below for a couple of reference sources if you wish to understand the matter more fully.

 

Is all hope lost then?

No! Many alternate lenders lend to self-employed borrowers and seek to work around these issues.

At Cove, we adapt our income requirements to accept NOAs and bank statements as proof of income. To satisfy our due diligence to our lenders, we request proof that GST and employee deduction remittances are up to date annually. And we obtain title insurance on all mortgages.

With these safeguards in place, we are pleased to accommodate borrowers who are self-employed, or small business owners.2

 

See also:

Underwriting Guidelines

Frequently Asked Questions

Contact Us

 

 

1 Super Priority definition: A claim that takes priority to other claims regardless of when they were incurred. Ie. Taxes, strata fees, CRA debts

2 However, due to the much higher risk of deemed trust claims on employee source deductions, we are limited in our ability to offer financing to borrowers with multiple employees.

 

 

References:

https://www.canada.ca/en/revenue-agency/services/about-canada-revenue-agency-cra/when-you-money-collections-cra/information-on-deemed-trust.html

https://www.torkinmanes.com/our-resources/publications-presentations/publication/a-big-win-for-the-Crown—deemed-trusts-take-priority-over-security-interests

Client Update: Supreme Court of Canada rules against Canada Revenue Agency in GST/HST deemed trust case – Stewart McKelvey

 

 

 

 

 

 

 

 

 

 

 

Help Us Help You!


Getting approval from the bank is tough these days

 

Here are a few tips to help us really understand your client’s needs and give them the best possible solution:

 

Tell us a story

Life happens! We get that. We want to help your client get back on track even if they’ve hit a speed bump on their financial journey. So tell us their story. We love a good story.

 

 

It’s NOT a numbers game

We look at more than just numbers. Let’s face it – numbers don’t always add up. We look past the credit score by reviewing all the details in the credit report – getting a sense of who your client is. So if your client doesn’t fit in the bank’s “box”, send them to us! We live outside the box in a land with real people, not numbers.

 

 

An eye for detail

A few details can go a long way. What is the purpose for the funds? Do they own other properties? Are they working towards an exit strategy? If their credit is bruised, is there a story there? (we love stories, remember?)

This kind of information helps us to provide a creative solution for your client’s individual needs.

 

 

We look forward to working with you on your next deal!

 

Email Heather or Carly for a quote or to submit a deal!