Justifying Non-Uniformity in Secured Financing Law of Canada and the United States

I. INTRODUCTION

In June 2009, the Supreme Court of Canada issued its decision in Caisse populaire Desjardins de l’Est de Drummond v. Canada.¹ The decision was met with uproar from the financial industry over its implications for personal property security law.² The financial industry took this opportunity to reassert demands that Canadian provinces and territories amend their personal property security acts (“PPSA”), abandoning the registration paradigm for deposit account perfection and priority positioning and, in its place, adopting a control paradigm akin to the model imposed by Article 9 of the Uniform Commercial Code.³ This change may be supported by the value commercial law has in uniformity, however, making the change on this basis would fail to recognize the substantial differences in income tax legislation between Canada and the United States. Specifically, it fails to recognize the differences between the collection remedies available to tax authorities in each jurisdiction.

II. THE INCOME TAX ACT DEEMED TRUST

Subsection 153(1) of the Income Tax Act⁴ requires tax to be withheld from any of the payments listed in that section (referred to collectively as “source deductions”) and requires that tax be remitted to the Receiver General, on account of the payee’s tax, in accordance with the ITA and the Regulations.

Subsections 227(4) and (4.1) of the ITA create a collection remedy for the Crown referred to as the statutory deemed trust.⁵ Subsection 227(4) deems a person withholding source deductions to be holding those amounts, separate and apart from all other property, in trust for Her Majesty and for payment to Her Majesty as required by the ITA. Where source deductions are not remitted, subsection 227(4.1) operates to attach a deemed trust⁶ to all property of the tax debtor, and any property held by a secured creditor that, but for the security interest, would be property of the debtor.⁷ The priority position of the ITA deemed trust is such that, where it is in operation⁸ and comes into competition with the “security interest”⁹ of a secured creditor, the deemed trust prevails.

III. THE FEDERAL TAX LIEN

The Federal Tax Lien is the collection remedy available to the United States Government to recover unpaid tax liabilities. Although it serves the same purpose as the ITA deemed trust, it is conceptually different. Whereas the deemed trust is juridically similar to a security interest, a federal tax lien is a security interest in favour of the United States Government, whose priority is determined through dovetailing provisions of the Internal Revenue Code¹⁰ and Article 9 of the Uniform Commercial Code.¹¹

The general rule that governs a priority competition between a Federal Tax Lien and a security interest is a first in time, first in right rule.¹² The timing is determined by when the security interest meets the definition of “security interest” in the IRC,¹³ and when the IRS registers a proper Notice of Federal Tax Lien.¹⁴

IV. VARIATION IN INTERPLAY BETWEEN TAX LAW AND SECURED FINANCING LAW

In Drummond, the Supreme Court was faced with a priority competition over a deposit account between the Caisse populaire (the “Credit Union”) and the Crown’s Income Tax Act deemed trust. On September 18, 2000, the Credit Union granted Camvrac Enterprises Inc. (“Camvrac”) a line of credit up to $277,000. Camvrac deposited $200,000 with the Credit Union pursuant to a “Term Savings Agreement” and a “Security Given Through Savings” agreement.¹⁵ The issue was whether the agreements between the Credit Union and Camvrac created a “security interest” within the meaning of section 224(1.3) of the Income Tax Act. The Supreme Court determined it did, and therefore the Crown had priority to the deposit under the ITA deemed trust.

The variation between taxation law in Canada and the United States can be demonstrated by considering the Drummond case as a hypothetical scenario in the United States.

On September 1, 2010, Bank grants J&J Construction Company a line of credit up to $250,000. Bank and J&J Construction agree, in writing, that J&J Construction’s deposit accounts maintained with Bank would serve as collateral to secure the line of credit. On September 10, 2010, J&J Construction deposits $200,000 into its deposit account maintained with Bank in accordance with a Term Savings Agreement, providing the deposit would mature on September 10, 2015.

On February 1, 2012, the IRS serves a deficiency notice on J&J Construction for an unpaid tax liability of $200,000. The IRS registers a proper Notice of Federal Tax Lien in the designated recording office on April 1, 2012.

Upon conducting a routine lien search in May 2012, Bank discovers the Notice of Federal Tax Lien against J&J Construction’s property. Bank and the IRS seek a declaratory judgment determining the priority of the two interests.

Under the IRC, Bank enjoys priority if it holds a “security interest”¹⁶ in J&J Construction’s deposit account when the IRS registered its Notice.¹⁷ In order to hold a “security interest”, Bank must have priority, pursuant to the UCC, over the interest of a judgment creditor that comes into existence on April 1, 2012.¹⁸

Bank has control of the deposit account,¹⁹ which means it has a perfected security interest under the UCC.²⁰ Further, because Bank’s interest in the deposit account is perfected before April 1, 2012, it enjoys priority over the IRS claim as a judgment creditor.^[21] Therefore, Bank has priority in J&J Construction’s deposit account because it holds a security interest under the IRC as of April 1, 2012, when the Notice of Federal Tax Lien was registered.²²

V. TAX LAW AS A BARRIER TO UNIFORMITY OF SECURED FINANCING LAW

At present, Québec is the only Canadian province with a legislative regime substantially similar to the UCC regarding deposit accounts.²³ Regardless of whether standardization, ease, and efficiency provide an intellectually acceptable argument for the adoption of a control paradigm for deposit accounts in the rest of Canada,²⁴ such uniformity with the United States would result in practical benefits.²⁵ However, legislators should consider the substantial differences in taxation law in Canada and the United States, and the resulting differences to the interplay between taxation law and secured financing law.

The legislative effect of the ITA deemed trust is to give to the Crown priority over all property of a tax debtor. ²⁶ This reflects the importance Parliament has placed on the ability of the Canada Revenue Agency (“CRA”) to collect source deductions,²⁷ the factual circumstances that the CRA does not have the same knowledge of a tax debtor’s finances, or its creditors, that the tax debtor’s creditors do,²⁸ and Canada’s historical support for a stronger centralized government, which requires a strong tax authority.

In contrast, the tax law of the United States dovetails with secured financing law. The effect of the United States legislation is to give the IRS a collection remedy with a priority status substantially similar to that of a UCC security interest.

The difference is examinable in the context of the Drummond case. Recall that, in Drummond, the Crown had priority over Camvrac’s deposit account held at the Credit Union because the agreements between Camvrac and the Credit Union represented a “security interest” within the meaning of the ITA.²⁹ It did not matter that the Credit Union’s interest in the deposit account was perfected and arose prior to when the Crown acted on its statutory deemed trust.

In the American hypothetical of the Drummond case, Bank had a perfected security interest in the deposit account by virtue of the automatic control provisions of the UCC.³⁰ Because Bank had control of the deposit account, its security interest was perfected³¹ and had priority over the interest of the IRS as a judgment lien creditor.

In the United States, the control paradigm plays an important role for banks that maintain deposit accounts. Due to the automatic control and perfection provisions of the UCC, whenever the IRS registers a Notice of Federal Tax Lien, a bank will have certainty that it will retain priority to the amount of the deposit account. The same cannot be said in Canada. Regardless of whether a Canadian financial institution has a perfected security interest in a deposit account, the ITA deemed trust will take priority over the security interest. In fact, importing the automatic control and perfection provisions of the UCC into Canada would likely eliminate any question as to whether a Canadian deposit taking institution has a “security interest,” within the meaning of the ITA, in a deposit account. Thereby eliminating the issue addressed by the Supreme Court in Drummond.

VI. CONCLUSION

There are important differences in the tax collection remedies available to the governments of Canada and the United States. In Canada, the ITA deemed trust gives the Crown absolute priority over any security interest in the tax debtor’s property. In the United States, the federal tax lien provisions of the IRC dovetail with the provisions of the UCC governing priority competitions between security interests and the interest of a judgment creditors. Consequently, the priority of a federal tax lien is dependent on when the IRS registers a compliant Notice of Federal Tax Lien. The result, in the deposit account scenario discussed in this comment, is that the control paradigm governing perfection and priority of interests in a deposit account ensures that a bank has certainty regarding its priority position. Even if the various PPSAs adopt a control paradigm for deposit accounts, Canadian financial institutions holding security interests in deposit accounts will still lose priority to the ITA deemed trust. Canadian lawmakers should note these differences in tax law and the resulting differences in the interplay between tax law and secured financing law. Although uniformity is a worthy value of commercial law, uniformity for its own sake in one area, while ignoring the entire context of that law’s operation, should not be viewed as a desirable justification for change.

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^* JD Candidate (University of Saskatchewan).

¹ 2009 SCC 29, [2009] 2 SCR 94 [Drummond].

² See Margaret Grottenthaler, “Supreme Court of Canada Decision Reveals Risk of Characterization of Cash Collateral Arrangements Creating Security Interests” (24 September 2009), Stikeman Elliott: Canadian Structured Finance Law (blog), online: <https://www.stikeman.com/en-ca/kh/canadian-structured-finance-law/supreme-court-of-canada-decision-reveals-risk-of-characterization-of-cash-collateral-arrangements-as-creating-security-interests>, archived: <https://perma.cc/42X3-BYDT>; Ian J Binnie, “Comment on Caisse populaire Desjardins de l’Est de Drummond v. Canada” (2011) 26:2 BFLR 327.

³ Ontario Bar Association, Personal Property Security Law Subcommittee, “Perfecting Security Interests in Cash Collateral” (submitted to the Ministry of Consumer Services; and the Ministry of Finance, 6 February 2012), online: <https://www.oba.org/CMSPages/GetFile.aspx?guid=c7abb959-f91f-4820-b236-3340d9101434>, archived: <https://perma.cc/AK7Q-8YA2>.

⁴ RSC 1985, c 1 (5th Supp) [ITA].

⁵ Subsections 23(3) and (4) of the Canada Pension Plan, RSC 1985, c C-8, and ss. 86(2) and (2.1) of the Employment Insurance Act, SC 1996, c 23, create an identical collection remedy for Canada Pension Plan (“CPP”) and Employment Insurance (“EI”) contributions respectively. Since the focus of this paper is on the collection remedies of the Canadian and American tax authorities, these provisions will not be discussed. The reader may assume that the statutory deemed trust for CPP and EI contributions operates in the same manner and with the same priority as the statutory deemed trust for tax in Canada.

⁶ The true juridical nature of the deemed trust is not that of a trust at all. The conceptual reality of the ITA deemed trust is that it is a charge. Much like a security interest, its effect is to subject the tax debtor’s assets to a charge in favour of the Crown that secures an amount equal to the amount of the unremitted source deductions. Despite the language of the ITA describing the interest as that of a trust, the tax debtor does not hold all of the assets on behalf of the Crown and therefore the Crown’s interest cannot be described as that of a trust beneficiary (Ronald CC Cuming, Catherine Walsh & Roderick Wood, Personal Property Security Law, 2nd ed (Irwin Law: Toronto, 2012) at 508).

⁷ ITA, supra note 4, s 227(4.1).

⁸ An example of where the deemed trust ceases to operate is where the tax debtor sells assets subject to the deemed trust, in the ordinary course, to a third-party purchaser. In such a scenario, the deemed trust ceases to attach to the assets sold and instead attaches to the proceeds of the sale (First Vancouver Finance v M.N.R., 2002 SCC 49 at paras 40 & 46, [2002] 2 SCR 720 [First Vancouver Finance]).

⁹ ITA, supra note 4, s 224(1.3). The ITA definition of security encompasses any interest in property that secures payment or performance of an obligation.

¹⁰ IRC (2017).

¹¹ UCC (2010).

¹² IRC, supra note 10, § 6323(a). Although the section does not specify that the competition between “valid” interests is determined by the old maxim first in time, first in right, it seems that the American lawmakers thought this idea was so fundamental to this area of law that it did not need to be written down (Lynn M LoPucki & Elizabeth Warren, Secured Credit: A Systems Approach, 2d ed (New York: Aspen Publishers, 1998) at 769).

¹³ Supra note 10, § 6323(h)(1). The test can be broken down into five elements (Timothy R Zinnecker, “Resolving Priority Disputes Between the IRS and the Secured Creditor Under Revised UCC Article 9: And the Winner is…?” (2002) 34:3 Ariz St LJ 921 at 926). Where the rubber hits the road is that the secured creditor’s interest must be protected under applicable local law (the UCC) against a subsequent judgment lien arising out of an unsecured obligation. This element represents the test to be applied to determine the priority of a security interest against a Federal Tax Lien (Peter F Coogan, “The Effect of the Federal Tax Lien Act of 1966 Upon Security Interests Created under the Uniform Commercial Code” (1968) 81:7 Harv L Rev 1369 at 1382).

¹⁴ See IRC, supra note 10, § 6323(f).

¹⁵ Drummond, supra note 1 at paras 3-4.

¹⁶ Supra note 10, § 6323(h)(1).

¹⁷ Ibid, § 6323(a).

¹⁸ Ibid, § 6323(h)(1)(A).

¹⁹ UCC, supra note 11, § 9-104(a)(1) (2010).

²⁰ Ibid, § 9-314(a) (2010).

²¹ Ibid, § 9-317(a)(2) (2010).

²² Supra note 10, § 6323(a).

²³ Arts 2713.1–2713.8 CCQ; see Bill 28, An Act mainly to implement certain provisions of the Budget Speech of 4 June 2014 and return to a balanced budget in 2015-16, 1st Sess, 41st Leg, Québec, 2014, s 325.

²⁴ Clayton Bangsund, Control v. Registration: Contemplating a Potential Paradigm Shift in the PPSA’s Governance of Security Interests in Deposit Accounts (PhD Thesis, University of Alberta Faculty of Law, 2017) at 272-73.

²⁵ Ibid at 273.

²⁶ First Vancouver Finance, supra note 8 at para 23.

²⁷ Ibid at para 22.

²⁸ Ibid at para 23.

²⁹ ITA, supra note 4, s 224(1.3); Drummond, supra note 1 at paras 30-32.

³⁰ Supra note 11, § 9-104(a)(1) (2010).

³¹ Ibid, § 9-314(a) (2010).