Unpaid payroll deductions: Federal Court Of Appeal affirms bona fide purchaser defence for unsecured creditors

Toronto-Dominion Bank (TD Canada Trust) v. Canada, 2026 FCA 25

Introduction: Unpaid Payroll Deductions: A Hidden Risk for Creditors

The Federal Court of Appeal's decision in Toronto-Dominion Bank (TD Canada Trust) v. Canada addresses an important issue in Canadian tax law: whether the Crown can recover unremitted payroll deductions from an unsecured creditor who received payment without knowing that the employer had failed to remit those deductions.

The case required the Court to interpret the "deemed trust" provisions in section 227 of the Income Tax Act (ITA). These provisions state that when an employer deducts income tax, the employer is deemed to hold those amounts in trust for the Crown. If the employer does not remit the funds, the Crown may assert priority over certain property of the employer.

The central question in this case was whether an unsecured creditor, who received payment from the proceeds of a sale of the employer's assets and had no knowledge of the tax default, must repay the Crown.

Background Facts in TD Canada Trust v. Canada

H.N.J. Enterprises Ltd., a restaurant business, failed to remit payroll source deductions between 2013 and 2015. In October 2015, the company sold its business assets for $100,000. The proceeds were deposited into its bank account.

The Toronto-Dominion Bank (TD Bank) was an unsecured creditor because of overdrafts in the company's account. The company used part of the sale proceeds to repay those overdrafts. The total amount received by the bank exceeded the unremitted source deductions.

At the time the bank received payment, it had no knowledge that the employer had failed to remit payroll deductions. Nearly two years later, the Canada Revenue Agency demanded payment from TD Bank, claiming that the bank must return the funds under the deemed trust provisions.

The Federal Court initially ruled in favour of the Canada Revenue Agency, holding that the deemed trust applied and that the bank could not rely on the "bona fide purchaser for value" defence. TD Bank appealed.

The Legal Issues in TD Canada Trust v. Canada

Two questions were posed:

1. Do the deemed trust provisions apply to unsecured creditors?
2. Can an unsecured creditor rely on the bona fide purchaser for value defence?

The Court of Appeal found that the first question was too broad. The real dispute concerned the second question — whether an unsecured creditor who innocently received payment could rely on the bona fide purchaser defence.

The Reasoning of the Court in TD Canada Trust v. Canada

The Deemed Trust Under the Income Tax Act

Section 227(4) and (4.1) of the ITA create a deemed trust when payroll deductions are withheld but not remitted. The trust attaches to property of the employer and gives the Crown priority over secured creditors in certain situations.

Previous cases had established that secured creditors cannot rely on the bona fide purchaser defence. In earlier litigation involving TD Bank as a secured creditor under similar provisions of the Excise Tax Act, courts ruled that secured creditors must repay funds received in priority to the Crown.

However, this case was different. TD Bank was an unsecured creditor.

The Bona Fide Purchaser for Value Defence

The bona fide purchaser for value defence is a long-standing principle in equity. It protects a person who acquires property for value, in good faith, and without notice of another's prior interest.

The Court examined whether Parliament intended to exclude this defence when drafting section 227. The legislation expressly refers to secured creditors but does not mention unsecured creditors or bona fide purchasers. The Court reasoned that Parliament is presumed to know established legal principles. If Parliament intended to remove this defence entirely, it could have said so clearly.

The Court also considered the broader context of the ITA. If employees were paid wages from sale proceeds and later forced to repay the Crown, those wages would still count as taxable income under section 5(1). Section 8(2) generally prohibits deductions from employment income unless specifically allowed. There is no provision allowing an employee to deduct repayment of such funds.

This would create unfair tax consequences. Employees would include the wages in income but receive no deduction if forced to repay the Crown. The Court found it unlikely that Parliament intended such a harsh result.

The Court's Decision in TD Canada Trust v. Canada

The Federal Court of Appeal allowed the appeal. It held that an unsecured creditor can rely on the bona fide purchaser for value defence when receiving payment from the proceeds of an employer's sale of assets, provided that the creditor had no notice of the employer's failure to remit source deductions.

The Court distinguished unsecured creditors from secured creditors. Secured creditors are specifically addressed in the statutory language and have a defined priority relationship. Unsecured creditors are not mentioned in the same way.

Therefore, the Crown cannot automatically recover the funds from an innocent unsecured creditor who received payment in good faith and for value.

Significance of the Court's Decision in TD Canada Trust v. Canada

This decision clarifies the limits of the deemed trust provisions in the ITA. It confirms that while the Crown enjoys strong priority rights, those rights are not unlimited.

The ruling protects ordinary unsecured creditors, including banks and employees, who receive payments without knowledge of a tax default. It reinforces the principle that Parliament must use clear language if it intends to override established equitable defences.

The decision also highlights the importance of interpreting statutes using a textual, contextual, and purposive approach. The Court did not rely solely on the wording of section 227 but considered its broader context within tax law and equitable principles.

In summary, Toronto-Dominion Bank v. Canada provides meaningful guidance on how Canada's tax deemed trust operates and confirms that innocent unsecured creditors are not automatically liable to repay the Crown.

David J Rotfleisch, CPA, JD is the founding tax lawyer of Taxpage.com and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm and is a Certified Specialist in Taxation Law who has completed the CICA in-depth tax planning course. He appears regularly in print, radio and TV and blogs extensively.  

With over 30 years of experience as both a lawyer and chartered professional accountant, he has helped start-up businesses, cryptocurrency traders, resident and non-resident business owners and corporations with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax audit representation and tax litigation. Visit www.Taxpage.com and email David at david@taxpage.com.

Read the original article in full on Tax Law Canada. Author photo courtesy Rotfleisch & Samulovitch P.C. The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Title image: The bilingual English and French sign of the Ferderal Court of Canada inside the Supreme Court of Canada building in Ottawa, iStock ID 1277383177.