CRA Priority

Can Government Scoop Builders' Lien Holdback for Tax Claims? 

Who gets the holdback monies in a face-off between Builders Lien claims, a Contractor’s back charges and a claim against those funds by Canada Revenue Agency (CRA)?  A recent British Columbia Supreme Court case, heard on September 11-12, 2008, does much to clear up the area of law, but produces some unexpected and arbitrary results.

 

FACTS

In the case, three applications were brought to determine whether the CRA is entitled to priority, pursuant to ss. 227(4) and (4.1) and s. 224(1.2) of the Income Tax Act [ITA], to various funds that certain general contractors held back from two sub-contractors Condura Forming Ltd. (“Condura”) and Norex Civil  Contractors Inc. (“Norex”), both of whom had defaulted on a number of contracts and also owed money to the CRA.

FINDINGS

The Court dismissed all of the CRA’s applications. While the CRA had claimed a right to monies paid into court by the general contractor to satisfy liens of two sub-subcontractors, Madame Justice Arnold-Bailey found that the CRA's entitlement to the holdback fund depended on what was due under subcontract, which required assessment of any chargeback to which the general contractor was entitled.

Therefore, if the CRA wished to assert an interest in the holdback fund, it was required to sue on behalf of Norex against the general contractor, in which general contractor and the sub-subcontractors would be entitled to rely on the general contractor's back charge.  In this case, because the CRA did not pursue Norex's entitlement to the holdback, the Court found that the holdback funds paid into court belonged to the sub-subcontractors.

The Court also addressed the CRA’s other claim – that its power to require the tax debtor to pay under s. 224(1.2) of the ITA gave it a greater claim to the holdback funds.  By way of background, the Requirement to Pay power of the CRA (“RTP”) is essentially a super-sized garnishing mechanism designed to ensure that taxes are collected.  It is normally used to collect deemed trust amounts that arise under ss. 227(4) and (4.1) of the ITA, and the employer portion of EI and CPP contributions along with penalties and interest. 

The Court rejected the CRA’s claim and held that the RTP gives the CRA no greater claim to the holdback than does the s. 227 deemed trust because the CRA’s interest under the RTP arises the moment the general contractor is required to pay the subcontractor. 

LESSONS LEARNED

The main lesson to be learned from this case is that the order of priority to the holdback fund may sometimes be unexpected and arbitrary because it always depends on whether the sub-contractor is entitled to receive the holdback. 

There are two possible scenarios regarding the contest between the CRA’s super-priority lien versus the subcontractors’ claim to a holdback.  If the back charge is larger than the holdback, the sub-contractor has no entitlement, and the sub-subcontractors’ lien claims will be satisfied from the fund. 

However, if the back charge is smaller than the holdback, the sub-contractors’ entitlement is equal to the amount of the holdback minus the chargeback.  Because the CRA has a super-priority lien over the other lien claimants, it would be entitled to claim any funds to which the sub-contractor would have been entitled but for the claims of the sub-subcontractors.  The sub-subcontractors would then be entitled to the remainder, or the amount of the contractor’s back charge, if any.

There are also two possible results regarding the contest between the CRA’s RTP versus the sub-subcontractors’ claim to a holdback.  If, for example, the sub-contractor has failed to remit payroll deductions, the Crown already has a conditional right to the holdback fund for these remittances under a “deemed trust” as provided by s. 227 of the ITA.  Therefore, if the holdback amount owing to the sub-contractor is less than the amount of the unremitted payroll deductions, the RTP is redundant.

However, if the amount of the remaining holdback after chargeback and the amount subject to the garnishment by the RTP are greater than the amount of unremitted payroll deductions or other s. 227 deemed trust, the sub-contractor will be at some point, entitled to the portion of the holdback remaining after any chargeback and deemed trust amounts are deducted.  The portion of the remaining holdback after chargeback will then be subject to the sub-subcontractors’ liens. 

If the RTP is served before the Crown liens are satisfied, then the CRA can take advantage of its super-priority lien to have priority over the remaining funds.  The lien-holders would then take the residue after the CRA has scooped its claims from the holdback.

NOTE: This article was written by Robert G. Kuhn a lawyer who practices in construction law at the law firm of Kuhn LLP. It is only intended as a guide and cannot cover every situation. It is important to get legal advice for specific situations. If you have questions or comments about this case or other construction law matters, please contact us at 604-864-8877.